Insider Trading--Should it Be Fully Legal?

[fortinbras]

One brutal example was Enron, where Ken Lay and other top execs were unloading their shares (and instructing their nearest and dearest to do likewise) while at the same time encouraging their own employees and others to buy up Enron shares - thus sustaining the prices at which they were secretly unloading.

I know of one instance in which an public relations man in an ad firm, having been given the assignment of working up an ad campaign for a marvelous new development that the client company was planning to spring on the public in a month or so, went out and bought up stock, expecting the price to rise when the new development started advertising. He bought enough stock to affect the price, and the client company and the SEC both noticed this, and the SEC tracked down the purchases and life got ugly for him. I would bet this wasn't the only advertising person to try this stunt.

[Arthur Rubin]

One brutal example was Enron, where Ken Lay and other top execs were unloading their shares (and instructing their nearest and dearest to do likewise) while at the same time encouraging their own employees and others to buy up Enron shares - thus sustaining the prices at which they were secretly unloading.

That appears to be incorrect, on both parts. Lay was not unloading shares, and the company's 401k administrator was trying to get employees not to invest 100% in company stock. This is not to say that Enron execs weren't committing fraud, but that they believed the fraud, as well.

[Number Six]

Some are calling on Congress to clearly define inside trading, as in Europe where it is illegal to trade on inside information: http://www.nytimes.com/2014/12/20/busin ... -news&_r=0

[.]

So, we have a page and a half of commentary on nebulous, legalistic "insider trading" BS, all of which was concocted in the interest of promoting some vague, misguided concept of market "fairness" and "integrity."

Here's the thing. Markets aren't fair, they're price-discovery mechanisms. If you prevent people from acting on their knowledge, you prevent price discovery from happening as rapidly as it should.

If I'm an insider (as legally defined -- officer, director, employee, 10% shareholder, blah, blah, blah) and I know that some bad news is coming and I adhere to the law, I'm prevented from acting on my knowledge.

What happens? The share price remains higher than it should be. Maybe by pennies, maybe by dollars. Maybe by many dollars, depending on how much I have available for sale and how much of a hurry I'm in to dump it.

In any case, the selling that should have taken place didn't and the price signal to everyone else in the investing universe is suppressed and distorted and the market has been misled. Only to be surprised by a huge gap down when the bad news is announced.

Who got screwed? Some of the other shareholders who would have sold because of the adverse price action (which didn't happen.) Some others, who bought just before the news because the price action looked more constructive than it turned out to be.

How's that for market "integrity"?

Not to mention the publicly-traded company itself -- many (not all) investors tend to shy away from high volatility.

Conversely, if good news is pending but can't be acted upon, the entire rest of the market is equally deceived and misled.

Who gets screwed? The entire universe of people who might have been alerted by the positive price action (which didn't happen) indicating that something good might be going on and who then have to pay a higher price later.

Those who sold (pre-news) because the (suppressed) price action wasn't up to their expectations.

Then there would be the short-sellers who would have been inspired to cover their shorts (pre-news) by the price action that never happened.

Nothing like unintended consequences, eh?

Beyond the who wins/gets screwed in any individual company situation are the overall implications for capital markets in general. Increasing volatility even marginally by trying to discourage insider trading is just not a good idea. Most investors dislike surprises and volatility. The fewer and smaller, the better.

What's funny is that there is obviously some combination of insider trading and astute analysis (proportions unknown and unknowable) causing money-flow -- in or out -- going on in every market, all the time. Always has been.

What's funnier yet is that the SEC claims that insider trading "undermines investor confidence in the fairness and integrity of the securities markets." Actually, the undermining factor is the SEC and their pitiful, periodic, publicity-seeking "insider-trading" witch-hunts. They had to nail poor Martha Stewart (not saying that she's a witch) on 18 USC 1001, not insider trading. (She lied to the FBI about it.)

A total waste of time. Better to junk the entire, ridiculous steaming pile of "insider trading" laws and let markets operate the way they're supposed to. And I say that as someone who has been trading securities for nearly 50 years.

Rampant, routine and widespread "insider trading" would be something to be applauded, it wouldn't "undermine" me or anyone else even one little bit, all we would all have is better information -- in terms of prices -- as to what is really going on.

Some stock going down (maybe to zero) is going to get there regardless of any temporary disruption caused by any law or SEC rule or reg. Same thing is true of something going higher.

Reporting of insider transactions after the fact, as we now have? No problem, that's a good thing. The more reporting of who owns significant amounts of what, the better. Some of us will take note of it.

