RoR: Forum

I wrote, "Isn't the burden of proof on the plaintiff -- on the party that wishes to impose a penalty for alleged wrongdoing?" Merlin replied,

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

But don't you see, it's the same general principle. If you're going to say that I deserve to be arrested for breaking what you think is a just law, then the burden of proof is on you to demonstrate that the law is just and that I deserve to be arrested for breaking it. It is not up to me to prove that the law is unjust and that I should not be arrested for breaking it.

Post 41

Wednesday, July 18, 2012 - 4:14am

Bill,

I did try to demonstrate that a law against insider trading is just. If you don't find it sufficient, that doesn't erase my demonstration.

On the other hand, your question (posts 35 & 40) is posed like you have no obligation at all to defend your answer to the question: Is insider trading right or wrong?

Post 42

Wednesday, July 18, 2012 - 10:43pm

Didn't read through all the posts (sorry!) But...

Couldn't a company pre IPO declare their insider trading policy, and whether they permit it or not be acceptable? If someone doesn't want to buy stocks where the company permits insider trading... then that's fine. If you want to take that risk, that's fine. If you as a company want to attract purchasers who are ok with one policy or another, that's fine that they can chose their own insider trading policy, so long as it is chosen and publically known at IPO.

Post 43

Thursday, July 19, 2012 - 9:39am

Dean, what penalties would violators of such policies face?

Without strictly monitored and enforced policies, they have no teeth and no meaning.

Post 44

Thursday, July 19, 2012 - 9:52am

Reply to post 42.

Is that pre-IPO decision permanent or can it be changed anytime? What if a company that allows insider trading is acquired by one that doesn't, or vice-versa?

It seems to me that each company deciding for itself and being able to toggle would make a confusing and chaotic situation. If a company prohibits it, who would pursue violations, even by tippees who don't work for the company? More plausible to me would be different exchanges, some permitting insider trading and others not. Exchanges would probably be better enforcers, too.

If there were different exchanges, some permitting insider trading and others not, where do you think investors in general would prefer to trade? Where would you -- as an outsider w/o inside sources -- want to trade?

(Edited by Merlin Jetton on 7/19, 10:48am)

Post 45

Thursday, July 19, 2012 - 10:18am

Merlin, I hope you consider fleshing this article into a full scholarly submission to an appropriate journal, especially one of a "libertarian" bent where you can spark a lively exchange before eyes that matter.

Characterizing insider trading as "crony capitalism" might work to your advantage, too.

(Edited by Luke Setzer on 7/19, 12:07pm)

Post 46

Thursday, July 19, 2012 - 7:11pm

Merlin,

I don't think you've shown it at all. And I did defend my answer. Since the burden of proof is on you, all that is necessary is to show that you haven't met that burden.

First you claim that it's a "breach of contract." Then when I question the specifics of the contract, you reply with "What contract?" When I point out the obvious contradiction, you claim that the contract is implied, while acknowledging that this leaves open just what the specifics of the contract are, which was my original point. There's no specific agreement against it. I'm tired of this merry-go-round. You're begging the question, and refusing to acknowledge it.

I'm done. Have a nice day!

(Edited by William Dwyer on 7/20, 1:33am)

Post 47

Friday, July 20, 2012 - 3:53am

Bill,

I'm tired of your merry-go-round and double standards.

I have not been contradictory at all. Note that I wrote breach of contract in quotes, not breach of written contract w/o quotes replying to you in post 2. Have you never heard of an unwritten contract? A handshake deal? Have you signed a written contract with your grocer prescribing everything you can do and not do with your grocer, and vice-versa?

Your double standards are:
1. Presuming that anything not prohibited need not be in writing, but anything prohibited must be done so in writing.
2. Insider trading is morally right and needs no justification, but a prohibition of insider trading is morally wrong and needs iron-clad justification.

I'm done. Have a nice day!

