Talk:Insider trading/Archive 1

Archive 1

Archived Discussion

Is this entirely based on the situation in the USA, or generally applicable?

The rules are not uniform round the world. Reporting standards, practices and loopholes vary considerably among jurisdictions.Two16 13:36 Jan 11, 2003 (UTC)

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Two justifications of laws against insider trading were recently posted on Wikipedia:Help desk. I quote them here so I can demonstrate the kinds of questions that I'd like to see answered in this article:

First we have

Information wants to be free but you can make lots of money if its not freely known. The game is rigged towards those with connections. The laws against insider trading are lip service paid to honesty.

"Information wants to be free" is an odd claim if you take it literally; I've certainly never seen, say, a volume of Britanica risk life and limb trying to escape from a totalitarian country. Presumibly this "really means" something else, perhaps that people want information to be free, or that information "naturally" replicates itself frequently. Nothing too big seems to follow from these, especially the second.

"The game is rigged towards those with connections" is most certainly true. Not just in financial markets, but in terms of getting a job, being asured of having someone to take care of you when you're old, and in most other areas of life. The question is: is this always a bad thing? Not everyone would answer yes, so a more careful investigation of when it is a bad thing is needed.

Also, I see no necessary connection between insider trading laws and "honesty". The only reasons insider traders have to be "dishonest" (i.e. have to hide the truth) are the laws that make their activities illegal, and the general consensus that they are somehow immoral. Without the current sorts of laws and social pressure, people could engage in all kinds of insider trading perfectly "honestly".

Next we have

the claim that markets are efficient allocators of resources rests on the condition that people have equal access to information (some claim that markets would be the most efficient way to allocate resources if all people had perfect information). When you have insider trading, some people have fundamentally different access to information than others, so the market cannot work efficiently.

Obviously this can only be proved for a particular technical definition of efficiency, and given particular assumptions about how the market works. Unless you're going to mention what kind of efficiency this is (so other questions like "efficient for whom?" and "is this actually a very valuable kind of efficiency?" can become meaningful), an efficiency argument is complete gobledegook. Also, it is clear that the ideal of "perfect information" can never be realized in a real market, so your argument had better take account of different degrees of information freedom.

--Ryguasu 01:40 Jan 11, 2003 (UTC)

The legal justification for making only certain types of insider trading illegal (not all of it is banned) is precisely in the breach of loyalty and trust. The management of a company is hired by the shareholders to earn profits for the shareholders. If the management uses the resources of a company (e.g. inside information) to personally profit to the detriment of the shareholders (who don't have the same access to that inside information), how is that conceptually any different from embezzlement? --Stephen C. Carlson 03:13 Jan 11, 2003 (UTC)~

Stephen, could you clarify which of these I am to read from your comment:

Insider trading is only illegal when it is detrimental to shareholders. (So if a CEO benefits from an insider trade but the shareholders are not "harmed", then would not be illegal.)

or

The sorts of insider trading that are illegal are usually detrimental to the shareholders.

or

The sorts of insider trading that are illegal are always detrimental to the shareholders?

In either case, how am I to read "detrimental to the shareholders"? Do courts of law have an established principle for this? "If the stock price drops" seems a little simpleminded. --Ryguasu

I think it would help things if you would answer my question first and not get bogged down on side issues. Do you consider the conversion of the company's assets for personal gain (e.g. non-public information that one has been entrusted with, in the case of illegal insider trading) a form of embezzlement? If not, why not? Stephen C. Carlson

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64.229.10.253 At the help desk I gave a snappy answer to a complex question. It's not so shallow if you remember where it was placed.

Information wants to be free but, you can make lots of money if that infomation is not freely known. ['its' replaced for clarity]

• Stockmarket game is played by large numbers of people, any information widely known is adjusted for by the market. Widely held information is valueless in terms of market advantage: having foreknowledge of market movements is often times lucherative. Outrangeously so if its the right information is held closely enough. Think dotcom bubble economy. Timing is important. Information will expire in terms of market advantage.

The game is rigged towards those with connections.

• Do you think this statement is (npov)?

The laws against insider trading are lip service paid to honesty.

• Its all about the transparency. Many folks at Enron made out like bandits trading in stock that they knew was worthless (cause they were the ones running the scam). If the information will cause a share price rise, laws are vitually uninforceable as resonable doubt can be manufactured in any rising price before the trades are made. Falling markets are trickier: if Martha had only sold half her stake, she would have a pretty good defence against charges of insider trading because she 'reduced her exposer to bad news while still maintaining a postion'. A pretty reasonable story of astute finacial judgement don't you think. Remember Martha already knew the bad news: its just harder to disguise insider trading if share prices are going to plummet.And she was greedy. Who knows why she did what she did?

This arguement against ineffective laws surrounding insider trading is a variation on a theme by Paine: If the laws are full of loopholes, we are doubly cursed because not only do we suffer the crime that we legislated against; but, we suffer an expensive, intrusive, regulation and we do it by our own hand.

I'm suprised "Information wants to be free.." didn't send the cliche alarms ringing. If you're not familiar with phrase, you have just recieved a common, frequently mutatingmeme.

