Insider Trading Prohibitions - are they pointless

Long Onion

With the recent news that hedge fund billionaire Raj Rajaratnam has been arrested for generating more than $25 million in illegal profits acting on insider information, coupled with the fact that further arrests are expected with companies such as Intel, Microsoft, IBM. I have begun to wonder if continuing attempts to prevent insider trading are futile.

Would it be better to throw open the doors, grant proprietary rights in information to those who gather it and allow the information be bought, sold and traded on?

It is patently clear from share price movements that insider trading is commonplace and remains, for the most part, undetected. At least if the public knew that the playing field was not level, they would be more accepting of the risks involved.

Tom Young

I don't believe so. I think the prohibitions should be tightened. For those who are unaware of this case, it was UK based and the information was ascertained from the son of the person charged with insider trading.

Due to the liberalisation of the Stock Markets and the MiFI Directive there has been a change to the structure and access to the main EU exchanges. This does not take away from the Offences and reporting requirements under Irish Law in relation to this problem.

I blame the trading houses for not incentivising against this sort of activity properly.

Tom

Long Onion

Tom Young wrote: »

I don't believe so. I think the prohibitions should be tightened. For those who are unaware of this case, it was UK based and the information was ascertained from the son or the person charged with insider trading.

Due to the liberalisation of the Stock Markets and the MiFI Directive there has been a change to the structure and access to the main EU exchanges. This does not take away from the Offences and reporting requirements under Irish Law in relation to this problem.

I blame the trading houses for not incentivising against this sort of activity properly.

Tom

Tom, my understanding is that it is a U.S. SEC case, the arrest was made two days ago and was forced early due to the fact that the accused had purchased a ticket to fly to London. There are at least 10 further arrests expected to follow. It is alleged that the reason he was being watched closely in the first place is due to potential links with the Tamil Tigers - absent this, it is likely to have remained undetected (or unenforced depending on your viewpoint).

My main point is that given necessary loopholes allowing insiders to sell personal shareholdings even if they are in posession of sensitive information (as long as this information is not the causative factor for the sale - how do we prove this one?) and the fact that detection rates are paltry in the extreme, it seems nigh on impossible to robustly enforce this aspect of commerce.

Is there another way forward?

silentrust

Sorry to revive such an old thread after the fact but I have spent all day wracking my brains about this?

Why is Insider Trading illegal in the first place, particularly given how easy it would be to get away with it?

The most recent case I saw back home it was the man's own broker who became suspicious and reported his trading activity -he must have been a peerless dunce as if he'd acted through a few straw buyers and made a few risky buys, they'd never have been able to prove he'd broken the law from his trading activity alone.

usernamegoes

Insider Trading Laws create mispriced securities. I am not really sure why we need to stop people trading on information they know, that would correct the price of a security other than people think it's unfair that people should profit from this.

silentrust

usernamegoes wrote: »

Insider Trading Laws create mispriced securities. I am not really sure why we need to stop people trading on information they know, that would correct the price of a security other than people think it's unfair that people should profit from this.

I suppose so - in the same way if it was a rigged boxing match it might skew the bets for everyone who wasn't in the know however I think the important difference is that a boxer who takes a dive might have won anyway... somebody who overhears the boxer spent the last two weeks in traction and bets accordingly wouldn't be punished.

I must be very stupid but I really can't see the harm, not that I condone law breaking of course! :-D

NoQuarter

Its a breach of trust. The boxer analogy isnt quite right in that if a random person overheard a CEO of a company saying they were about to merge with another company, they can trade on that and not break any laws.

But if a member of a legal team involved in the merger or a friend of the CEO that has been deliberately told about the merger so they can make money from it trades on it, then it breaks the law.

For every gain on the market, there is a corresponding loss. Trading on information that isn't public domain is unfair to the people on the other side of the traders gain.

usernamegoes

NoQuarter wrote: »

Its a breach of trust. The boxer analogy isnt quite right in that if a random person overheard a CEO of a company saying they were about to merge with another company, they can trade on that and not break any laws.

But if a member of a legal team involved in the merger or a friend of the CEO that has been deliberately told about the merger so they can make money from it trades on it, then it breaks the law.

For every gain on the market, there is a corresponding loss. Trading on information that isn't public domain is unfair to the people on the other side of the traders gain.

The person on the other side of the trade only trades because they think it's worth it. There's nothing wrong with that. If I see an antique for sale in a car boot sale, and the seller has no idea, should it be illegal for me to make a deal with him without telling him what I know? Is it immoral for him to get a price he was happy to sell for?