(Edited by Merlin Jetton on 7/20, 6:11am)

Post 48

Friday, July 20, 2012 - 4:01am

Luke,

I will consider your suggestion. It seems you think what I've said has some merit, and I appreciate that.

Post 49

Friday, July 20, 2012 - 4:24am

Yes, Merlin, I think you and Sam have made some valid objections to the idea of insider trading as moral and lawfully permissible. Those need much more fleshing and reinforcement to make them truly "truck-like" to borrow Leonard Peikoff's metaphor. Such an article would at least spark a healthy dialogue about the matter before risking a drive off the edge of the cliff in the name of "liberty"!

Post 50

Tuesday, July 24, 2012 - 5:43pm

I'd like to add a different perspective since people are assuming that the insiders are harming the existing stockholders. This assumed harm is taken as justification for making insider trading illegal, so it should be understood more clearly.

Let's pretend there's a relatively stable company in a relatively stable economy. Instead of assuming stock prices are mere fads or psychological in nature, we'll assume that they are grounded in actual economic data. The company makes X dollars in profit (which it pays entirely as dividends) each year with Y shares, and so there is a relatively stable interest for your investment. In a relatively stable market, the price of the stock changes over time to reflect the rate of return. Each share earns about 10% of its market price in dividends each year. The reason for these assumptions is to take a simple case where the stock price is not treated as random, but as a product of the underlying business conditions.

Now, say the company loses a part of its market share and that diminishes the profits from X to Z. We can even pretend it's very predictable and not expected to change after this fact. The insider CEO has this information and realizes that the stock price will go down. Since people are buying the stock based on underlying business conditions, he can anticipate the new price.

Now the assumption made in many of the posts is that if the CEO leaks the data to his friends or whoever, he's harming the stockholders. But what if he keeps it a secret? What if he decides to not tell a single person. Are the stockholders saved? No. Eventually they'll see their dividends check reduced. If they think it is a fluke, they'll get confirmation eventually that it is the new normal. What happens at that point? The value of the stock is now overpriced. New investors won't buy it at the elevated price because it doesn't provide a good return on investment compared to everything else. So the stock price will fall.

The fact is that the underlying business conditions are what changed the value of the stock, not the leaking of information. The CEO could never leak the information if we wanted, and the price would still go down. The only way you can assume the stock price will stay at its current value is if you assume that it is completely disconnected from underlying statistics. And if so, you'd have to argue that a CEO who ever broke bad news, even if he told everyone at the same time, would be damaging the stock value. Is anyone making the claim that bad news must never be told to anyone for fear of it harming the shareholders? It seems that if the word fraud is to come up in this discussion, this would be such an example.

Now let's pretend that the CEO tells everyone at once everything he knows. He says not only that there was a loss of business, but how much of a loss, and how much the stock price would have to be to get the same return on investment. What happens to the existing stockholders? The stock price would instantly drop to the new, lower value. There would be no way they could sell off their shares at the higher price because all potential buyers would already be informed. What this shows is that the CEO does not hurt the current shareholders by letting people act on insider trading. In fact, he allows current stockholders the opportunity to sell as the price starts going down before it hits the new equilibrium price.

What this shows is that the leaking of information is not what hurt the stock price, and does not hurt the current stockholders. It was the underlying business conditions that changed, and those conditions are what hurt the current stockholders. Even the CEO kept it a secret, they would still be "hurt". If he told everyone at once, they would be "hurt". The fact is that the value of the stock diminished before the CEO's decision. How the information is spread doesn't change that at all. Blaming the CEO for the stock price drop is mistaken.

Now we can talk about what leaking the information actually does, as opposed to keeping it a secret or spreading it all at once. What leaking does do is allow certain stockholders, or someone willing to short the stock, to take advantage of the ignorance of new buyers. If anyone manages to sell the stock at a price higher than the new equilibrium point, it is the buyers that are "harmed" if anyone is.

