Some Zuccotti Park Thoughts On Insider Trading

It’s fun to get all riled up about insider trading! So let’s.

But first, I see you have some XYZ shares. Would you like to sell them to me? Here are some things you might want to know about it:
1. Warren Buffett is secretly buying loads of it.
2. Congress is going to do something that will make it go up, like kill pending legislation that would restrict its profits.
Let’s say I know those things and you don’t. I buy XYZ from you. Have I committed a crime? Maybe – but it’s not as easy as that.

Let’s start with what insider trading is. Actually let’s start with what it isn’t. Henry Blodget gives a popular simplification, “The definition of insider trading is trading while in possession of material non-public information.” If you think that, then clearly Congresspeople are committing crimes by trading on the knowledge that they’re going to earmark loads of cash to a company or deregulate it or just blow up the financial system or whatever they’re up to.

But that’s not the definition of insider trading, or at least of illegal insider trading. You can tell that by doing this little thought experiment:

1. Buffett knows he’s going to buy ten yards or so of IBM
2. He knows that that will move the market, so it’s material
3. He hasn’t told anyone yet, so it’s non-public
4. So he’s got “material” “non-public” information about IBM
5. He buys it anyway
6. Has he committed a crime?

Duh, no. Obviously buying while knowing that you’re buying can’t really be illegal, even if you’re Warren Buffett.* Just trading while you have material nonpublic information isn’t enough for it to be criminal. Instead, you need to be “in breach of a fiduciary duty or other relationship of trust and confidence” for it to count. Warren Buffett is okay trading while he knows about his own intentions because that’s, like, why he has those intentions. David Sokol, perhaps not so much. In fact, the SEC is so solicitous of Buffett keeping his secret sauce secret and saucy that it lets him avoid otherwise applicable rules about disclosing stock holdings so that he can build his stake without pushing the stock up.

Similarly, it’s not illegal for Congress to trade just because it has inside information: it has to have some sort of duty to or agreement with someone to keep that information secret. Now, maybe it does. Blodget cites a law professor who claims that Congress does have that duty, to the people who elected it, and that “nonpublic congressional information constitutes property which, like congressional funds and tangible property, rightfully belongs to the federal government and its citizens,” which so depressingly and obviously should be right but which I suspect isn’t. Other law professors are skeptical, and the fact that there was a proposed law (which went nowhere) to make Congressional insider trading illegal certainly suggests that – well, that Congress thinks it’s currently legal, for whatever that’s worth.

One thing to hold in your heart when you think about the U.S. securities laws is that, while they are in part designed to protect little investors and whatnot from big evil investors, they’re really designed to protect big nice companies from big evil investors. Thus you could get a little riled up about the fact that Buffett gets special treatment in not disclosing his positions – but you could also reasonably ask why anyone should have to disclose their positions. The answer is that we have a disclosure regime that was put in place in the 1960s to protect companies from hostile takeovers. Because, y’know. Companies hire lots of lobbyists.

That regime is reflected in the current practice: the SEC likes Buffett and other money managers to tell everyone what they’re up to, but lets company-friendly non-activist investors like Buffett skip that disclosure if “it would be likely to cause substantial harm to the Manager’s competitive position.” No such luck for activists and raiders: if you buy over 5% of a company and are not a passive investor, you have to put up a 13D disclosing it, and the SEC doesn’t give a damn about your competitive position. Sometimes that leads to weird workarounds, but they mostly don’t work.