But, think of this. The market is mispriced because the information is not released, I buy the shares in XYZ and then the information is released and the price falls through the floor. How fair is that? Would I have bought they share without that artificial impediment?

NoQuarter

usernamegoes wrote: »

The person on the other side of the trade only trades because they think it's worth it. There's nothing wrong with that. If I see an antique for sale in a car boot sale, and the seller has no idea, should it be illegal for me to make a deal with him without telling him what I know? Is it immoral for him to get a price he was happy to sell for?

But, think of this. The market is mispriced because the information is not released, I buy the shares in XYZ and then the information is released and the price falls through the floor. How fair is that? Would I have bought they share without that artificial impediment?

But on your first point, consider whereby persons are trading on inside information and the NAV is moving because of that information which shouldnt have been released.

Its the flip side of your second point which I take.

That said, there is something inherently immoral or wrong about trading on insider info. I suppose it "feels" wrong in a way.

silentrust

usernamegoes wrote: »

The person on the other side of the trade only trades because they think it's worth it. There's nothing wrong with that. If I see an antique for sale in a car boot sale, and the seller has no idea, should it be illegal for me to make a deal with him without telling him what I know? Is it immoral for him to get a price he was happy to sell for?

But, think of this. The market is mispriced because the information is not released, I buy the shares in XYZ and then the information is released and the price falls through the floor. How fair is that? Would I have bought they share without that artificial impediment?

An excellent point usernamegoes, this strikes to the heart of the mystery for me!

Particularly when you also consider that it is actually also a crime to fail to sell your shares due to information gained from insider trading, even if it's inadvertent e.g you're working for a law firm and see a memo about the dissolution of a company.

I have worked in Intellectual Property for the past two years, I understand the idea of information being seen as the sole province of those who created it but I do think too much responsibility is placed on people who're privy to it, the mind boggles.

silentrust

NoQuarter wrote: »

But on your first point, consider whereby persons are trading on inside information and the NAV is moving because of that information which shouldnt have been released.

Its the flip side of your second point which I take.

That said, there is something inherently immoral or wrong about trading on insider info. I suppose it "feels" wrong in a way.

How far should we run with this logic though? Let's say I start keeping an eye on the trading portfolio of the CEO of a major company who repeatedly gets in the bottom floor and you decide to mirror all his trades as a result. If a friend then asks you how you're able to make more money than you lose every time would it be wrong to withhold that information from them?

I suppose the difference in this case is that's it information that any fool could access in theory but it wouldn't be illegal to fail to withhold the information under those circumstances even though from a certain point of view you have an unfair advantage.

Thank you all for your thoughts incidentally, I think we're cutting to the heart of the issue very quickly!

NoQuarter

silentrust wrote: »

Particularly when you also consider that it is actually also a crime to fail to sell your shares due to information gained from insider trading, even if it's inadvertent e.g you're working for a law firm and see a memo about the dissolution of a company.

Is that right? Is there an obligation to dispose? Or is the obligation merely NOT to dispose of the stock if you know the price is about to fall? I ask out of interest and thoughts of Actus Reus flow through my mind.

Its an interesting area that I dont know enough about but have read up on before. Here is the law set out from 2008:

http://hb.betterregulation.com/external/Insider%20Trading%20Law%20in%20Ireland.pdf

silentrust

NoQuarter wrote: »

Is that right? Is there an obligation to dispose? Or is the obligation merely NOT to dispose of the stock if you know the price is about to fall? I ask out of interest and thoughts of Actus Reus flow through my mind.

Its an interesting area that I dont know enough about but have read up on before. Here is the law set out from 2008:

http://hb.betterregulation.com/external/Insider%20Trading%20Law%20in%20Ireland.pdf

Good point! In fairness I should say I only really know what I saw while watching the original of Wall Street as well as what I read on the SEC website today so can only speak about US law.

I too am confused how far this logic goes. Let's say for instance you work for a Meteorological station and you know a hurricane is going to hit a major city soon - would it be wrong to sell your shares in any big companies registered there or could you only do so after a much publicised TV rant screaming, "SELL EVERYTHING AND RUN FOR YOUR LIVES!" ? :-)

Victor

Sod it, how about allowing criminal defence lawyers claim the reward from the police if they rat on their clients?

Insider trading is illegal as it allows the insiders, who have duties to shareholders, to defraud those shareholders. You guys sound like shills for criminals.

silentrust

Victor wrote: »

Sod it, how about allowing criminal defence lawyers claim the reward from the police if they rat on their clients?