What this means is that any talk of the CEO's responsibility or "breach of contract" would not be because he defrauded the current stockholders. If anything, he is benefiting them by letting some of them sell before it hits the new lower price. The "harm", if it can be called that, is to the buyers. If there was a responsibility that was broken, it would presumably be a responsibility to non-owners of stock. (Someone could own stock and buy more, but then he functions in both the role of an owner and a buyer, and he is harmed as a buyer, not as an owner). And that responsibility is more difficult to assume. Does the CEO have a responsibility to non-stockholders?

In fact, if the CEO had a responsibility to the stockholders, perhaps he'd be required to let them all know about it immediately, but to not tell any non-stockholders. That would allow the current stockholders to benefit at the expense of others. But as soon as those others found out, they would be stockholders and would have to be informed immediately.

This isn't an argument for or against insider trading. Once could still try to make the case that insider trading somehow violated the rights of the new buyers, or that the CEO has a responsibility to them over the existing stockholders. Or for those who think it's a kind of fraud, it is the new buyers that are being defrauded. The point of this is to identify who the victims are. Too much discussion of insider trading assumes that the current stockholders are the ones hurt, when in fact they are hurt by the change in underlying business conditions and the spread of information just makes that harm apparent. That's just a case of shooting the messenger.

A final note is that I used a simple and clear example of a business where we could see how the underlying business conditions affect the stock price. In the real world, the connection is usually more complicated. But as noted above, if you are trying to take into account pure psychological reasons for the stock price to be high, then you'd have to be upset at the CEO for ever telling bad news, and not just mad about the way he communicated it. I don't think you can base a discussion of insider trading on such an assumption.

Post 51

Tuesday, July 24, 2012 - 8:50pm

First of all, you are all arguing in the dark. You talk about shares of stock and contract rights,
but you clearly have never actually read a stock certificate. As a numismatist with some interest
in scripophily, I have actual stock certificates in my possession.

(1) It depends on the state in which the corporation is licensed; different states have different laws.

(2) While we all generally understand the distinctions among common stock, preferred stock, and bonds, those, too, have different rights depending on the state laws and terms of contract. Some shares of stock are sold according to the laws of real estate (land): "... as joint tenants with right of survivorship and not as tenants in common." (Erie Railroad, August 18, 1952.) But equities are not land. Is there a metaphysical difference? I believe so. And in a theoretical discussion of property rights, the nature of the property makes a difference.

(3) Before you can argue whether a contract has been violated, you need to know what that contract really is. Just to say, mostly here it comes down to Joseph Rowlands in Post 50: "... Let's
pretend ... Now, say ... Now let's pretend ..." (Rowlands was otherwise cogent and valid. I only
point out that after Merlin's post, not much corresponded to empirical fact, but to supposition.)

(4) Sometimes common stock has no nominal par value (New York Central, April 17, 1941). Sometimes it does (Rocket Jet Engineering, January 15, 1951). The consequences of insider trading could be widely different depending on the actual terms of issue of the stock in question. And as for the actual contract terms, well, you would have to pay me to transcribe 300 lines of 1-point type. Many shares have no statements on them, but only say that you can get the terms on request. So, you are in the dark, even if you have the shares before you. As Alan Greenspan among others pointed out, a lot of capitalism depends on trust.

(5) It is not true that once stock is issued, any sales and resales do not raise new capital. The corporation holds stock in itself and the market value of that fund is an asset.

It is nice to seek right action, but you need facts before you can argue theory.

Crimes begin as harms. This is beyond the collectivist claim that one man's gain is another man's loss. Merlin Jetton did indeed raise valid issues of harm.

Luke's reply does reveal an incomplete framing of the statement, though, as Merlin offered it. In other words, the problem is (1) what constitutes an ethical breach in the release of information and (2) what is to be done about it. Luke cogently differentiated tort from crime. What if there were no actual penalty? (If you know the contents of a surprise present and reveal it to the recipient ahead of the gift, you have caused harm, but clearly without legal reprisals. You are just a clod. Objectivism seeks to raise us above that, I think.) On that basis, Merlin's question stands: regardless of any laws, is the privileged release of confidential information an ethical lapse?