Now that I'm here and been insulted. I think I might read the article;-) Two16

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Moved pov material from the main article:

Perhaps the most common moral argument for condemning at least some kinds of insider trading is that the practice is unfair, especially to outsiders without privileged information. Rarely, however, is it clarified what sort of fairness is involved. Rarely is it noted that alternative conceptions of fairness might produce different views on insider trading. Restrictions on insider trader must necessarily restrict certain people's rights, which might be perceived as unfair by those who find individual rights of prime importance. Rarely is the level of unfairness involved here compared to other kinds of unfairness that might be said to exist in the stock market, especially for those who don't have the resources to participate.

Some arguments for prohibitions on insider trading argue that they make the market more "efficient" in one way or another. ...

If it goes back in, the criticisms should reflect the specific kinds of insider trading that are illegal, because not all kinds of insider trading are illegal. Also, there should be no insinuation that the SEC has not given thought when making some kinds of it illegal. Stephen C. Carlson

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I'm glad Stephen removed my POVful rant. The follow up on the NPOV efforts, I'm wondering if the following isn't POVful:

Illegal inside trading occurs when the insider violates a fiduciary duty? or other relationship of trust and confidence in the process. Thus, some insider trading is legal and other is illegal, depending on whether there is a breach of trust.

Are "fiduciary duty", "trust", and "confidence" all technical legal terms? If so, this may be a NPOV statement, although the technical nature of the terms should be clarified, and a summary of what these terms mean in Average Joe's English should be provided.

I'd have to look all of my notes on the topic up, but yes fiduciary duty, confidence, and trust are all legal terms. Basically, a "fiduciary duty" is the duty that the law imposes imposes on all officers and directors of a company to act in the best interests of the company. There are two types of fiduciary duty: the duty of loyalty and the duty of due case. Of these duties, insider trading is concerned with the duty of loyalty. Note that his fiduciary duty does not apply to all employees of the company. The issues of breach of trust also apply to the attorneys, accountants, assistants, and other people the officers hire who have been entrusted with confidential information. Stephen C. Carlson

If these are not meant as technical legal terms, then this seems to imply that the SEC is omniscient and omnibenevolent in deciding what trades to make illegal. Among other things, it implies that it is clear as day how much trust in "the process" is required, whose trust must be ensured, how this is to be accomplished, what "the process" is to accomplish, who is supposed to benefit, etc.. --Ryguasu

Neither the SEC nor any other govt. agency is omniscient and omnibenevolent -- that's why there is a right to a jury trial. "In the process" is nothing mysterious just my terminology for "by virtue of the insider trading" without getting too repetitive. Stephen C. Carlson

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Information wants to be free

I'm not sure if this is what the author meant, but this could be a reference to the theory of rational expectations, which says that (at least in securities markets) the prices will converge to the same limit as if all traders had access to all information. To put it simply, if you have inside information, you cannot benefit from it without partially revealing it, because others can observe how you trade. CyborgTosser 20:28, 26 Aug 2004 (UTC)

what are the regulation related to insider trading

The SEC Insider Trading article should provide you with some insight. Rbcwa 01:33, 10 February 2006 (UTC)

"Ratios" section removeal...

Note: I removed this secction because, as written, it's more confusing than it is useful, IMO. It seems like it contains an interesting point (executives often don't acquire their stock on the open market) so if somebody can figure out how to reintegrate it that would be good. --Robert Merkel 00:47, 8 Feb 2005 (UTC)

Ratios

Why does insider selling always oustrip buying by volumes? For example: (2004)

• "Month" "$ Value Sells" "$ Value Buys" "Sell / Buy Ratio"
• DECEMBER $7,414,582,159 $464,231,802 15.97
• NOVEMBER $12,606,254,699 $710,053,742 17.75
• OCTOBER $5,080,665,973 $306,684,065 16.57
• SEPTEMBER $6,479,040,607 $463,166,914 13.99

By being awarded options, many executives don't have to purchase shares on the open market in order to increase their holdings. And option exercises (stock is bought, or given by company if it's employee stock options) isn't included in the stock buy number. However all option exercise have to be reported to the SEC on a "form 4" since the Securities Exchange Act Of 1934. And could theoretically bring down the sell/buy ratio. ue Sells" "$ Value Buys" "Sell / Buy Ratio"

• DECEMBER $7,414,582,159 $464,231,802 15.97
• NOVEMBER $12,606,254,699 $710,053,742 17.75
• OCTOBER $5,080,665,973 $306,684,065 16.57
• SEPTEMBER $6,479,040,607 $463,166,914 13.99

By being awarded options, many executives don't have to purchase shares on the open market in order to increase their holdings. And option exercises (stock is bought, or given by company if it's employee stock options) isn't included in the stock buy number. However all option exercise have to be reported to the SEC on a "form 4" since the Securities Exchange Act Of 1934. And could theoretically bring down the sell/buy ratio.

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Wall Street and the Free Market

There's a certain implication that because America is the Land of the Free and Wall Street is located there, that the stock market is a demonstration of the free market at work. Yet at the core of all the trading laws in place to control the market for our protection is this idea that insider trading is against the rules.