Insider trading is illegal as it allows the insiders, who have duties to shareholders, to defraud those shareholders. You guys sound like shills for criminals.

I don't think it's the same thing as in one case an innocent person may end up behind bars but it's hard to find a victim in the case of insider Trading as of course they're not changing the nature of the stock market per re. I think this line of thinking is the reducto ad absurdum viz. privileged information - as I said I worked in Intellectual Property and naturally employees were asked to sign confidentiality agreements re: up and coming inventions/trade marks to stop us from registering them ourselves.*

However it doesn't follow logically that a) everything one hears in the course of one's day to day business is therefore privileged information nor b) the only way to capitalise on this information is to undermine justice and/or harm people.

In fact, it actually is illegal for a Solicitor to represent someone they know to be guilty if a defendant repeats anything they know to be untrue but let's not dwell on that.

As for sounding like criminals, let's not be silly- questioning why something is illegal and breaking the law are two different things.

*patent/trade mark trolling is actually fairly common but it would be very unlikely to succeed if we had attempted it as the client would have been able to prove they were the original creators, plus we'd lose our jobs, so it was very easy to detect and enforce theft of this kind. It never happened and probably never will for exactly the reasons I've outlined here.

silentrust

Very interesting article on the subject:

http://www.cato.org/publications/commentary/its-time-legalize-insider-trading

ST

Grudaire

silentrust wrote: »

Very interesting article on the subject:

http://www.cato.org/publications/commentary/its-time-legalize-insider-trading

I'm not sure that the guy writing the article fully understands how insider trading works when he says this:

The beneficiary of inside information may not deserve to be so lucky, but then, neither does the big money lottery winner.

The issue with insider trading is simply that it means the cards are stacked in certain peoples favour.
For example: if everyone knows that company X's CEO is trading on the market while regularly using insider info - then logically noone would trade with the CEO - because they would be guaranteed to lose.

Unfortunately it is not always possible to identify who exactly is the other side of a transaction - thus any logical traders would stop trading in company X's shares.

silentrust

Cliste wrote: »

I'm not sure that the guy writing the article fully understands how insider trading works when he says this:



The issue with insider trading is simply that it means the cards are stacked in certain peoples favour.
For example: if everyone knows that company X's CEO is trading on the market while regularly using insider info - then logically noone would trade with the CEO - because they would be guaranteed to lose.

Unfortunately it is not always possible to identify who exactly is the other side of a transaction - thus any logical traders would stop trading in company X's shares.

With respect I don't think that the statement there was meant to be description of how Insider Trading works but simply about how much merit or worth we attach to someone who exploits this kind of information as opposed to someone who simply happens to buy the winning lottery ticket - or perhaps to emphasise the point that the reverse isn't true in that total ignorance of how the system works such as that a lottery winner might have doesn't have virtue or worth in itself.

The scenario you mention with the CEO exploiting insider information would be true insofar as it applied to buying shares in their own company - however there is an extent to which this is beyond his control.

For instance the example we used is that of a smaller company merging with a much more powerful one. If the Directors have already decided this will take place, then the market is affected in the same way whether the CEO buys shares in the larger company or not. The only difference it might make is if a canny trader suspected the CEO was indulging in insider trading, they might simply mimic his buying activities.

This sort of exposes the nonsense of it all because, as I said, you'd not be obliged to disclose this to other speculators, even if you strongly suspected that another person was indulging in unfair practices.

Even if the CEO writes a press release announcing the merger and handed it to a Journalist to print in a major newspaper, if said journalist were to call his broker as he went to his car to buy some shares, he could be prosecuted, even if the news is about to become public knowledge imminently.

The only difference is that he or she makes a few extra Benjamins - am I the only one who thinks this wouldn't be disastrous for the economy if it was legalised?

Grudaire

silentrust wrote: »

The only difference is that he or she makes a few extra Benjamins - am I the only one who thinks this wouldn't be disastrous for the economy if it was legalised?

It's about market confidence.

If you believe that people are insider trading then logically you shouldn't participate in that market.

For example you wouldn't participate in a game of Poker where one (unknown) other person at the table could see your cards.

silentrust

Cliste wrote: »

It's about market confidence.

If you believe that people are insider trading then logically you shouldn't participate in that market.

For example you wouldn't participate in a game of Poker where one (unknown) other person at the table could see your cards.

Isn't poker a zero sum game though? i.e any money you win comes from what I've lost - would the example above have an actual victim? Who actually loses money?