I am suprised, even shocked, that none of you has ever signed a non-compete non-disclose contract. On a recent project I was a mere hourly employee, a technical writer on a huge contract with huge entities. I was prohibited from unauthorized disclosure of confidential information. Period. I only can imagine what actually does constrain a CEO or CIO or COO.

Moreover, for 30 years, we have lived in the days of ESOPs Employee Stock Ownership Programs. Any shipping clerk can see when there is a problem, but people in that capacity rarely understand the financial consequences of what they perceive - or do not perceive - in their daily work. But I am different. How do you feel if I trade what I learn as a temporary employee on the dock, that shipments in or out are late, or that materials newly arrived are below specification and have been rejected? It is not just the high-level managers who have the opportunity for insider trading. That fact is a serious challenge to Merlin's thesis: we all know something. Can we act on the basis of what we know? As above, really, perhaps all employees should be contractually bound by non-disclosure.

While the instant reply that the government has no business interfering in business is nice, the fact is that Hayek, von Mises and Friedman all saw needs for regulations that we reject. They might all be wrong - it has been known - but, perhaps, we should consider why they made those assertions. I believe that it is because they expected a sophisticated economy to require a higher moral standard than a flea market held in a parking lot.

Finally, I submit that there may be no one right answer and that to seek one right answer without context, without facts, is an error. While we all nominally assert ourselves to be "objectivists" the arguments here so far engage formalism, absolutism, deonotology, and relativism. Basically, we know how we feel, and from there we find "reasons" to support our expectations. I think that Merlin's question deserves cold consideration.

(Edited by Michael E. Marotta on 7/25, 3:46am)

Post 52

Wednesday, July 25, 2012 - 3:44am

Michael take look at your wording:

...you are all arguing in the dark.
....you clearly have never actually read a stock certificate.
....I have actual stock certificates in my possession, which most of you apparently have never seen.
....Rowlands was otherwise cogent and valid
....not much corresponded to empirical fact, but to supposition
....I am surprised, even shocked, that none of you has ever signed a non-compete non-disclose contract.
....I can imagine what actually does constain a CEO or CIO or COO and none of you can, apparently.

Maybe it's just me, but that comes across as kind of condescending. Was that the intention?

Post 53

Wednesday, July 25, 2012 - 3:47am

The point that Joe makes is a game changer. The price of the stock changes due to underlying causes. The CEO's effect can only be to slow down, or hasten that change, and/or to spread the information evenly or unevenly.

My thought all along is that this is not a big issue one way or another.

Post 54

Wednesday, July 25, 2012 - 3:51am

Steve, I will stop editing, as you jumped in here. I have been working on this through the night while thinking it through. You often have a problem with what you regard as my condescending tone. I don't care. ( I did tone it down considerably over the past five hours.) Basically, I expect a lot of my peers and I am disappointed when they do not live up to my standards, but that's my own problem. We all have issues...

And as I pointed out, any employee is in a privileged position, so many are bound by non-disclosure agreements.

(Edited by Michael E. Marotta on 7/25, 3:55am)

Post 55

Wednesday, July 25, 2012 - 4:10am

Michael,

We've gone around and around on a number of things. But my post wasn't intended as an attack, and it didn't arise out of desire to snipe at you. It was just that it seemed like you could have made your points without what struck me as condescending - not towards me, but kind of to all your readers - Weirdly enough, my post was intended as an almost friendly nudge. I wasn't insulted by anything you wrote, and there is no issue in there that I feel a need to defend, so please do feel free to ignore it.

Best Wishes,
Steve

Post 56

Wednesday, July 25, 2012 - 6:47am

Dean:

Couldn't a company pre IPO declare their insider trading policy, and whether they permit it or not be acceptable?

