Famous Insider Trader Says Insider Trading Laws Are Dumb

Posted by Lee D, Mar 14, 2007 10:56AM

In my uninformed opinion, there is a big difference between capitalizing on having superior intel, and deliberately manipulating and defrauding investors.

Should regulatory agencies pursue and punish people who have the advantage of knowing the right thing? Or would their resources be better spent going after people and groups who lie and cheat to gain an advantage?

When was anything in the world expected to be "fair?" In any trade, the buyer thinks he has a reason to buy, and the seller thinks he has a reason to sell. If one party is correct in his thinking and the other isn't, how is that ever going to be "fair?"

If God himself came to you and told you, direct as a thunderbolt, exactly what tommorow's winning lottery numbers are, do you have an obligation to NOT buy a ticket because that wouldn't be fair to other lottery players?

Posted by Random Walker, Mar 14, 2007 11:12AM

I've heard several people try to argue markets will be made more efficient if we allow insider trading because "more information will be built into the stock price". Unfortunately these people always forget one the tenants of efficient markets is symmetrical information.

He debunks his own argument in the first line: "People invest because they think they know more". Exactly. If they KNOW they know more, we have a problem.

Posted by Anonymous, Mar 14, 2007 11:32AM

You are all wrong. First of all, the average person does not invest because he thinks more. The average person invests because he knows that, in the long run, stock prices generally rise over time. Secondly, in no way does Efficient Market Theory have a "tenant" about "symmetrical information." Strong form Efficient Market Theory asserts that not even people with insider information will be able to beat the market because even insider information is efficiently priced in before the insider trader can act on his information. Efficient Market Theory basically says that there ARE information asymmetries but the activities of those who have an information advantage cause the price to move to a level that fully reflects the relevant information. If insider trading were allowed then the market would indeed become much more efficient because more people, with more information, would be impacting price levels (causing the price to reflect the information).

The problem with insider trader is that it erodes the investor confidence in the market. The investor is unwilling to buy/sell a stock if he knows that the seller/buyer the stock is an insider who knows something. The investor feels that only an insider could make any money in such a game, and everyone else would be left holding bags. So the investor will simply leave the market, which would be cataclysmic for the financial system. Theory tells us that insider trading would make the markets more efficient, it would benefit outsiders by saving them money, all market participants would be able to prosper, and insiders would have no lasting advantage because their insider info would spread on the street like wildfire. But the average investor is not moved by such arguments. The average investor would (stupidly) lose confidence lin the market if insider trading were legal. And that would pose a very real problem for the system. So in order to appease the irrational psychology of Joe Schmo, it is necessary to criminalize insider trading.

Posted by Anonymous, Mar 14, 2007 11:34AM

Sorry there was a tupo in the second sentence. What I meant to say is that the average person does not invest because he thinks he knows more.

Posted by Duh, Mar 14, 2007 11:51AM

"If insider trading were allowed then the market would indeed become much more efficient because more people, with more information, would be impacting price levels (causing the price to reflect the information)."

See, there it is again. But you refute it in your second paragraph. The average investor would (correctly) lose confidence in the markets, spreads would widen and liquidity would dry up, making markets less efficient. I can't believe rational people even try and argue this. I'll agree insider trading laws aren't perfect, but they're the best we've got.

Besides, you want to trade inside information, just go to the CDS market.

Posted by Anonymous2, Mar 14, 2007 11:52AM

Efficient markets theory has "tenants"? When did they move in? How much rent are they paying? Wow, you learn something new about the market every day...

Posted by art vandalay, Mar 14, 2007 12:41PM

that works if half of investors are insiders. apply your theory to the recent private equity offer for utility

Posted by voiceoftheemployee, Mar 14, 2007 1:38PM

my head hurts...

Posted by The Corner, Mar 14, 2007 2:40PM

Who is the "average investor" anyway? Cuz I'm pretty sure equity trading has been dominated by institutions since back before any of us were born.

On a side note, allowing a journalist to trade on his own writing creates incentive for said journalist to juice the news.

Posted by Foster Winans, Mar 14, 2007 5:17PM

Thanks for noticing my column. There is much more to be said but the one aspect that seems to be overlooked about this issue is that there is rarely a situation when someone can know 100% that inside information is going to make them money. One could "know" that a bid is coming for TXU, but there is market risk, industry dynamics, and a host of other variables. My principal argument is based on the following question: when was the last time someone was prosecuted for losing money using inside information. I highly recommend the late Harry Browne's piece on this subject at the following url: http://www.harrybrown.org/articles/Insidertrading.htm

Posted by The Corner, Mar 14, 2007 8:35PM

GASP! A trader in our midst!

Posted by anon, Mar 15, 2007 10:57AM

Foster,

People are being prsoecuted as we speak for losing money on inside information. The people in the Plotkin case are being charged with trading on the information that Smith leaked from the BMY grand jury. The net result of that trade was a loss.

Posted by Auto, Mar 15, 2007 4:07PM

Anonymous, what are you talking about? I thought it's been pretty well established that strong form EMH does not work -- as in, insiders can profit from non-public info.

But the real problem with allowing insider trading is political. Most Americans at best tolerate Wall Street, and then only when markets are rising. Legalizing insider trading increases the perception that Wall Street (which is not always synonymous with corporate insiders) is a rigged game designed to abuse widows and orphans.

Meaning that sooner or later, when average Joes lose money, they're going to turn to Congress for redress. Which will not be good news for Wall Street.

It's like social security reform. Does Wall Street really think Congress is going to turn over the retirement savings of every working American and that this gift is going to come without strings?

Supporting social security reform and the legalization of insider trading are testimony to the political stupidity of Wall Street.

Posted by Anonymous, Mar 15, 2007 4:15PM

Auto, I think we're basically both saying the same thing. The only difference is that I'm talking about average Joes voting against the stock market with their money, while you're talking about average Joes voting against the stock market by electing crazed politicians.

Posted by Anonymous2, Mar 17, 2007 10:15PM

...or maybe you meant "tenets", instead of "tenants"... I guess No Child Left Behind came too late for you guys...