Grudaire

Effectively the markets are a zero sum game as well.

If you look at it on a trade-by-trade level any person trading with someone with insider knowledge will be losing out.

It probably doesn't seem as 'unfair' because the other party may be very happy with the trade, and indeed may have sold it on before the market recieves the news.

However for one trader to make a profit on the markets another must lose out - the money comes from somewhere!

NoQuarter

silentrust wrote: »

In fact, it actually is illegal for a Solicitor to represent someone they know to be guilty if a defendant repeats anything they know to be untrue but let's not dwell on that.

Not quite, solicitor/counsel can still represent the client but merely make no assertion of innocence. But the prosecution can still be put to full proof.


Having thought a bit more on it, I think it simply boils down to the professionalism of the recipients of the insider information. IF it was legal, a CEO may not want to use a legal team for a merger or acquisition in the knowledge that they are going to use the information for personal gain. It just doesnt have the ring of professionalism.

Now lets go one level deeper, think about this; insider trading is legal and commonplace, a CEO tells his legal team that they are going to acquire another company, the legal team act on that knowledge and buy shares. The CEO then decides its not in the interests of the company and abandons the merger.

Is the CEO liable to the traders in negligence in that he knew or ought to have known that the legal team would rely on his information? Is he liable to the traders for damages? There is proximity and reasonable forseeability imo.

NoQuarter

Cliste wrote: »

It probably doesn't seem as 'unfair' because the other party may be very happy with the trade, and indeed may have sold it on before the market recieves the news.

However for one trader to make a profit on the markets another must lose out - the money comes from somewhere!

Exactly my point earlier!

silentrust

NoQuarter wrote: »

Exactly my point earlier!

But the money doesn't come from earlier investors, it reflects the new level of investment by others in the company in the example above, it's not been stolen from existing shareholders surely?

silentrust

My August colleague has reminded me that when I went to work for my current employer, I signed a non disclosure agreement as do most working professionals so to indulge in insider trading would in the nature of things amount to a breach of trust between employer and employee if nothing else - particularly if you send hot tips to a friend not connected with your employer.

Well, the law's the law people, let's suck it up I suppose.

NoQuarter

Sure us lawyers are paid too much already anyways! :pac:

househero

I think its remarkable that MORE insider trader does not happen! If you were aware of information that could make you rich, would you make the most of it?

It probably happens a lot more than we realise, there must be an under the radar figure that goes unnoticed.

NoQuarter

househero wrote: »

I think its remarkable that MORE insider trader does not happen! If you were aware of information that could make you rich, would you make the most of it?

It probably happens a lot more than we realise, there must be an under the radar figure that goes unnoticed.

I'd imagine there is. That said, anyone in a position whereby they know what trading is and they are in a position to be privvy to information that can make them rich will be smart enough to be aware that taking that opportunity is against the law so they would have that moral dilemma.

silentrust

NoQuarter wrote: »

I'd imagine there is. That said, anyone in a position whereby they know what trading is and they are in a position to be privvy to information that can make them rich will be smart enough to be aware that taking that opportunity is against the law so they would have that moral dilemma.

They would have to use what is known as a straw buyer i.e get someone to buy the shares on their behalf. This would be tricky insofar as they would have to give out the information in such a way that it can't be traced back to them, trust the straw buyer to make the correct trades and split the profits with them, then return the funds to them in a way which can't be traced.

Obviously I don't want to spark a discussion into methods of how they can do that but I agree the detection rate for this kind of crime is still rather low!

NoQuarter

A straw buyer is the best way it can be done (or anonymous trading where possible) but its certainly not fool proof. As soon as something that effects a trade price occurs, the value of the shares will be examined for any unusual trades in the lead up to the announcement of that event. So the identification of the straw buyer would be very easy. The problem then lies in establishing a connection but I certainly wouldnt feel safe if I did it.

silentrust

NoQuarter wrote: »

A straw buyer is the best way it can be done (or anonymous trading where possible) but its certainly not fool proof. As soon as something that effects a trade price occurs, the value of the shares will be examined for any unusual trades in the lead up to the announcement of that event. So the identification of the straw buyer would be very easy. The problem then lies in establishing a connection but I certainly wouldnt feel safe if I did it.

I know that the SEC has software they use to look at unusual trading patterns. You would probably have to use a number of straw buyers and mix it in with legitimate trades to throw them off the scent but then you can't rely on hearing a red hot tip every time before calling your broker. I agree you certainly shouldn't make a habit out of it!