• 15 Nov 2011 at 1:07 PM

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.

Comments (47)

  1. Posted by Mitch | November 15, 2011 at 1:18 PM

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

  2. Posted by Guest | November 15, 2011 at 1:19 PM

    Somebody just OD'd on hyperlinks.

  3. Posted by Put_Option | November 15, 2011 at 1:20 PM

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

  4. Posted by Chevy_Chased | November 15, 2011 at 1:21 PM

    *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. Posted by Mexi_Cant | November 15, 2011 at 1:22 PM

    Dude…just split it into 3 articles.

  6. Posted by Guest | November 15, 2011 at 1:24 PM

    you meant 36 articles?

  7. Posted by Cut Me | November 15, 2011 at 1:29 PM

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

  8. Posted by UVA Secure | November 15, 2011 at 1:29 PM

    Above the Law is a douche.

  9. Posted by DingALing | November 15, 2011 at 1:31 PM

    Will this post be available in Sparks Notes anytime soon?

  10. Posted by Stacey | November 15, 2011 at 1:32 PM

    No chart?

    My eyes still hurt from the pepper spray.

  11. Posted by OriginalityPolice | November 15, 2011 at 1:34 PM

    Who plays Raj?

  12. Posted by PMCO/1+(1-Tc)x(D/E) | November 15, 2011 at 1:37 PM

    didnt even try this…

  13. Posted by pazzo83 | November 15, 2011 at 1:38 PM

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

  14. Posted by Guest | November 15, 2011 at 1:39 PM

    …for when you need that clean that vinegar alone just can't provide.

  15. Posted by Anonymous | November 15, 2011 at 1:44 PM

    Matt – you are NOT getting paid by the word.
    Bess

  16. Posted by Avid Reader | November 15, 2011 at 1:47 PM

    +1, Matt. Good stuff.

  17. Posted by Guest | November 15, 2011 at 1:54 PM

    Who is to the right of Buffett in the picture?

  18. Posted by Mike | November 15, 2011 at 1:59 PM

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

  19. Posted by CFA Lvl I Candidate | November 15, 2011 at 2:11 PM

    LiLo? Oh god I think I missed that LOS

  20. Posted by Jeff Skilling | November 15, 2011 at 2:12 PM

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

  21. Posted by Guest | November 15, 2011 at 2:19 PM

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

  22. Posted by Guess | November 15, 2011 at 2:29 PM

    An extra 10 thumbs up over here

  23. Posted by Zvi Goffer | November 15, 2011 at 2:30 PM

    You realize Matt Levine is the name I use for the legitimate years, right?

  24. Posted by InfiniteGuest | November 15, 2011 at 2:36 PM

    Insider trading laws are intended to protect widows and orphans. Procter is the widow and Gamble is the orphan.
    Congress says that Congressional self-dealing is OK.

    - not PMCO but a fan of her avatars

  25. Posted by Anonymous | November 15, 2011 at 2:45 PM

    concise
    adjective
    - brief and to the point; short and clear
    NOT Matt

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

  26. Posted by guest | November 15, 2011 at 2:45 PM

    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.

    Cheers,
    Warren

  27. Posted by Rev. Maclean | November 15, 2011 at 3:00 PM

    Again, half as long.

  28. Posted by I know a guy | November 15, 2011 at 3:00 PM

    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

  29. Posted by D Sokol | November 15, 2011 at 3:21 PM

    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.

  30. Posted by What about his legitimate years? | November 15, 2011 at 3:35 PM

    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.

  31. Posted by guesticles | November 15, 2011 at 3:39 PM

    too compliance didn't read

  32. Posted by Wm. Faulkner | November 15, 2011 at 6:33 PM

    Fuck you Ernest!! Did you ever use a word that would send people to a dictionary? And that fucking "war wound" was really where the water tank on a shitter fell and hit your drunk ass head one night. You insufferable prick!

  33. Posted by Benji | November 15, 2011 at 6:56 PM

    Too much punctuation not written like real faulkner

  34. Posted by Above the Law douche | November 15, 2011 at 7:00 PM

    No, we're good. Writing like this is terrific for business.

  35. Posted by Put_Option | November 15, 2011 at 8:48 PM

    Very typical beta male comment. You legal eagles keep winning ok?

  36. Posted by Guest | November 15, 2011 at 11:04 PM

    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.

  37. Posted by Mattisdunce | November 15, 2011 at 11:15 PM

    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.

  38. Posted by Vick in a Box | November 15, 2011 at 11:18 PM

    Jabba the Hut

  39. Posted by [email protected] | November 15, 2011 at 11:46 PM

    Warren buffet essentially wants the stock to in the short term drop in price.
    People trading on illegal insider info want the stock to in the short term rise in price.

    -Guy who thinks replacing the chicken doesn't necessarily make the egg taste different but doesn't rule out that selecting top breeds of chickens should be based on how good their eggs are.

  40. Posted by Mercury | November 16, 2011 at 8:58 AM

    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.

  41. Posted by George Constanza | November 16, 2011 at 11:37 AM

    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 …

  42. Posted by guest | November 16, 2011 at 1:58 PM

    like

  43. Posted by DatingA1Percntr | November 16, 2011 at 2:48 PM

    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.

  44. Posted by Guest | November 16, 2011 at 11:49 PM

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

  45. Posted by Geral Sosbee | November 17, 2011 at 9:42 AM

    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:
    http://ttu.academia.edu/geralsosbee

    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:
    http://www.sosbeevfbi.com/part19a-updatefo.html

    QUESTIONS! geral sosbee (956)536-0439

    One agency of government above all others must be destroyed:
    the federal burro of investigation (fbi).
    http://sosbeevfbi.ning.com/forum/topics/americans

    http://www.sosbeevfbi.com/oliverwendallhol.html

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

    * http://barbarahartwellvscia.blogspot.com/2011/03/

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  47. Posted by Car Title Loans | October 2, 2013 at 3:32 AM

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