You can look at insider trading through the same lens. If you believe that insider trading law is intended to create a level playing field for all investors, you’d be confused by things like the apparent legality of Congressional insider trading, or the fact that knowing what Buffett is up to prevents Sokol, but not Buffett, from trading. If your model of insider trading prohibition is “the SEC doesn’t want insiders to front-run companies on mergers and stuff, because that would make deals more expensive for those companies, and it wants corporate employees to have an incentive to fix problems rather than just shorting to profit from them,” then those cases are easier. As is the story of Foster Winans, whom I’ve written about before. Winans wrote a column in the Wall Street Journal that moved the stocks he covered, and he and his buddies traded in advance of the column to make money front-running his picks. The Supreme Court affirmed his conviction for insider trading, but also said:

Admittedly, … the Wall Street Journal or its parent, Dow Jones Company, might perhaps lawfully disregard its own confidentiality policy by trading in the stock of companies to be discussed in forthcoming articles. … Although the employer may perhaps lawfully destroy its own reputation, its employees should be and are barred from destroying their employer’s reputation by misappropriating their employer’s informational property. … Here, appellants, constrained by the employer’s confidentiality policy, could not lawfully trade by fraudulently violating that policy, even if the Journal, the employer imposing the policy, might not be said to defraud itself should it make its own trades.

Got it? The Journal could creepily profit by trading in advance of its own column, but the guy who wrote the column couldn’t.

Criminalizing insider trading is popular because it’s easy to misrepresent what it’s about. Prosecutors can posture that “Insider trading simply makes a mockery of the principle that no one individual has an advantage in the market … It’s completely wrong that it’s a victimless crime,” and courts calculate sentences based on how much the “victims” “lost,” but that’s not really the principle that the laws protect.

Insider trading law isn’t really about protecting the E*Trade baby from big scary Raj Rajaratnam; even without insider trading big accounts have access to expert networks, IPO allocations, better research, better technology, etc. etc. compared to small investors. It’s about protecting Procter & Gamble from Raj: P&G doesn’t want its board members leaking their discussions, and it doesn’t want people dumping it stock in advance of an earnings miss. And the Procter & Gambles of the world are the ones who the securities laws were written for. If you remember that the securities laws are mainly intended to protect companies, not small investors, from big investors, then they will make more sense. And if you remember that one thing that Congress cares more about than big companies is itself, then you will not be surprised to see that Congressional insider trading remains legal.

No, It Is NOT “Legal” For Congress To Insider-Trade — The SEC Should Launch Investigation Immediately [BI]

Congressional insider trading errors [Stephen Bainbridge]

One Secret Buffett Gets to Keep [DealBook]

Earlier: If We’re Not Supposed To Care About What S&P Says, Why Do We Care When They Said It?

* Though actually it kind of is for companies buying their own stock, which is why Berkshire did disclose in advance that it was buying back its own shares.

(hidden for your protection)
Show all comments

47 Responses to “Some Zuccotti Park Thoughts On Insider Trading”

  1. Mitch says:

    LiLo to play Chiesi in Wall Street 3: The Return of Raj?

  2. Guest says:

    Somebody just OD'd on hyperlinks.

  3. Put_Option says:

    Can't wait for the Above the Law douche to lay down his smug comments on insider trading

  4. Chevy_Chased says:

    *Note: The opinions expressed by Matthew Levine do not represent the views of Breaking Media or any of Deal Breaker's affiliates. Breaking media will also speak with Mr. Levine regarding his borderline obsession with defending this 'victimless crime', his habitually lengthy posts, and unoriginal tags.

    -Breaking Media Legal Dept.

  5. Mexi_Cant says:

    Dude…just split it into 3 articles.

  6. Cut Me says:

    Woohoo! New record set here. I made it to paragraph 2 before saying fuck it.

  7. DingALing says:

    Will this post be available in Sparks Notes anytime soon?

  8. Stacey says:

    No chart?

    My eyes still hurt from the pepper spray.

  9. PMCO/1+(1-Tc)x(D/E) says:

    didnt even try this…

  10. pazzo83 says:

    Things that Congress thinks are legal : things that are legal :: Sino-Forest : real companies

  11. Anonymous says:

    Matt – you are NOT getting paid by the word.

  12. Avid Reader says:

    +1, Matt. Good stuff.

  13. Guest says:

    Who is to the right of Buffett in the picture?

  14. Mike says:

    No need to write long boring posts to prove you are writing something smart.