A "free market" means that if there is a willing buyer, and a willing seller, a trade can occur. Each side feels that they are ending up better off than they were before.

Information is the most valuable commodity. When any commodity is in short supply, entrepreneurs will search for a way to provide that scarce item in return for a profit. Where information is lacking, entreprenuers will see that the information is spread as widely as possible.

Insider trading laws are difficult to enforce. A stock tip spreads by word of mouth, rumor to rumor, until it reaches a particular fellow who buys the stock. Even a small amount of information is very useful, and it takes very little effort to deliver that information. If I sit outside a factory wharehouse and count the shipments leaving the big bay doors, I now have information that was not made available to the all the public at the same time. If I now know that sales are up 50% this quarter, I have information that could put an executive of that company in jail, if he had told me.

On the other hand, if you allow "insider trading," the information can be freely distributed as soon as it is discovered. Newsletters of stock tips can be distributed to whomever is willing to pay for them. If people want to know, the details will come out.

This benefits the "average" stock investor because now he has a chance to buy the newsletter of hot tips, instead of sneaky insiders being the only ones to have the info.

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Bizarre argument

I would like to remove this paragraph:

Advocates of legalization sometimes also make free speech arguments. Imprisoning someone for telling someone else about a development pertinent to the next day's likely stock moves would seem, prima facie, to be a punishment of prohibited speech, i.e. an act of censorship.

It doesn't make sense. Insider trading as I understand it is the act of making deals based on privileged information, not on disseminating the information itself. I would have just ripped out this text, but do these "advocates of legalization" really make such an argument? If they do, then the text should remain, and I will add a sentence explaining that it doesn't make sense anyway. Jeeves 13:26, 21 Apr 2005 (UTC)

Actually, the SEC does prohibited disseminating the information in some cases. And, free speech arguments are made. Here is a source: [1] Among other things, it talks about a case involving "Dirks" where a broker was punished for telling his clients nonpublic information so they could get out of their position and not lose money.RJII 18:17, 21 Apr 2005 (UTC)

Insider dealing = acting on non-public info. What you are talking about is Professional Secrecy. This should be interpretted exactly the same as is the case for lawyers and doctors. The only difference is that these two, popularly known for their professional secret, are not required by law to devulge the information even under court order. _└ ^VodkaJazz / _talk ^┐ 12:37, 16 May 2006 (UTC)

any source for this?

"Insider trading is usually performed by the already wealthy..." ? RJII 20:47, 15 November 2005 (UTC)

I would have thought it was pretty self-evident, actually. To get prosecuted for insider trading, you're generally either a stockbroker, a senior manager, or a director of a company. The most recent Australian example of somebody accused of illegal insider trading was Steve Vizard (he did a deal to avoid prosecution). In any case, to make any real money from insider trading you need access to a fair whack of capital - you might make substantial profit margins, but the ROI isn't as high as, say, robbing a bank with a shotgun and balaclava. --Robert Merkel 11:57, 17 November 2005 (UTC)

I wouldn't consider your average stockbroker as "wealthy." And besides stockbrokers I'm sure a lot of insider trading goes on among professional traders --I know most of them aren't wealthy either. Also, sure you need "access" to a decent amount of capital to make a substantial profit, but you don't need to be wealthy to have access to that. Check out some of the proprietary trading firms --the trader gets anywhere from 10/1 to 25/1 leverage. Put in 10K and you have access to 250K of buying power. Buy and hold on inside information of an upcoming buyout and, if the tip you've been told is good you've made a small fortune. I'm dubious about the claim that most insider trading is done by the already wealthy --I would think most of it would be done by those of more modest means. Now, as far as prosecutions go, it's possible they only go for the wealthier people but I'd have to see evidence of that as well --I have seen cases made against small-time stockbrokers as well. RJII 13:19, 17 November 2005 (UTC)

Trial by jury

POV material moved from main article:

"(an obvious drawback of trial by jury)"

This is an editorial, and a debatable one at that. One of the biggest benefits of trial by jury, at least in theory, is that randomly selected jurors have a hard time understanding, and therefore convicting under, arcane and confusing laws. This is, again at least in theory, one of the factors that ensure that laws are at least somewhat understandable by the public, or at the very minimum, that incomprehensible laws are difficult to enforce. This would be an example of exactly this happening. Calion 02:16, 7 December 2005 (UTC)

Martha Stewart

"Martha Stewart: Living Went to jail for insider trading."

It's important to note that Martha Stewart did NOT go to jail for insider trading, but for lying to a federal agent. Calion 02:16, 7 December 2005 (UTC)

Right. And her case may even be too tangential from insider trading to even mention. RJII 04:06, 7 December 2005 (UTC)

i remember reading somewhere that the main reason she wasn't tried for insider trading is that the prosecution didn't think an average jury would be able to understand the details. i have no source for this other than my memory though. --dan 23:30, 23 September 2006 (UTC)

Legal Insider Trading

The current article seems to have a limited amount of information on legitimate insider trading. Does anyone have a problem with me contributing more information on legal insider trading?

