RoR: Forum

The articles referred to in the first paragraph are:
http://www.cato.org/publications/commentary/its-time-legalize-insider-trading
http://www.atlassociety.org/brc/economic-defense-insider-trading
http://www.atlassociety.org/brc/morality-insider-trading
http://capitalism.org/category/insider-trading/

(Edited by Merlin Jetton on 7/13, 12:43pm)

Post 1

Friday, July 13, 2012 - 12:47pm

How does insider trading violate individual rights? Who has had force initiated against them or been defrauded when someone with insider knowledge takes advantage of it?

When an entrepreneur exploits a profit opportunity based on specialized knowledge that others don't possess, did those who weren't privy to that knowledge have their rights violated? If not, how is insider trading any different? Aren't insider traders simply using their specialized knowledge to exploit a profit opportunity?

Post 2

Friday, July 13, 2012 - 12:59pm

How does insider trading violate individual rights? Who has had force initiated against them or been defrauded when someone with insider knowledge takes advantage of it?

My article says what's wrong. Did you read it? It's not force or fraud, but "breach of contract."

Post 3

Friday, July 13, 2012 - 2:15pm

I asked, "How does insider trading violate individual rights? Who has had force initiated against them or been defrauded when someone with insider knowledge takes advantage of it?" Merlin replied,

My article says what's wrong. Did you read it? It's not force or fraud, but "breach of contract.

Breach of contract is fraud, but I didn't see that you demonstrated this. The closest you came, as far as I can tell, is in the following passage:

All outside shareholders should have equal opportunity to get material information from insiders and act upon it at the same time . . .

Is this something that is specified in the contract? I didn't think it was; otherwise, insider trading would be an obvious breach of contract, and advocates of free markets would be unlikely to defend the practice. In any case, I should think it is a condition that is virtually impossible to fulfill. How do you guarantee that all outside shareholders have an equal opportunity to get material information from insiders and act upon it at the same time?

. . . For insiders to selectively favor some shareholders (even non-shareholders) over other shareholders in getting such material information is a diminution of property rights of the shareholders who don't get the same information, or at least have the opportunity to get it. How is it moral for an insider to selectively convey material information to some shareholders (even non-shareholders) but not others? All shares carry equal rights -- to vote, receive dividends, and receive financial reports such as quarterly earnings.

True, but unless it's spelled out in the contract, this does not mean that if insiders acquire information before outsiders receive it through dividends and financial reports, the insiders are breaching a contract by acting on it. If you can show that it is spelled out in the contract, then I think you have a good argument. Otherwise, I don't think you can argue that it's fraud.

(Edited by William Dwyer on 7/13, 2:17pm)

Post 4

Friday, July 13, 2012 - 3:07pm

Will anyone disagree with me when I say that if an officer of the XYZ Corp were to tell his brother-in-law that he was going to approve a merger tomorrow, and the brother-in-law trades on that information, that that is not a legitimate and reasonable transaction? Is being able to give friends, neighbors and relatives confidential information a perk of being a CEO? If I'm a shareholder and I'm not one of the preferred few then shouldn't I at least be told of that fact?

Those trades that take place put me at a disadvantage when the news is formally released because the prices will have already taken the news into consideration.

Sam

Post 5

Friday, July 13, 2012 - 3:29pm

If someone accidentally stumbles onto this "insider" information and then acts on it to his benefit, should he go to jail for it or simply face civil action from fellow shareholders who lacked this privileged information?

I have less a problem with the "civil breach of contract" argument that Bill advances than I do with a "criminal breach of law" argument currently on the books.

I am hard pressed to argue against shareholders with "privileged" information acting in their self-interest but certainly can support shareholders seeking to recover damages from those "insiders" if they can prove such damages in court.

Sending productive people like Martha Stewart to jail for acting on sound information in a self-interested fashion just strikes me as profoundly wrong.

Post 6

Friday, July 13, 2012 - 5:48pm

Bill wrote:

Is this something that is specified in the contract?

What contract? Have you ever owned individual stocks, e.g. IBM or XOM? If so, did you sign a contract with the company which spelled out how the company would treat you as a shareholder?

