Audio Clips

01 January 2011

Insider Trading

The new Freeman issue has a really interesting article on insider trading. Warren Gibson lays out the problems with a blanket prohibition and vilification of insider trading. Insider trading could actually have some benefits. As it stands right now, corporate insiders are not allowed to trade on material information that is not widely known. If that is the case the people who tend to benefit from the information are those who find out about it next after the corporate insiders and that tends to be stock market professionals, like analysts. That means that the benefits of the information tend to accrue first to stock market professionals who may be outside the corporation. Why should they be the first to benefit?

Mr. Gibson provides some alternative solutions that I found intriguing. Rather than having a one-size-fits-all federal solution to insider trading, why not let each corporation have their own policies in their by-laws? That way each corporation could find their own approach to the issue. Having that many laboratories would allow the market to discover effective approaches to handing insider trading. Mr. Gibson provides some ideas of his own that I think would work really well. I would recommend reading the article in its entirety.

2 comments:

Nathan said...

His most incisive point was: "Anyone who buys or sells shares ... does so because he believes he has information that is not widely known and therefore not adequately reflected in the current price." Given that indisputable reality, how can anyone make a carte-blanche statement that insider trading is always wrong?

I also liked his point that considers the mirror image of insider trading—insider nontrading: "It is impossible to police nontrading. What if an insider had planned to sell but, having heard inside good news, decides to hold instead? Insider gains from such inaction could be very real but impossible to detect or punish." Although I suppose that just because one wrong is hard to punish doesn't mean we shouldn't punish other wrongs.

I was confused when he said, "The dissemination of significant news about a company is blocked by insider-trading restrictions." I thought federal restrictions prevented insiders from acting on their information; do they also prevent them from sharing it? Why? Wouldn't it reinforce the purpose of the federal restrictions to allow (even encourage) insiders to share their limited-access information?

Joshua Richardson said...

Any "material, not-generally-known information" that is shared with an outsider is still considered insider information. That's what happened to Martha Stewart. She was not an insider, but her broker allegedly found out some insider information and they traded on it and she got hounded for it.

That's ultimately the problem with this law, it's too subjective. What information should be deemed "material"? When is the information sufficiently widely-known as to no longer be insider information? We have to wait until analysts figure it out? So then the people who are paying for that particular analyst's information are the first to benefit from it? Why are they the first line of benefit rather than the existing shareholders of the company? There is so much that is completely nonsensical about insider trading regulations.