Rbcwa 01:22, 10 February 2006 (UTC)

Go for it. RJII 04:34, 10 February 2006 (UTC)

I'll do that! Rbcwa 04:57, 10 February 2006 (UTC)

What is the FEA

Anyone know what the FEA is. It is referred to in the Trading by "insiders" of a corporation section. Rbcwa 01:32, 14 February 2006 (UTC)

Intro improvements

I found the intro as formally written in serious need of improvement. The term "insider trading" should have been bolded as per Wikipedia style guidelines. Since the term is largely used to refer to the illegal practice i felt it should be made clearer that this is how the term is most often used these days. It didn't feel that the use of bullet points to describe the separate uses of the term for legal and illegal practices was the best way to convey the info in this case and thus incorporated the different definitions into the intro paragraph instead. --Cab88 11:12, 21 February 2006 (UTC)

As someone who monitors the 1000+ recorded insider transactions each business day I think the legal kind is very common as well. I think that by highlighting the illegal kind of insider trading only colors the article with a non-neutral tone. I don't mind folding the bullets into the paragraph.

Rbcwa 17:24, 21 February 2006 (UTC)

This needs a lot of improvement

More than half of this article seems to be very impassioned arguments for making insider trading legal. Subtract the passion please (its POV). I think the law deserves to be explained in full. There are many cases that could be mentioned, and the court's theories as well as your own private (insider) ones.Smallbones

That is because there really are few arguments in favour of insider trading laws. The section does not provide a cogent exposition of the arguments against, but it is difficult to provide POV when there really is little by way of an opposition argument other than various a priori arguments (such as certainty; a specious argument at that) and a perverse attempt to apply morality to markets with bizarre conclusions as to what constitutes 'fair' (e.g. all participants have equal information is 'fair' versus all participants are unfettered and free to buy and sell information as a commodity, like any other, albeit with different costs) 144.135.253.137 06:48, 31 March 2006 (UTC)lambsy.

Despite the "few arguments" in favor of insider trading laws, every significant financial market in the world now outlaws the practice, if for no other reason than the practical: markets that prohibit insider trading perform much better than markets that don't. There has been a considerable amount of economic and legal research (e.g., La Porta, Schliefer, et al.) showing that companies listed in countries with strong anti-insider trading laws are able to access capital at considerably lower cost than companies listed in countries with lax insider trading laws. (70.92.247.123 03:51, 4 April 2006 (UTC))

Avoiding edit war

The last 2 edits where essentially - this needs to be taken out - no, this needs to be left in. This logic will just lead to a lame edit war. let's avoid this. As in the comment above, I think this article needs a lot of improvement. Much of it is written from a point of view of "let's remove these silly laws!"

First let's divide up things into two sections 1. why the laws are there and how they are justified and 2. criticisms of the law. I do think that part 2 should address why they don't think insider trading is fraud, i.e. misapropriation of corporate property (information). If we can get 2 reaonable sections like this, then maybe a good summary may be possible putting together both parts. Smallbones 14:57, 8 March 2006 (UTC)

Sounds good to me. Rbcwa 19:51, 8 March 2006 (UTC)

Geologists by analogy

I suggest deleting the following in the "arguments for insider trading" section:

Also, legalization advocates question why activity that is similar to insider trading is legal in other markets, such as real estate, but not in the stock market. For example, if a geologist knows there is a high likelihood of the discovery of petroleum under Farmer Smith's land, he is entitled to make Smith an offer for the land, and buy it, without first telling Farmer Smith, or competing potential buyers, of the geological data and reasoning that justify his interest. If the value of the hidden oil can be acquired in such a manner in real estate transactions, legalization advocates believe that the 'hidden value' of stocks should be allowed to be acquired in a similar manner.

The reason I suggest deleting this is because the example given above, in a securities market context, would not be illegal. The example above states that a geologist, who has specialized (but publicly available) training, guesses (albeit an educated guess) that there is oil under Farmer Smith's land, and he has no obligation to notify Farmer Smith of this guess when making an offer to purchase. However, if a hedge fund manager, through specialized training or a trading methodology he or she developed, "knows there is a high likelihood" that a company is substantially over- or under- valued, he or she doesn't have to notify the public of this guess, either -- and wouldn't be charged with insider trading if he or she conducted trades on this guess. The point is that the geologist above doesn't "know" that there is oil under Farmer Smith's land and certainly hasn't acquired this knowledge from a position of trust which assumes confidentiality. This is central to the "misappropriations theory" of insider trading that now underpins U.S. law in this area. Certain types of insider trading are illegal because the trader has access to "material, non-public information" that they gained access to, not through specialized training, skill, or intelligence, but because of a special position they are in. This would be akin to a geologist being paid by Farmer Smith to analyze his soil, discovers that there is oil under the property, fails to tell Farmer Smith about it, and then proceeds to try to buy Farmer Smith's property secretly through his sister. That would most likely be considered fraud.

Fundamentally, the "geologist" argument doesn't support the position being taken -- that activities similar to insider trading are permitted in different types of markets. Securities market trading analogous to the deleted paragraph is perfectly legal in the United States.