Just add another letter to the stock symbol.

It would be an interesting experiment. In some ways, it would make actual insider trading more clearly unethical, given that an ethical alternative exists.

But, a comparison. Suppose a casino advertised its policy of letting dealers see the cards of players at the black jack table? Or, of selectively sharing that information with only some players, based on cronyism? Black jack is a bad example...say poker.

Who is going to rush to those tables, other than cronies? A kind of select clientele.

So...who are they going to sell a sinking stock to when they must, under those conditions? Who, after thinking it through, is going to volunteer to be that guy?

regards,
Fred
(Edited by Fred Bartlett on 7/25, 6:49am)

Post 57

Wednesday, July 25, 2012 - 6:51am

Reply to Merlin Jetton:

As I said, this deserves cold consideration. My reply here barely suffices. The issue is complicated, and, in fact, is many problems centered under one label, "insider trading." No surprise, also, as I indicated in my "Libor" post, I initially went with the free market minority on this, by reflex. However, after crafting some thoughts overnight, as you can see above in #51, I changed my opinion on this. That said, my present view now is not 180 degrees full about.

Before I comment directly on your original post, I call up a scene in Atlas Shrugged in which Lilian Rearden asks Hank about a d'Anconia disaster, "He had a duty to his stockholders, didn't he?" Years later, Ayn Rand demolished the concept of duty. She did not do that in her speech at West Point, however, and that allows us to re-open the question of duty.

Some say it is unfair simply if the buyer and seller have unequal information, the one with insider information presumably having more, especially material information the other party doesn't have. However, that is not my argument.
...
All outside shareholders should have 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.

I read a contradiction in that. You do seem to be making the argument that insider trading is unfair because it diminishes property rights, or that the diminution is the signal of unfairness.

All shares carry equal rights -- to vote, receive dividends, and receive financial reports such as quarterly earnings. Inside shareholders and other favored shareholders do not pay more for their shares to justify such privileges as receiving more information, getting it sooner, or receiving higher dividends per share

But different shares could carry different rights. The "dual investment" instruments of the 1960s are still with us, though not so popular. The same certificate entitles the holder to either of two payments: increased face value on the stock, or the receipt of a dividend. Also, as you note, preferred stock and bonds are different instruments as well. Would you approve of bond holders receiving information denied to those who own common stock, and them both from employees or creditors? Different people do get different information via different paths.

I recommend those who believe insider trading should be completely legal imagine ... It would be absurd to try to restrict those on a government payroll to not take advantage of material nonpublic information such as legislation-to-be or a future announcement about whether or not a drug will be approved or disapproved by the Food & Drug Administration.

That speaks to the climate of regulation in a mixed economy, but the fact is that all such information is readily used by those who have it. You can overhear people talking at Starbucks. Where do we draw the line? Well, as I said, a non-disclose contract draws a very bright line. Without one, though, we are talking about personal ethics, perhaps a more important consideration, if not the most. Even if it were not illegal, would it still be wrong? I think so.

In Atlas Shrugged, following a d'Anconia disaster, Lilian Rearden asks Hank, "He had a duty to his stockholders, didn't he?" Years later, Ayn Rand demolished the concept of duty -- but she did not do that in her speech at West Point, which allows us now to re-open the question of duty. The executor of a trust has a duty to act in their client's best interests, even if it is contrary to their own.

Inside shareholders and other favored shareholders do not pay more for their shares to ...

They might, in any number of ways. That is how one gets inside. Shares cost more early on when the risk is greater, even if the price is the same years later. The wife puts up with a lot to make the husband successful. Paint any story you want. The price quoted on the exchange is just the core value.

And what about the time spent learning to read a quarterly report or a 10K? Perhaps it is nominally available to "everyone" but I think that we invest a lot via trust. As I said, capitalism is more than a succession of shady deals at flea markets. Even without government regulations, the stock exchanges have rules of conduct.