Most importantly, rising or falling prices mean something -- it's the very purpose of our markets. Suppressing price changes with "insider trading" laws and regs is counter-productive folly and nonsense.

[fortinbras]

Permitting anything that smacks of insider trading will cheat and drive out the average investor. It's as if a casino used marked cards and certain privileged players were enabled to read the markings but the hoi polloi were kept in the dark and continuing wondering why they would only lose. Once insider trading is allowed there will be a complete seachange in the stock market; insider information will be raffled to the highest bidder, some conmen will have short but lucrative careers peddling fake insider information, and the vast majority of investors will pull out of the stock market, which turns into a wild battle among the well-heeled.

[notorial dissent]

It comes under the heading of when does cheating and defrauding your shareholders a valid method of business? Which is precisely what insider trading is.

As a point this is part of the business model that lead up to the collapse of the market in 1929. There was a reason the SEC was formed, and insider trading became a serious crime.

[.]

Always good to hear from people stuck in the 1930s.

All that hand-wringing was really very funny, considering that the "average investor" and the "hoi polloi" left the market decades ago. Those figments of your imaginations mostly own mutual funds and ETFs, not individual stocks. Their money is now run by institutions.

Retail investors (including me) account for less than 2% of all stock trading volume, and have for at least the last 6 years. Here are the 3/13/15 numbers from the NYSE: http://www.nyxdata.com/Data-Products/Product-Summaries

It's not about "cheating" or "fraud" or 1929, it's about providing information to markets by trading. And the "market" is 98% professionals, all of whom are aware that probably 99% of all insider trading goes undetected by the SEC. Doesn't scare them (the pros, not the SEC) a bit.

Of course, that's the same SEC that had Bernie Madoff presented to them on a silver platter, and promptly ignored it. For years.

I'll go with what I've said and add a gem from a Nobel economist:

You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that.

[fortinbras]

A prime example of recent insider trading was the Enron collapse. As the ground gave way under this enormous swindle, Ken Lay and several (I think ALL) of his fellow directors and executives unloaded every share of Enron they had, stashing the money in places they hoped the govt and judgment creditors could never reach, WHILE AT THE SAME TIME encouraging their own employees and the general public to put all their nest egg into Enron stock. When the collapse came (employees were given 30 minutes to clear out their desks) Enron stock was worth less than Confederate currency. [Political comment redacted]

If insider trading and inside information is tolerated in the market, sensible/honest members of the public will get out and stay out. New enterprises will have much more trouble attracting investors because all the money will be concentrated where investors have insider sources.

Investing in the stock market will resemble betting on television wrestling matches.

[.]

So, fortinbras, if you say everything twice it becomes true? Rubin and I have already refuted your immediately prior post, which is a rehash of your post 7 above that.

[chronistra]

The SEC ( http://www.sec.gov/news/press/2004-94.htm ) sure thought Ken Lay was selling Enron stock based on information he had that the general public did not.

[.]

Well, that's interesting to note what the SEC thought.

Funny how they always get there after the horse is not just out of the barn but about two counties away, huh?

This junk is 15 years old and I'm not looking up all the details, but Lay/other insiders had many SEC pre-filed selling programs for major amounts of shares -- all completely legal. The sales by Lay referenced by the SEC were in addition to that and weren't to the public market.

The guy said lots of things along the ugly slope from 100+ to 0. To anyone who owned the stock, by the time it broke 80 obviously something was wrong, no matter what he said. That's no longer "profit-taking" or a "minor correction," that's the market -- INCLUDING INSIDER SELLING -- telling you that something's probably wrong, whether you want to listen or not.

Insiders should be able to legally freely trade on the information they have, it gets crucial information to the market faster.

Wanna cook up a new law and prosecute some insider for not disclosing a trade immediately? Fine by me. Easy to prosecute and win. You're an insider by definition, you traded, you didn't file notice of it with the SEC within 24 hours. Lead-pipe cinch. Pay your fine and/or go to jail.

[Famspear]

The effect of the Newman case has arguably been limited somewhat by the United States Supreme Court decision in Salman v. United States, case no. 15-628, 580 U.S. ___ (Dec. 6, 2016).

In Salman, the Supreme Court held that an insider tipper’s gift of confidential information to a trading relative or a friend is enough to establish that the tippee has committed securities fraud, even if the insider tipper’s goal was not to obtain money, property or something of tangible value, and even if the tipper received nothing of a pecuniary or similarly valuable nature, where the tippee was aware that the information had been improperly disclosed.