162.138.176.51 21:45, 14 March 2006 (UTC)

There are many scholars (the editor below, who agrees with you in the main, names two of them) who believe that the distinction has been fudged and that present interpretations of the law in the US do threaten securities trading analogous to the land trade in that example. I keep putting it back in as a summary of their arguments, and will keep doing so unless a better summary is offered. --Christofurio 14:10, 2 May 2006 (UTC)

== Arguments in favor of legalizing insider trading ==

There seems to be a consistent trend to argue in favor of legalizing insider trading. While there are certainly some legal scholars who support this view (Fischel and Easterbrook, for example), this is not the dominant view. Coffee, Langevoort, Seligman, etc. would definitely not fall into this camp. And to propose that insider trading laws are in danger of "evaporating" is plainly ridiculous. Over the past 20 years, laws against insider trading have evolved from a quirk of US law to nearly universal in every market in the world (even if not always enforced). (Epstein's Mother 06:01, 29 April 2006 (UTC))

The "trend" is not to argue for a position, but to represent fairly the fact that such arguments are made, by notable folk. My 'geographer' example, which you keep deleting, is an effort to summarize their arguments. For specifics, you might look at Thomas' argument in his dissent in the O'Hagan case, or at an article published in The Federal Lawyer soon thereafter, by one Christopher Faille. TFL, by the way, is the official publication of the FBA. --Christofurio 14:07, 2 May 2006 (UTC)

Let's look at this paragraph in some detail and see what's wrong with it (since it keeps returning). I have some sympathy for the position that insider trading laws are sometimes unclear or unworkable, but this paragraph seems to deny that there is any logic behind them. The arguments "for" and "against" should be properly summarized, but not passionately argued, or simply denied.

Also, legalization advocates question why activity that is similar to insider trading is legal in other markets, such as real estate, but not in the stock market. For example, if a geologist knows there is a high likelihood of the discovery of petroleum under Farmer Smith's land, he is entitled to make Smith an offer for the land, and buy it, without first telling Farmer Smith, or competing potential buyers, of the geological data and reasoning that justify his interest. If the value of the hidden oil can be acquired in such a manner in real estate transactions, legalization advocates believe that the 'hidden value' of stocks should be allowed to be acquired in a similar manner. Some people read the recent case of U.S. v. O'Hagan as a stretching of the concept of "fiduciary duty" to include the buyside, in other words the abolition of such a concept as a limiting principle. It is this reading which endangers our hypothetical geologist. Others dispute that reading of O'Hagan.

Problems with this paragraph: A. If a geologist works for Farmer Smith and buys Smith's land without telling him that he found oil on it, it is fraud (as I understand it). If the geologist works for himself, then it is not fraud - that's the same way the insider trading laws are applied in the stock market. The only controversial case might be if the geologist works for Farmer Jones - under the misappropriation theory this type of thing would be against the law in the securities markets - and I think that Farmer Jones would have some sort of complaint against his self-dealing employee in the land market as well.

B. The Supreme Court decided that 3rd party misappropriation of info is fraud in "the recent case of U.S. v. O'Hagan." They've been wrong in the past, of course, but you can't ignore the whole concept of fraud. To ignore the conflict of interest - the "insider" part of insider trading - is just to ignore the whole thrust of the law.

C. I just don't understand what the following means "Some people read the recent case of U.S. v. O'Hagan as a stretching of the concept of "fiduciary duty" to include the buyside, in other words the abolition of such a concept as a limiting principle. It is this reading which endangers our hypothetical geologist. Others dispute that reading of O'Hagan." Smallbones 12:58, 3 May 2006 (UTC)

O'Hagan wasn't an "insider" of the company whose stock he was trading on in any conventional sense of the term, any more than our geologist was an "insider" of the incumbent landowner. The older concept of insider trading was based on a notion of fiduciary responsibility -- such as the responsibility of a company's management to its stockholders. If someone is holding land in trust, then he has a similar obligation to the trustees. But the geologist doesn't have that either. To stretch the notion of an "insider" to outsiders (O'Hagan worked at the law firm representing the acquiring firm, whose stock he didn't trade in) without any fiduciary connection ... that's the problem here. --Christofurio 23:16, 3 May 2006 (UTC)

Are you suggesting there is a parallel between how a geologist might obtain the knowledge about how to assess the likelihood that there is oil under Farmer Smith's land, and O'Hagan's ability to assess the likelihood that the company would be engaged in a merger (and thus that the price of the company's stock would increase suddenly)? For the geologist, this information is specialized, but publicly available. O'Hagan, however, didn't learn this in law school. He got it by talking to his colleagues upstairs. In other words, this is information that is not publicly available, no matter what level of expertise you might have. It can only be gotten from someone in some kind of privileged position. The geologist is not in this position.

In addition, you are misreading both Faille and the Thomas dissent in O'Hagan. In the Faille article, the geologist example that you repeat here is used as an example of a problem that could arise in a different context if the O'Hagan logic was carried to its conclusion. It does not suggest that this analogy is completely apropos to insider trading generally (in other words, that the condemned activity is "permitted" in other markets.) The Thomas dissent is even clearer: Thomas makes clear that he believes that the fidiciary duty theory of insider trading is the correct test--it is most unambiguously not a critique of laws against insider trading generally. In both cases, the "limiting principle" is the key point, because both believe that the O'Hagan logic has no clear end until all information asymmetries are abolished. But even more generally, as Faille notes, information assymetries in real estate markets are prohibited on the sell-side. In other words, if you know your land is sitting on a toxic waste dump, you must report that to a prospective buyer. The reason for that is that, for most realistic purposes, a seller is much more likely to have good information about real estate than the buyer. (The classic "lemons" problem in economics.) In other situations, where the seller has better information, this information either came through public sources (which is also completely legal in the securities context, and the subject of this debate), or, as Christofurio notes, may also constitute fraud. In either case, your description is inaccurate.