The trade does not move capital from X to Y.

As I pointed out in #51 above, a corporation holds a large block of its own shares. Not only do the actions of insiders or outsiders matter, but those acting for the corporation have the opportunity to engage in special trades based on special knowledge not available to others.

If material nonpublic information about the intended acquisition is leaked ...

The same information might be discovered (or inferred) by anyone who watches the companies involved, knows them and their markets, and expects a merger (or spin-off), and buys or sells accordingly. It would take a smoking gun of emails, diaries, etc., to prove your charge, but let us assume that it stands as you claim. Then, those inside are under a special burden to know less than an outsider, or to act as if they do. That seems curious, perhaps, but it is the nature of a trust relationship.

Lastly, with no ban, anyone could claim to have "inside info". Imagine all the rumors and consequent fact-checking required. Would that increase market efficiency?

You allude to the plethora of sucker sheets out there already. You have to learn to whom to trust and in what contexts. You assume that people are providing information. Some must be leaking disinformation, lies, and fake-outs. How do you sort that out? Basically, each of us decides whom to trust under what circumstances.

What is moral about a corporation selectively giving material information to somebody such as Martha Stewart or Raj Rajaratnam (even non-shareholders) without telling other shareholders? For those who contend it is okay for a corporation to treat its shareholders unequally, how far does that go? Would it be fair to pay unequal dividends per share, too?

But, again, you can get your information by overhearing people at Starbucks. Most companies discourage employees from talking shop outside the doors for this very reason. An engineer who disassembles a competitive product knows much more about the future of that company than most people, including, perhaps, the CEO.

I agree with your main thesis: insider trading diminishes the contractual rights of shareholders. But I have no clear idea of the number or reach of those rights... or what to do about the problem... I guess the only sound advice is to know your limitations.

Post 58

Wednesday, July 25, 2012 - 7:45am

Joe wrote:

The fact is that the underlying business conditions are what changed the value of the stock, not the leaking of information.

I took that for granted and assumed others would, too

What this means is that any talk of the CEO's responsibility or "breach of contract" would not be because he defrauded the current stockholders. If anything, he is benefiting them by letting some of them sell before it hits the new lower price. The "harm", if it can be called that, is to the buyers.

While fraud may accompany insider trading, it is not a necessary part. My article's focus was on the selective distribution of material, inside information. My view of who is harmed -- not the buyers -- was clearly given in my article -- the stockholders not selected.

Too much discussion of insider trading assumes that the current stockholders are the ones hurt, when in fact they are hurt by the change in underlying business conditions and the spread of information just makes that harm apparent. That's just a case of shooting the messenger.

The issue is not whether the news is good or bad. The issue is whether or not there is selective distribution of news by the corporation, more exactly insiders.

Michael wrote:

you clearly have never actually read a stock certificate.

How do you know? The fact is I have. Certificates don't say much, except indirectly by reference to othr documents. The owner of a certificate signs it only to convey its transfer to somebody else.

It is not true that once stock is issued, any sales and resales do not raise new capital. The corporation holds stock in itself and the market value of that fund is an asset.

I disagree. The market value of a corporation's own stock is not its stated value in the corporation's balance sheet as owner's equity. "Since the assets are not reported on the balance sheet at their current fair market value, owner's equity appearing on the balance sheet is not an indication of the fair market value of the company" (link). Also, a commonly-used metric for common stock is market-to-book ratio (link).

I am suprised, even shocked, that none of you has ever signed a non-compete non-disclose contract.

I question the relevance of this, but how do you know? The fact is I have signed both kinds of contracts.

Steve wrote:

The point that Joe makes is a game changer. The price of the stock changes due to underlying causes. The CEO's effect can only be to slow down, or hasten that change, and/or to spread the information evenly or unevenly.

I didn't see any game changer. I largely agree with the rest, the exception being that prices can change due to rumors later found false.

Post 59

Wednesday, July 25, 2012 - 11:10am