Non-Crime of Insider Trading
some reason that completely escapes me, most people cheer from the
sidelines when the SEC has upstanding businessmen handcuffed and
hauled away for the so-called crime of insider trading.
Why is this? Given that there is nobody who can claim to be
the victim of insider trading, all I can figure is that they cheer
out of jealousy and resentment.
to the SEC, insider trading is the act of buying or selling a security
while in possession of relevant, "nonpublic" information about that
security. A person is also in violation if they "tip" this
nonpublic information, whatever that means.
of all, the law is ambiguous and necessarily arbitrary. What
is "nonpublic" information and what is "tipping"? If
I have a web site with 100 members and I provide some information,
is that "tipping," or is the information now public? How about
1000 members? 10,000? What if the site is CNN.com?
nobody has all the information, and each person has different
sources of information than the others. The SEC wouldn't have us
trade stocks based on no information at all, would they? That
would just be gambling. And even if everyone had all the same
information, on what basis would some of us want to buy and others
want to sell? The only reason you trade at all is because
you think you have better or more information than others in the
market. Otherwise, you're just guessing.
all this, the idea of criminalizing insider trading seems to have
broad support. I think this comes from the mistaken notion
that these "insiders" are profiting at the expense of the average
Joe stockholder. Is this really true? Who is the victim?
use the fictional case of a drug company executive who is waiting
on FDA approval of his company's new wonder drug. Prior to
official public release of the information, he becomes aware that
the FDA has denied approval of the drug. He has two choices:
(A) sell his shares in the company and get out before the stock
price plummets, or (B) sit on his shares like a fool and lose half
the other side of the country someplace, we have two classes of
investors, those who already own stock prior to the insider information
becoming available, and those who are considering a purchase in
the period of time between when the insider information became available
and when it becomes public. Anything that happens after the
information goes public is irrelevant; all the information is out
and the stock will settle at its new price, say 50% of where it
was prior to the FDA decision.
the victim again? Let's look at the investor who already owns
the stock prior to the insider information becoming available.
If the executive chooses (B) and does nothing, the investor will
suffer the same fate as the executive. He will wake up one
morning and find that he lost 50% of his investment. Unlike
the executive, he at least is allowed by law to get lucky and sell
his shares in the time period after the insider information is available.
If the executive chooses the evil course (A), the investor may or
may not suffer the same fate. He could get lucky, or
he could notice that a large number of shares are being unloaded
onto the market and sell early, possibly saving himself some money.
Regardless, he's no worse off as a result of the insider trading.
about the investor who is considering a purchase during the "insider
information" time period? This is probably the one most people
would point to as the victim in all this. After all, he could,
conceivably, be buying the exact same shares that the insider is
unloading! Of course, this is not a face-to-face transaction,
and the insider has made no claims to anyone about what the stock
price will do in the future. If any false claims were made,
this would be fraud, requiring no insider trading laws to
the investor who buys, while the insider is selling, a victim?
Suppose the insider chooses option (B) and rides his shares into
the ground. Obviously, if the investor had made up his mind
to buy, the fact that the insider is doing nothing will not
cause him to change his mind. Thus, he will buy the shares
and will lose 50% of his money when the FDA decision becomes public.
What if the insider chooses course (A) and dumps his stock on the
market? A few things can happen. If the investor is
astute, he may notice that the price is dropping as the insider's
shares are dumped onto the market. He may not buy, and may
save himself a bundle of money. If he doesn't notice, he will
still buy, but will get the stock at a lower price as a result of
the insider's selling. He will still lose a lot of money,
but not as much as he would have if the insider had done nothing.
in all cases, nobody loses any more money than they would have if
the insider had "gone down with the ship." By using his inside
information, the executive simply brings the stock price more quickly
to its appropriate market value. Why then, force the insider
to either lose a bunch of money for no reason, or risk going to
jail? As I said at the beginning, the only reason I can imagine
is that people are bitter and resentful that the insider had the
opportunity to escape the sinking ship where they did not.
But this is not a case where he escaped at anyone else's expense.
someone else lose their shirt because "misery likes company" is
ridiculous. Hauling innocent businessmen off to jail is a disgusting
perversion of justice that should end now.
McDowell [send him mail]
is an electrical engineer in Cedar Rapids, Iowa.
© 2003 LewRockwell.com