Epstein's Mother 06:24, 11 May 2006 (UTC)

Yes, I am suggesting a parallel between the geologist and O'Hagan. You say that O'Hagan didn't learn about Pillsbury's value in law school. True, but the geologist in my example didn't learn about value of the particular plot of land at issue while studying for his Ph.D., either. He learned it from field work nearby. To complete Faille's example, suppose he rented the use of land owned by a neighbor of Farmer Brown and did some field work (soil samples, seismic tomography, whatever) right next to the boundary line. Then he is in something very much like O'Hagan's position. He is in a contractual relationship with Neighbor, who was briefly his landlord. Suppose even that he lied to Neighbor about why he wanted to use the land. Does that affect the example? I'm not sure that Neighbor has any cause of action even civilly, and I'm very sure there's nothing analogous to an insider-trading criminal action arising from that.

The point is, Geologist isn't buying Neighbor's land. He's buying Brown's. He was not in any fiduciary relationship with Brown. Even more important to my thinking, which is Faille's and Thomas' in all important respect (you're hair-splitting here): this ends up as an example of the proper working of the real estate market. The land ends up finding a more productive use than the one Brown had been making of it, which serves the public interest. At any rate, the article now includes the caveat "Others dispute that reading of O'Hagan," so I think its fairly stated as is.

Let me put it this way. There isn't a lot of room for "arguments in favor of the violation of fiduciary duties." So if your contention is that "insider trading" is just a synonym for "violation of fiduciary duties," then you'll probably want to delete anything that is offered as an argument in its favor as inherently confused. I understand that. But that isn't what the real-world dispute over insider trading is about. After all, if "insider trading" is simply a synonym for "violation of fiduciary duties," then why not just delete one or the other of those phrases from the American variant of the English language altogether? Well, because they in fact have different meanings, that's why. The dispute over insider trading in the real world is over (a) the extent to which "insider trading" has or hasn't come to include actions that --don't involve a fiduciary relationship, and (b) whether it is wrong to prohibit it in such cases. That is why the O'Hagan matter was controversial, after all, and the geologist analogy is useful in bringing this out. --Christofurio 19:08, 12 May 2006 (UTC)

This is, nonetheless, about information asymmetries. And there is a reason that information asymmetries are prohibited on at least one side of a real estate transaction--because the information asymmetry you point out in the geologist example is not intrinsic to one's position. Sure, the geologist could test the neighbor's soil and get a pretty good idea about whether there is oil under Farmer's land. But Farmer is perfectly free to test his own soil as well. There's nothing stopping him, other than a lack of common sense. From the buy-side perspective, however, there may well be information about the property that Geologist is just not in a position to know, even after reasonable due diligence. You only learn that kind of information by living there. Hence, most state property laws require that information to be disclosed. It is the same situation in an insider trading example. There was no way for John Q. Investor to know that Pillsbury was about to be involved in a merger. There was no way for O'Hagan to know this, either, except through his priviledged position. The information asymmetry is entirely positional, and the corresponding positional information asymmetry in real estate is also prohibited. That is the reason the geologist example isn't a good parallel.

I agree that there are some deeply problematic issues with the O'Hagan case. The difference between what I'm calling "positional" and "non-positional" is not necessarily clear in reality, and O'Hagan is expansive. But my point is that the true parallel to the geologist example is perfectly legal.

As for your point that the real issue is whether resources are being put to better use--well, sure, all things being equal. But would you say theft is justified if the thief can put the stolen goods to better use than the owner? Because that is what this is all about--the definition of fraud. (The Eighth Circuit decision that originally ran against the SEC in the O'Hagan matter stated that the SEC had exceeded its powers because only Congress had the power to define what constitutes fraud. The Supreme Court ruled against this decision when it said the SEC had the power to "prohibit acts, not themselves fraudulent under the common law or Sect. 10(b), if the prohibition is reasonably designed to prevent acts and practices [that] are fraudulent.") And that is aside from the purely utilitarian argument that insider trading undermines overall investor confidence and increases the cost of capital for all issuers. Epstein's Mother 06:15, 14 May 2006 (UTC)

