RoR: Forum

I would like to hear from those who advocate legalizing insider trading what they believe matters would be like if it were entirely legal.

Here is what I imagine. Some money managers, e.g. Goldman-Sachs and some hedge fund managers, would relentlessly pursue material nonpublic information. Some would even pay bribes to get it. Many insiders would have no reservations about giving out such information and some would even take bribes for it. After all, it's all perfectly legal!

Post 21

Saturday, July 14, 2012 - 5:15pm

I think I have already stated my view of the outcome. Per "The Assault on Integrity" mentioned earlier, companies seeking investors would have to find ways to assure investors reliably that they do in fact look for the best interests of those investors. I have less confidence in the SEC to do this than I do in a marketplace that openly competes for finite investment funds. Mutual funds would also likely play an even larger role in the economy than they do now, since full-time fund managers have more resources at their disposal than does the average individual investor. Ultimately, "index funds" that cut across large swaths of the economy may become the de facto standard investment instrument for the individual. As for "cheating," even in a "loser pays" tort system, I still think incidents of gross disservice to stockholders could result in successful recovery of damages from the offenders.

I admit that my MBA alone makes me no expert, but then I question the expertise of most people who express opinions on these matters. Just because Paul Krugman is a Nobel laureate economist does not make him right. Neither does any number of other "expert" labels.

(Edited by Luke Setzer on 7/14, 5:19pm)

Post 22

Saturday, July 14, 2012 - 9:44pm

Sam,

You asked, "Have none of you actively traded stocks?"

I've traded stock - not in an active day-trader way, but more of a long-term buy and sell.
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You asked, "Are all shareholders equal or not?"

I see serveral layers of answers to this one.
1. They clearly are not equal in intelligence, experience, effort expended, knowledge, etc.
2. They are not equal in degree of inside information.
3. They are not equal in "luck" - experiencing the particular 'random' events in life that turn out to boost or to diminish our financial success.
4. They should be treated equal under the articles of incorporation and bylaws of the company in which they hold stock.
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You asked, "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."

In my post, I mentioned that I think its a form of misfeasance or malfeasance... and actionable under tort law (my guess since I'm not an attorney) - as a kind of breach of contract - if the CEO told some of the shareholders but not the others. He has an obligation that his actions benefit the shareholders as a group, not just some of them.
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Post 23

Sunday, July 15, 2012 - 6:22am

I'm not a corporate lawyer but when an officer of a corporation divulges privileged information he is working against those who employ him. I don't know what explicit terms are part of his employment contract but if there isn't a clause regarding confidentiality there should be. In any case, it's surely implicit. Whether he can be criminally prosecuted is beyond my knowledge but he should be sued for all he's worth by the stock holders.

I don't think that the recipient of the information should be prosecuted because that person doesn't have an obligation to the company. The divulger is the culprit.

Sam

Post 24

Sunday, July 15, 2012 - 6:44am

Sam wrote:

I don't think that the recipient of the information should be prosecuted because that person doesn't have an obligation to the company. The divulger is the culprit.

I wholly agree with the latter. The recipient is akin to a receiver of stolen goods. If he/she knows or suspects the information is material and nonpublic, then he/she should not exploit it.

Post 25

Sunday, July 15, 2012 - 7:25am

Merlin asserted:

I wholly agree with the latter. The recipient is akin to a receiver of stolen goods. If he/she knows or suspects the information is material and nonpublic, then he/she should not exploit it.

If the recipient does exploit it, are you suggesting that the recipient should be criminally prosecuted or civilly sued?

How does the refusal to act on such knowledge square with acting in one's self-interest?

Unlike materially stolen goods like a car or intellectually stolen goods like software, I am not sure what the "property status" of "information" is.

(Edited by Luke Setzer on 7/15, 7:28am)

Post 26

Sunday, July 15, 2012 - 9:08am

Suppose I, as a stock holder, discover some damaging or negative information about a company that few other stockholders (if any) are aware of, and decide to act on it before conveying the information to the other stockholders. Should I be prosecuted for fraud?

Moreover, suppose my discovery of the information is the result of a special effort on my part to investigate the future prospects of the company, a process which others have neglected to undertake. Am I obligated to give this information to all other stockholders free of charge despite the fact that they made no similar effort to discover it? Am I to be prohibited from acting on it unless I do?

Post 27

Sunday, July 15, 2012 - 9:21am

Bill:

Suppose I, as a stock holder, discover some damaging or negative information about a company that few other stockholders (if any) are aware of, and decide to act on it before conveying the information to the other stockholders. Should I be prosecuted for fraud?

Of course not. You're doing what other stock holders can do, namely: due diligence. Of course you can't bug the corporate board room but sniffing around is just good investment practice.

Many investors go to the factory or whatever and are given a tour. They may get an interview with an officer or CEO just as many stock analysts do. Ongoing operations aren't "secret" or "sensitive" issues. General policy and overall strategy are just open subjects.

