Maybe insider trading should be legal

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OMG, you whispered something to someone who whispered to somebody on the subway and a guy overheard and made a trade and NOW YOU ARE ALL GOING TO JAIL! What the heck is happening? Every fund in the world is being raided, people are being threatened on the eve of Thanksgiving with prosecution, and all we want to do is just relax and get back to being scammed in this rigged market. Why are these billionaires even risking jail with at the very least a very gray area of the law is the main question I have. But first, should insider trading even be illegal?

Lets look back at an ancient case: the Galleon insider buying of Hilton (HLT) the day before it was acquired by Blackstone. Galleon supposedly paid an analyst $10,000 to give up the information on this merger.  Galleon made $4,000,000 on the trade.

On July 3, 2007, after the market closed, Blackstone announced they were buying Hilton. Raj had known and made a ton of money. Everyone knew at the time there was insider trading involved. I even went on CNBC that very weekend to discuss what had happened.

On July 2, the day before the deal was announced, Hilton shares were at $33.87. On July 3, Hilton shares made one of their biggest moves ever, closing almost 7% higher at $36.05 on double the normal volume before the deal was announced. And, by the way, it was a half day in the markets that day. Then Blackstone offered $47.50 a share for Hilton. It was clear even then that someone big had known something and had acted illegally on that information. In a column for the Financial Times I wrote “Certainly they’ll catch one or two criminals here” and they did. Its very hard to track down insider trading and I give the SEC kudos for doing a great job here. Did they catch all the culprits? Probably not, but they certainly made anyone thinking of doing this crime very very scared.

But should insider trading even be illegal? The obvious answer is of course it should be, else the average investor will get taken advantage of. If some players in a market have an advantage, then some have a disadvantage and that’s not fair. However, I’m not sure its so black and white. Here are the benefits of making insider trading legal:

  • The more information in a market, any market, the more efficient prices become. If informed investors start buying or selling based on privileged information, asset prices will rise to their “correct” level. For instance, in the Hilton case, we probably would have seen a smooth progression of the stock price from33 to45 over the prior month as talks progressed, instead of the spike in just one day.
  • Fraud will be exposed earlier. This is a very key point to the argument. Enron is an example where tens of thousands of investors got burned because they were piling into the stocks during the later stages of its fraud. If insiders were selling we would’ve seen a much swifter move down, and probable fraud exposed.
  • Companies will either become more transparent, to keep the retail investor happy, or will themselves enforce secrecy rather than being complacent with the idea that the law somehow protects their secrets.
  • One concern is that there will be a flight of liquidity because people will be concerned about the legitimacy of our markets. Rather, the opposite will occur. More enforcement dollars will be used to uncover actual frauds such as the next Enron or Worldcom. Arguably, these frauds are a thousand times more dangerous for the retail investor than what is probably a victimless crime such as insider trading.
  • Insider trading is almost impossible to prosecute and the government wastes countless dollars trying.

I’m simply raising the question. Could legal insider trading lead to a more efficient market that would ultimately benefit investors and allow investigators to probe elsewhere? I’m scared about all the ponzi schemes, the mini-Madoffs, left uncovered. What do you think?

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  • http://maverickoptions.com dan

    A better question might be phrased something like this: “Should billionaire’s have free reign in the marketplace with not even a pretense of obeying market rules?”

  • FS

    James your being foolish trying to argue that insider trading should be legal. You are putting a bullseye on your own back. The argument that insider trading should be legal is ridiculous. You are going to make people think that you trade on inside info. people who dont like you are going to use this as fuel to ruin your reputation. just stay away from this topic.

    • Doubting Thomas

      Agreed. It is this type of thought that led Karl Marx to wonder what the inevitable conclusion was. Let’s stave off as long as we can the popular uprising that will inevitably occur when 90% of the country’s wealth is concentrated with 1% of the population, hmm? I don’t want to starve to death on a collective farm with your children, even if you get to die a trillionaire on a private island beforehand.

  • PG99

    Uh, let’s see. The small investor, like myself, is already relegated to eating the crumbs that fall between the slats of the tables of corporate and institutional investors and making insider trading a ‘free for all’ would not only skew the profit skimming further toward their side, and further insure that only those who can buy or schmooze insider info can make any real money in the market. The Market should be an equal-opportunity vehicle for everyone to win or lose in the basis of what they can legally research, analyze, and determine without having access to proprietary and privileged information that is not publicly available (if even for a subscription price). The argument is absurd. Making this legal would probably cause a collapse in the market, just as we’ve nearly experienced in mortgage lending, where sloppy and questionabe (and sometimes illegal) shortcuts led to widespread ‘profit mining’ on a grand scale.

    Let me make a simple analogy. If you wanted to buy concert tickets to your all time favorite band, which happened to be a nationwide favorite, and you could never get ticket because the promoter allowed a mechanism whereby wealthy patrons could purchase ticket allottments for large blocks of tickets, insuring very few tickets were were ever available to the general public — and those few that were, were sold at inflated prices — how would you feel about that? Well, if it were me, I’d stop seeking tickets, give up on the band and just let the wealthy ‘own’ the band.

    That’s what would happen to the market, in my opinion. I’m all for wealth and the wealthy, but by all means — we all deserve a fair chance to join that club.