Post 7

Friday, July 13, 2012 - 6:13pm

Luke wrote:

Sending productive people like Martha Stewart to jail for acting on sound information in a self-interested fashion just strikes me as profoundly wrong.

"Stewart, who averted more than $51,000 in losses by selling when she did, was not charged with insider trading; instead, she and her broker were accused of lying about the transaction and altering records to support the alleged cover story" (link).

I wonder how you guys would react if it had been somebody at the FDA who traded on the same inside info about ImClone as Martha Stewart did. :-)

(Edited by Merlin Jetton on 7/13, 7:43pm)

Post 8

Friday, July 13, 2012 - 6:19pm

1. Abolish insider trading laws and no motive to commit perjury need arise.
2. Abolish the FDA and no concerns about FDA insider trading need arise.

(Edited by Luke Setzer on 7/13, 6:20pm)

Post 9

Saturday, July 14, 2012 - 3:02am

I think that Luke has a good point about it being a civil offense rather than a criminal offence. I'd guess that it doesn't need to be in a contract between the CEO (or other officer) and the shareholders (the corporation) because giving out insider information that alters the value of the stock negatively would be acting against the interests of the shareholders as a group - and they are the owners, and the officer is but their employee. It is always an implied part of all employment contracts (written or verbal) that certain acts can be construed as misfeasance or malfeasance if they are against the general purpose of the position they were hired to fulfill. (But this isn't an area I have any expertise in).

I dislike the current law and the witch-hunts it generates (like Martha Stewart), but I also am uncomfortable with those who manage the shareholder's equity making money, not from improving the shareholder's equity, but making themselves and their cronies rich with manipulations. What about this... a corporation holds some of its own shares almost all the time. Shouldn't the corporate officers be obliged to treat that pool of stock as a crony or friend that comes first - either selling or buying - and doing so suddenly, before the information goes out to anyone else? That would be a result that would benefit all shareholders evenly. Failure to do that would stand as prima facie evidence that they put an outsider ahead of the well-being of the stockholders as a group.

I suspect that equity market inefficiencies are due much more to other forms of ignorance on the part of stockholders than due to lack of inside information. Most stock is held "stupidly" - that is by holders that don't have even a tiny fraction of what knowledge they could have without inside info. As an example, consider the efficiency of the horse-racing tote board as it lists the odds based upon the bets currently made, and remember that some people bet based up the color the jockey wears, or their lucky number, or any number of made up theories.

Post 10

Saturday, July 14, 2012 - 6:02am

Luke wrote:

Abolish the FDA and no concerns about FDA insider trading need arise.

That might reduce the problem, but I don't believe it eliminates it. If there were no FDA, I imagine there would be private organizations that test drugs for safety and effectiveness for other firms that make them. Then some employees of said organizations would know about test results before anybody else. In other words, they would have material nonpublic information that could be exploited.

(Edited by Merlin Jetton on 7/14, 9:03am)

Post 11

Saturday, July 14, 2012 - 9:28am

Bill, Luke, Steve:

I asked a very simple question. Have none of you actively traded stocks? Are all shareholders equal or not? Suppose that you're the only shareholder not "in the loop" and don't know it while all the others know they are in it. You will be robbed.

Sam

Post 12

Saturday, July 14, 2012 - 10:36am

I wrote, "Is this something that is specified in the contract?" Merlin replied,

What contract? Have you ever owned individual stocks, e.g. IBM or XOM? If so, did you sign a contract with the company which spelled out how the company would treat you as a shareholder?

Merlin, forgive me, for I must be missing something obvious. In Post 3, you said,

My article says what's wrong. Did you read it? It's not force or fraud, but "breach of contract."

If it's breach of contract, then there must be a contract. If there's no contract, then how can insider trading be a breach of contract?

Post 13

Saturday, July 14, 2012 - 11:16am

Sam, I trade strictly in mutual funds, so I am not sure the question would even apply to me. In any case, it is possible that all shareholders are not equal in a totally free market. This "lack of equality" would affect how markets act if known. In other words, companies would begin to have incentives to install their own verifications of "equality of information" to attract more equity investors which would in turn improve stock performance with no SEC required.