(Edited by Sam Erica on 7/15, 9:29am)

Post 28

Sunday, July 15, 2012 - 12:10pm

Okay, Sam, what if I find something damaging that is being kept secret, and decide to protect myself by acting on it. Am I responsible for making sure that every other stockholder is apprised of this damaging information before I take action?

Post 29

Sunday, July 15, 2012 - 2:53pm

You're not the leaker. If you haven't engaged in industrial espionage or other skullduggery you can do whatever you wish. Suppose that a piece of paper just happened to float out of the corporate office's window. You have no idea as to the veracity, context or even if it was planned to mislead you. So, if you act on it you're taking a big risk and you wouldn't even have to divulge the "information" after you took action.

Way back in the '60s when I was working in a computer center there was a contour plot generated by a client for Black Bay Uranium which showed a great concentration of contour lines at a certain location. Some of the operators thought that this was hot news and bought heavily into the stock. As it turned out, the person that submitted the plot made a mistake as to the contour interval that showed the apparently huge anomaly. Of course a lot of money was lost ... and gained by the sellers.

Further to laissez-"fairness:" The contracts for the officers of the corporation are public knowledge. I suggest that there should be, optionally, a secrecy clause that states that the officer will be criminally charged if he leaks confidential information (and the courts would acknowledge this and prosecute). Anyone doing due diligence, including stock analysts, could find this out and any competent analyst would advise his subscribers to be wary of any lack of this clause. The stock price would be punished accordingly and, IMO, it would become a standard practice in the industry to include one. Thus no one's freedom of action would be infringed.

Further to due diligence: I decided to visit the premises of a contractor of a company that I had a very big position in. I talked to the president and was able to look around the premises. In spite of them being completely above board, hiding nothing, I failed to take notice of some very evident facts and I lost a lot of money. My fault. I was in love with the stock.

I think you guys are wedded to the idea of the CEO being an heroic visionary. He may well be one but when he's not the owner of the company and just a hireling he may be out to feather his own nest.

Fractional ownership is one of the great innovations of capitalism. If investors lose confidence in it .... poofffft.

Sam

(Edited by Sam Erica on 7/15, 4:01pm)

(Edited by Sam Erica on 7/15, 8:23pm)

Post 30

Monday, July 16, 2012 - 3:54am

Luke wrote:

If the recipient does exploit it, are you suggesting that the recipient should be criminally prosecuted or civilly sued?

No, I don't believe a tippee should be criminally prosecuted. In general, a fine proportionate to the gain or the loss avoided (plus costs) seems apt.

Post 31

Monday, July 16, 2012 - 4:46am

Merlin suggested:

No, I don't believe a tippee should be criminally prosecuted. In general, a fine proportionate to the gain or the loss avoided (plus costs) seems apt.

I am not sure what differentiates the two. If a fine is imposed, then a crime -- a violation of law -- has been committed. Semantics aside, would you call "inside information" a "trade secret" protected by intellectual property laws similar to those that protect the formula for Coca-Cola? If not, are you calling "inside information" a species of property unique unto itself? I read the article repeatedly and while it talks of stocks as property and implied the information as an intrinsic value of the stock, I would like to see this aspect explicitly fleshed onto the skeleton of your argument. For example, saying that the information is a "trade secret" to which stockholders have exclusive and equal "first rights of claim" would strengthen your argument. As it stands now, I am still groping to fit your argument into the wider context of property rights, free speech, and the non-initiation of force principle.

As an aside, is it common for those who argue in favor of insider trading also to argue against intellectual property rights? Based on the preceding paragraph, I can imagine that they would share common ground. But I have not researched that.

Post 32

Monday, July 16, 2012 - 3:35pm

Luke wrote:

Semantics aside, would you call "inside information" a "trade secret" protected by intellectual property laws similar to those that protect the formula for Coca-Cola?

I hadn't thought about it, but trade secret seems to have little in common with insider trading.

If not, are you calling "inside information" a species of property unique unto itself? I read the article repeatedly and while it talks of stocks as property and implied the information as an intrinsic value of the stock, I would like to see this aspect explicitly fleshed onto the skeleton of your argument. For example, saying that the information is a "trade secret" to which stockholders have exclusive and equal "first rights of claim" would strengthen your argument.

Okay, would it be fair to arbitrarily give greater voting rights to some selected shareholders and not others? Okay, would it be fair to arbitrarily pay bigger dividends (per share) to some selected shareholders and not others? If you reply 'no', then the next question is about material information.

As an aside, is it common for those who argue in favor of insider trading also to argue against intellectual property rights? Based on the preceding paragraph, I can imagine that they would share common ground. But I have not researched that.