  • Hubert Heijmeijer

    An interesting thought. Back to the future?
    What about the President of the United States personally benefitting from his upcoming veto?
    Definitely Smart. Not?
    Ciao

  • A. Skupp

    To give credit where credit is due, the best case for the permissibility of insider trading was made by economist and law professor Henry G. Manne in “Insider Trading and the Stock Market” (1966). His view was correct then, and still is.

  • Mac

    The one hinge your premise sits upon is that by allowing that information to be acted on, more info will get out and be available and therefore you have a more efficient market. I would argue that you would actually have less information getting out. Here’s why. That information since it can be acted upon before public release would be worth a great deal of money and the longer it could be kept secret while it is sold and told to individuals who can make those in the know rich, the better.

    In addition to this organizations would begin to form up that would begin paying for inside information because it would become even more valuable and since it is free and open to give but not mandatory to make public it would make a nice side business to any execs in the know.

    Rumors would also become even worse because of the secretive nature of the inside information that has now become usable in a legal way.

    So you might think companies would become more transparent. They would not. What would happen is those at the top who have the information would make deals with it before they allow it to trickle down. The info in a lot of ways due to the increased value would make it even more secretive and valuable on a legal and exclusive market.

    Part of your premise says that companies in talks about mergers will make all of that public during the process. Companies would still keep those talks secret because they would not want the stock prices to jump or competition to know their intentions. Nondisclosure agreements would still be necessary. But it doesn’t mean you can run out and load up on options. Why would they suddenly make that info public? They would not.

    • Davearoundthecorner

       But you can only keep it secret if you don’t act on the information. Once you act, your information becomes reflected in the price of the asset because you’ve affected supply and demand. That’s the whole point of the article.

  • Juan

    Yes must be illegal insider-trading, we (most of us) that invest in mutual funds thru 401k, IRAs, 529’s etc invest for value not for trading that add non-value whatsoever. Worst when these people were supposed to read and read all their prospects companies financial reports, based on what is transpiring on the media, they got priviledge information to make their moves. This adds non-value to any organization, they are doing it for their own benefit, the full-strenght of the law must be applied to prevent this from happening.

  • http://paracelsus.net garyd144

    I’m still not certain who the victim is: the act, yes, the perpetrator, yes, the victim, ?
    Or are you talking about the “little guy” who still gets stock tips from his barber?
    Sorta reminds me of Little League Baseball for five year olds: every team has to be given a trophy so nobody’s feelings should be hurt.

  • http://www.stevenferreri.com Steven

    This has and will always be an interesting debate. When I think of insider trading, I tend to wonder why insider trading was never made legal to begin with. Your question should ask why trading on inside information was ever made illegal to begin with? First off people are doing it out in the open! Let’s take “flash trades” for example. For those of you who are not aware of flash trading, flash trading allows a select few traders to see the spread before everyone else and bid between the lines. The funny thing is, flash trading has been going on for years but only until last year have they attempted to put a stop to it. Technically, flash trading is trading on inside information to me. It’s cheating plain and simple.

    Secondly, it is my belief that certain government officials have traded off of illegal inside information as well, or released inside information to participants on Wall Street. Take for example, Hank Paulson and his contacts with certain market participants at a time prior to interest rate cuts. A writer of the NY Post actually covered this story and explained that through the Freedom of Information act, he obtained phone logs between Paulson, Bernanke, and market participants, and that these logs present a clear issue of how Paulson potentially released information on the Fed’s move to cut rates. According to the market activity prior to the cuts, it clearly looks as if someone knew about the Fed’s move before its release and traded on it.

    Now, I do have to agree to some extent with other comments on this board like Mac’s. Rumors could be explosive, and additional regulation would have to occur that our regulators would simply put, have a difficult time stopping! Regardless, they are getting paid to do a job. Aside from that, I do believe that sudden pops and drops would be eliminated and a genuine flow of market price would be the outcome. Statistically, we would have less fraud on the street! I agree with Mr. Altucher to every extent on how making insider trading legal benefits the retail investor. My only question is, do those in prison for trading on inside information then get released? Other then that, I hope you all had a happy thanksgiving and a great weekend. =)

    Steve

  • anon

    isn’t it legal in Japan?

  • HedgeYbet

    I agree…It should be legal…insider info..just means good business or you are good at getting inside info..and that makes you good…Ha…just a thought..

  • Rodney M.

    I think the ultimate question is this: who owns the relevant financial information about the company? “Relevant” may be hard to define but if you can stipulate that it at least includes information about potential buyouts or future earnings, it belongs to all of the current shareholders. It certainly doesn’t belong to management and they can’t just dole that property out to anyone they choose. 

    The only thing that makes sense is to share it to all current shareholders. But does it have to go to the public? Not necessarily although the clear argument from the SEC and Congress is that if the public is potentially buying the stock, then the information has to also be shared with them. I think it’s a pretty simply and fair concept. And the fact that it’s difficult to enforce is not a great argument for getting rid of the law. For example, child abuse and neglect is difficult to detect and enforce but we don’t want to get rid of those laws do we? It may mean, however, that we have to have other mechanisms to enforce it.

  • Anonymous

    Insider trading is legal for Congress members.