Why would it hurt investor confidence? Confidence in what exactly? Confidence that no individual trader has more information than any other trader? Such confidence is not there in the first place. If there was such confidence, and it were true, the stock market would be very illiquid as all attempts to earn a greater than average profit would cease. And, it's very problematic to call insider trading "fraud." Fraud is stealing by deception. Where is the fraud? When insider trading was legal where was the fraud? Profiting in the market through having access to superior information is not fraud in any moral sense at all. So, why are people going to jail? If it were true that legalized insider trading would hurt investor confidence (which I think is false), then shouldn't that be up to private self-regulation such as the NASD? For example, if the NASD's self-regulation made insider trading against the rules, then they would simply bar an NASD member from trading in the NASDAQ if they had broken the rule. It's quite another matter for the government to come in and throw someone in jail for committing no moral crime at all. People are sitting in jail for "insider trading" right now that harmed no one --they've "stolen" nothing at all. If it wasn't fraud when it was legal, then how does it suddenly become fraud when it is outlawed? When looked at from a moral standpoint, it's hard not to see the evil (or moral crime) perpetrated by government when they send people to jail for insider trading. Sending someone to jail that has not committed a moral offense against anyone violates fundamental principles of individual liberty. Attempting to buttress investor confidence is all well and good, but at what expense? This moral argument needs to be covered in the article. RJII 08:15, 14 May 2006 (UTC)

Those are two separate issues. On one hand, you are asking about investor confidence, which is a purely utilitarian matter. You can easily imagine a situation where the overall society benefits from prohibiting an activity even though there is nothing instrinsically "immoral" about that activity. Most traffic laws fall under this category. Obviously, morality and the law are not necessarily linked, nor should they be. (There is a story that Judge Learned Hand once said farewell to Justice Oliver Wendell Holmes by saying, "Do justice, sir. Do justice!" Holmes responded by saying, "That is not my job. My job is to apply the law.") So saying the government throws people in jail even though they have committed "no moral crime" is meaningless. Of course they do. There are lots of things, up to and including speeding, taking drugs, paying for sex, etc., that may not be intrinsically immoral (depending on your moral system), but which might still land you in jail.

However, in response to the first part of the question, as I noted above, the problem with insider trading is not that one side has superior information, but how this superior information was obtained and used. If you obtain this information through superior research or better analysis, that's fine. But if you obtain this information because you are in a special position, that's a quite different thing. To return to our beaten-to-death geologist example, imagine that Mr. Geologist doesn't learn that Farmer Smith has oil under his land, but, instead, his wife works in the mayor's office and has become aware that the city plans to build a new building complex on the property. Further, to avoid a nasty eminent domain lawsuit, the city council has just agreed to offer the owner of that land 3 times market value for the place. This decision was just made and is considered confidential. Ms. Geologist tells Mr. Geologist, tells him it is secret, and Mr. Geologist then goes out and buys the property from Farmer Smith. When the city's plans come to light, will Farmer Smith have a case against Mr. Geologist for fraud? Quite possibly. But, as in insider trading, it's not the superior knowledge that causes the fraud, but where it comes from and how it is used.

Deception, of course, is an integral part of insider trading. If John Q. Investor knows that you may well have special knowledge about a stock that would be impossible for the public to know--if, for no other reason, than you are in a position to influence the creation of that information (which would be the case if you were a senior officer of the firm)--would anyone in their right mind buy company stock from you without discounting the value put on that stock to adjust for the additional risk ? Of course not. Instead, the insider trader not only has to have special information that is not otherwise available to others (no matter how smart or how diligent in conducting research), but the insider has to convince the buyer (or seller) that the insider has no such privileged knowledge. This is what economists call the "lemon problem"--and that is why a new car suddenly drops in value as soon as you drive it off the dealer's lot. (Did that 5 miles really cause the car $5000 worth of damage? Obviously not. The problem is that if you try to resell the car after only 5 miles, every prospective buyer is going to assume that you know something about that car that they don't, and offer you $5000 less because they believe the car must be a lemon.)

And this, of course, is where the damage to investor confidence comes in. If insider trading is common, all non-insiders (which, for any particular stock, is going to be the vast majority of potential investors) are going to assume that the market is dominated by those with material non-public information. They are going to assume the game is rigged. They will still play, but they will offer much less for the security (and demand a higher return) to compensate them for the higher perceived risk. This means that issuers will have to pay more (in the form of returns) to attract capital. This applies whether the securities in a particular issuer are plagued by insider trading or not. The assumption will be that it is, and this is bad for issuers. Saying this is "fair" or "not fair" trivializes what this is about.

As for your point about the NASD, the NASD has no authority to punish investors, only the entities it regulates. It certainly has no authority to investigate this kind of conduct, except insofar as it is conducted by regulated entities (such as broker-dealers)--it cannot issuer subpoenas or compel witness testimony.

Fundamentally, the proof is in the pudding. There are lots of markets in the world where insider trading laws are not enforced. They do not perform as well as those that do enforce these laws. There is a reason that the US capital market makes up more than 50% of world market capitalization. (Epstein's Mother 04:54, 15 May 2006 (UTC))

Certainly before I support criminalizing conduct, I want to know that there are more definite boundaries to it than the notion of a "special position" or an "asymmetry." Of what kind? The notion of a fiduciary responsibility is a good deal more definite than those, but doesn't apply either to the geologist or to a member of the buyer's law firm trading on the stock of the target company.

As for our Farmer -- the proper sort of soil testing etc. may only suggest themselves to a mind properly prepared by a geological education. It isn't the Farmer's fault he doesn't have that education. It hardly means, in your words, that he "lacks common sense"! Some people have specialized knowledge, which they can get by their educational background or they can get by working in a particular law firm. Either way, it is all part of the process whence resources tend toward their most profitable usage. The analogy is a very good one for bringing this out.