I don't know.
(Edited by Merlin Jetton on 7/16, 4:42pm)

Post 33

Monday, July 16, 2012 - 4:02pm

Your article gives interesting food for thought, Merlin, but ultimately I do not find it airtight. I like Sam's idea of contracting the officers and other trusted information guardians such that they face substantial penalties if they divulge information and are caught. Of course, good luck finding people willing to do so. As for the rest, well, everyone seeks to act in self-interest, so I have trouble accepting restrictions on their freedoms to do so. So, yes, it is conceivably permissible for some shareholders to acquire extra "knowledge power" with legal impunity in a free market. Finders keepers. Losers weepers. Such conditions would impact how investors actually invest, e.g. seeking to invest via well-managed stock mutual funds rather than directly in stocks, selecting more "secure" instruments such as bonds, etc. This approach could streamline investing without the worries of "proving innocence" to the SEC witch-hunts that now plague the process.

(Edited by Luke Setzer on 7/16, 4:03pm)

Post 34

Tuesday, July 17, 2012 - 10:38am

Luke,

If I couldn't persuade you, that's okay. You can and should think for yourself.

Regardless, I have yet to see an airtight argument for legalizing insider trading. :-)

Even for somebody who only invests via mutual funds, the issue remains. Why should some shareholders (even non-shareholders) be favored over mutual funds that are non-favored shareholders?

Post 35

Tuesday, July 17, 2012 - 12:35pm

Regardless, I have yet to see an airtight argument for legalizing insider trading. :-)

Isn't the burden of proof on the plaintiff -- on the party that wishes to impose a penalty for alleged wrongdoing? If I'm engaged in a practice that you think should be illegal, isn't it up to you prove that it should be illegal, in the absence of which it should be permitted? It isn't up to me to prove that it should be legal, in the absence of which it should be prohibited.

Post 36

Tuesday, July 17, 2012 - 12:50pm

Bill wrote:

Isn't the burden of proof on the plaintiff -- on the party that wishes to impose a penalty for alleged wrongdoing?

The analogy doesn't fit. The discussion isn't akin to whether or not somebody broke the law, but the morality of the law.

Post 37

Tuesday, July 17, 2012 - 1:14pm

The argument is that if there are no restrictions on leaking confidential information the leaker can, with impunity, enrich his cronies with an expectation of having the favor returned in one form or another. Whether he leaks it to another stockholder or not isn't material ... it damages the fortunes of the stockholders to whom he is bound to protect. He could equally well leak information to a foreign power or the competition. I would regard any confidential information as trade secrets, just as computer code, new inventions or processes are.

Until the happy day when we reach the libertarian goal of a non-coercive society that would embrace my suggestion of post #29 paragraph 3 we have to protect the rights of stockholders from depredation by the officers of the company. Unlike Merlin, I'm not basing my argument on morality, per se, but on property rights.

I may be off line for some time so I may not be able to respond but, Bill, please dissect my argument, if you can. I've expressed my opinion as best I can.

I'm done.

Sam

(Edited by Sam Erica on 7/17, 3:13pm)

Post 38

Tuesday, July 17, 2012 - 6:18pm

It is one thing to publicly trade on publicly known information; that is why companies 'go public.'

But it is fraud to offer public securities, and receive the benefit of public offerings, but then trade based on non-public preferred information. That is fraud; that is forced association.

Psssst; we're being indicted tomorrow. Sell your stock today, because tomorrow it will be worth less.

In order to sell your stock today, someone needs to buy your stock today. You are knowingly foisting crap on someone. You are stealing from them, if you are trading publicly. It is one thing to assess the value of a stock based on publicly known data and trade on that assessment.

It is another thing to rig the deck.

Here is another example in Pennsylvania:

Psssst; the Commonwealth is about to approve go ahead on this 'fracking' thing. Go out and buy gas and mineral rights for pennies on the dollar, before the public knows about this.

Harrisburg made deals all over the state, trading on this inside information. People gave up their gas and mineral rights to cronies connected in some way to Harrisburg, not knowing the real value of those rights, which were about to go up massively because of legislative action known only to some.

Here is a variant:

John Hancock Venture Capital agrees to sell Company C back their class A stock at less than full liquidation value under the condition that Company C will not liquidate the company within X time (because that would be stealing discounted value from JHVC.) This allows JHVC to make money on their investment in getting COmpany C launched, and still return the class A stock to the company and allow it to remain in business, which is the intent of VC investment.

The CEO of Company C agrees, and the next day, moves to liquidate the company and make a killing. After all they now own all the classA stock and to Hell with JHVC.

The JHVC folks walk into the dissolution meeting with their lawyers, present their agreement, and sue the Company and CEO and any directors that went along with him in order to make an example out of them. They shake the money out of Company C and make it part of their suit, but leave the employees and products and building intact and barely in business.

This is a real example (Cyborg Corp, Newton, MA in the 80s) and was made a Harvard Business School case study of what not to do to venture capitalists...)

What I wonder is, how did JHVC know the CEO was going to do this? It was literally the next day...somebody dropped a dime no doubt about it.

This CEO is now a 'business consultant and mentor.' Swear to God.

Post 39

Tuesday, July 17, 2012 - 6:29pm