If I'm a shareholder and I'm not one of the preferred few then shouldn't I at least be told of that fact?

Perhaps that should be an "assumed" fact in a totally free market with lawsuits of "cheated" investors flowing accordingly when companies that promise "equal" information fail to deliver it.

(Edited by Luke Setzer on 7/14, 11:23am)

Post 14

Saturday, July 14, 2012 - 11:26am

Bill wrote:

If it's breach of contract, then there must be a contract. If there's no contract, then how can insider trading be a breach of contract?

Note that I put breach of contract in quotes. Many contracts are not in writing. Much is taken for granted. That is the case for most investing. (Clearly that raises questions about what are the exact terms of the implicit contract.)

(Edited by Merlin Jetton on 7/14, 11:28am)

Post 15

Saturday, July 14, 2012 - 1:17pm

Luke:

To put it even simpler. If I and the CEO's brother-in-law are the only stockholders and the CEO tells his relative that the company will probably go bankrupt, and the relative sells all his stock on that basis, the price will plummet and I will have a huge loss. How can that possibly be approved as moral, ethical or fair?

As a stockholder I could sniff around, perhaps even staking out the company headquarters to see what executives were meeting with what executives, but that is due diligence and far removed from nepotism.

A CEO could even subvert his own company by releasing misleading information in order to manipulate the price. His cronies knowing that the information is misleading trade on that information to the detriment of the other stockholders. The CEO gets his payoff later as favors from his cohorts.

Sam

Post 16

Saturday, July 14, 2012 - 1:38pm

Sam, tell us your "ideal" system. Stocks exist because laws allow "fictional" entities like corporations to exist. The universal accounting equation is:

Assets = Liabilities + Equities

Firms finance themselves for commencement via borrowing from others (liabilities) and financial investments by others (equities). Hundreds of years of accounting history back this approach in various forms. Laws arose to support this system of entrepreneurship. Whether those laws are "ideal" or not is another matter. But the bottom line is that for now, bondholders have a higher place on the recovery totem pole than stockholders when the company gets in financial trouble. In other words, the officers of a corporation, for example, cannot vote to omit the interest payments on bonds but can vote to omit the dividends on stocks. In addition, there are "preferred" stockholders and "common" stockholders with each entitled to different privileges in running the company and earning dividends.

I could continue, but I think we talk past each other. I am looking for the least intrusive method of allowing companies to function by putting "due diligence" burdens onto the shoulders of the investors. Is that really so much to ask? Part of the problem with government growth arises from the people themselves "expecting" government to protect them from their own lack of such "due diligence." See, for example, the essay in CUI by Alan Greenspan called "The Assault on Integrity" in which he defended "competition by reputation" as a protection of consumers against ripoffs by various professions.

Please tell us your "ideal" system for financing companies in ways that minimize government intrusion and thus actualize the "laissez-faire" ideal that Ayn Rand advocated.

Notice that we are talking "legal" here rather than "moral, ethical, or fair" just to clarify context. All sorts of "immoral" activities are "legal" in a free society. Sorting which ones actually cross the line to "initiation of force or fraud" seems to be our central disagreement. Methods of enforcement (civil or criminal) constitutes part of that disagreement.

(Edited by Luke Setzer on 7/14, 1:43pm)

Post 17

Saturday, July 14, 2012 - 3:20pm

I have no problem with corporations as they are presently set up except for the fact that I think that the shareholders should vote on executive compensation rather than the board of directors, which is nothing but an old boy's network that perpetuates mutual favors. But it's a breach of trust for insiders to reveal, leak, or otherwise disclose anything that they don't also disclose to their competition.

When they leak information to insiders they're behaving exactly as if they were leaking their trade secrets to their competitors. They are betraying their owners to which they have loyalty.

A discussion of preferred stock vs. ordinary stock isn't relevant because they each have their own market.

Sam

Post 18

Saturday, July 14, 2012 - 3:43pm

But how would you enforce your desired code of conduct, Sam?

Post 19

Saturday, July 14, 2012 - 4:31pm