  15. Jeff Skilling says:

    Congressmen trading on inside info they get from their role as legislators? Sounds like "theft of honest services" to me. My cellmate agrees.

  16. Guest says:

    How much time did you waste writing all of this Matt? Other than your mother, not a single person read it.

  17. Anonymous says:

    – brief and to the point; short and clear
    NOT Matt

    – so wordy as to be tiresome; verbose
    – using more words than are necessary; long-winded

  18. guest says:

    Dear Raj,

    Next time cloak yourself in aw-shucks-middle-class virtue. It makes it easier to court policymakers, avoid populist wrath, and tap dance around the gray area of the law. Anyway, that missing dump truck of TARP money just showed up on my front lawn, so I need to run.


  19. Rev. Maclean says:

    Again, half as long.

  20. I know a guy says:

    If you write one masterpiece of a paragraph and 99 paragraphs of shit. Make sure those 99 see the delete key.
    This goes for you OWS folks, too.

    E. Hemmingway

  21. D Sokol says:

    Error: If Warren Buffett knows that Berkshire Hathaway is about to buy a significant share in a company and he buys first for his own account (which is probably a Cayman Islands trust), that would be insider trading (and a few other crimes as well). If he doesn't want to wind up in jail like Sokol has (he has been indicted and convicted, hasn't he?!) then he should be careful with his material inside info.

  22. What about his legitimate years? says:

    One day Matt you’ll also get a job at slate to write 4 stories for 80k a year and life will be good again. Youll grow a beard and smoke a pipe and have some scotch in your drawer to make you look even more legit as a writer. Good times are coming, only 100,000 words to go buddy. Keep it up.

  23. guesticles says:

    too compliance didn't read

  24. Guest says:

    Matt you missed the pointer on the sec page for insider trades:Government employees who learned of such information because of their employment by the government.

  25. Mattisdunce says:

    Matt, are you demented or just plain stupid?

    Warren Buffett is in essence the catalyst for the movement in the stock price.
    People trading on illegal insider info are not the catalysts for the movement in price.

  26. Mercury says:

    No, try this thought experiment: If Buffett plans to buy 10 yards of IBM for Berkshire Hathaway but buys one yard for his PA first is this insider trading? Yes, it's called front-running.

  27. George Constanza says:

    The post was pretty good …

    But that picture of Warren Buffet drunk on his ass after buying ten yards of IBM and then knocking back a half bottle of Johnny Walker Blue is priceless …

  28. Again, my ADD kicked in after the title. Too long to read in full, but from what I did read, I already knew: Insider Trading is bad. When the big guys move, so does the market. Conclusion: As of right now, it's still legal. So, who cares.

  29. Guest says:

    Seems someone is struggling with the ethics section of the CFA curriculum

  30. Geral Sosbee says:

    Re: Insider Trades:

    Well, fbi smugly murmurs, "everyone's doing it".
    Must now see why congress refuses to investigate my charges of insider trading in derivatives by the fbi:

    Now, the rest of the story:

    fbi, military intelligence (James Wolf), police, UT chancellor, UT legal counsel all team up to create a fraudulent police report with patently false contents in order to find a way to illegally arrest this fbi whistleblower. See this and related links:

    QUESTIONS! geral sosbee (956)536-0439

    One agency of government above all others must be destroyed:
    the federal burro of investigation (fbi).

    *Feinstein is one of the most treacherous traitors in congress.


  31. Dalahoppy says:

    hello there and thank you for your info – I have definitely picked up anything new from right here. I did however expertise some technical points using this web site, as I experienced to reload the web site many times previous to I could get it to load properly. I had been wondering if your hosting is OK? Not that I’m complaining, but sluggish loading instances times will often affect your placement in google and can damage your high quality score if ads and marketing with Adwords. Well I am adding this RSS to my e-mail and can look out for much more of your respective exciting content. Ensure that you update this again soon.. – garage doors Houston TX

  32. insider trading is terrible and if it only being used to stabilize the economy with dummy corporations then so be it.