Interestingly, Jeffrey Skilling was acquitted on nine of the charges against him. All of those nine charges were insider trading counts. Can we draw any conclusion from this? Hardly that the jury sympathizes with Skilling -- they convicted him on enough else to put him away for the rest of his natural life if the sentencing judge is so inclined. Still, the acquitted him of nine insider trading charges. A little bit of jury nullification, perhaps? Is the notion that the criminalization of "insider trading" is a bad idea percolating outward? Possibly. --Christofurio 17:01, 27 May 2006 (UTC)

To recall O'Hagan, the lawyer didn't get his specialized knowledge by being a lawyer. It wasn't the fact that he worked at a law firm. It was that he worked at a law firm doing a deal involving the company. Hence the information asymmetry. O'Hagan could have just as easily been the janitor, with all the professional knowledge about corporate finance that that entails. In short, someone who knew privileged information told him something, and O'Hagan knew that this information was priviledged and not to be traded on. And, at any rate, the point in question isn't an argument against expanding the law against insider trading beyond the fiduciary concept. It is an argument against prohibiting any insider trading. Likewise, fundamentally, the geology analogy is poor and, as a factual matter, misunderstands the law. The corresponding activity in the securities realm is not illegal. I won't try to remove it at this point, because such an edit war is pointless, but anyone reading it should be aware that you'd get that question wrong on a law exam if that were your answer. As for Jeffrey Skilling, unless you've interviewed the jurors, I think the suggestion that this is some kind of ideological jury nullification is a stretch at best, and completely unfounded. Seems more likely to me that, with all the wrongful activities involved in the collapse of Enron, insider trading presented the weakest case. According to O'Hagan, Section 10(b) and Rule 10b-5 are violated when "a corporate insider trades in the securities of his corporation on the basis of material non-public information." O'Hagan, 117 S.Ct. at 2207. Skilling sold lots of Enron stock despite knowing that Enron's financial statements were fraudulent. However, making the case, beyond a reasonable doubt, that each of these trades were consciously made "on the basis of material non-public information" is no small task. It will be interesting to see if this same result holds once the SEC's civil case against Skilling (with its concommitant lower burden of proof) is completed. (Epstein's Mother 03:29, 29 May 2006 (UTC))

The arguments against the criminalization of insider trading presented in the text aren't, any of them, necessarily arguments in favor of anything that might go by that name. SFAIK, everybody of any importance who has written on the subject would concede that some of the actions that do go by that name are wrong, and should be punished. Perhaps we need to make this point more clear in the text? I don't believe that Milton Friedman ever came out in favor of the violation of fiduciary responsibilities. The issue is whether the specific classification "insider trading" does more harm than good. And the geologist example helps make the case that it does harm, and why. --Christofurio 23:15, 31 May 2006 (UTC)

Milton Friedman is a great economist, but he is not a finance specialist. He's not really the best cite for this kind of thing, IMHO (let alone Thomas Sowell, who really is more of a columnist than an economist). But there are several economists and legal scholars--advocates of the "hard" version of the efficient market hypothesis--who would permit insider trading even by fiduciaries, unless there is a specific contract provision prohibiting it. Easterbrook and Fischel are probably the two most prominent. But the problem with the geologist example is that there is no distinction between what the geologist is doing in your example and what an equity analyst does, or what a negative researcher does for short sellers. And those are perfectly legal activities. As to your point that O'Hagan knows no limits, the Barry Switzer decision is still considered good law, even today. Epstein's Mother 03:43, 2 June 2006 (UTC)

If Sowell is so irrelevant, why did you bring him up? I didn't. I mentioned Friedman because, as you say, he is a great economist who has written about this subject and because his name is so widely known. Another example you might prefer is Henry Manne, former dean of George Mason University's law school. He has an article in the op-ed section of today's (June 13) WSJ, which promises to be the first of a two-parter, called "The Welfare of American Investors" which makes the case for "legalizing most insider trading." His bottom line is that "only those privately enjoined by contract or other legal duty from trading should be excluded" from the legalization he has in mind. That is, I submit, quite generally to position taken by advocates of reform in this area -- nobody is supporting the breach of a fiduciary duty. --Christofurio 11:50, 13 June 2006 (UTC)

Skilling WAS CONVICTED of one of the ten insider trading counts against himSmallbones 08:45, 29 May 2006 (UTC)

Good point. That's like saying because a jury only convicted a person of murdering 1 of 10 alleged victims, this must be a case of the jury believing killing someone should be legal. Epstein's Mother 20:41, 29 May 2006 (UTC)

I'll accept your analogy and work with it. Suppose someone opened up with a machine gun in a crowded place, and ten people died as a result. If the jury found this defendant guilty of 'only' one murder, and innocent of the other nine, wouldn't we have to suspect that something unusual had taken place? Especially if they had been properly instructed about transferred intent, etc.? I certainly didn't say that Skilling was convicted of all the insider trading charges against him. I said (accurately) that all of the charges on which he was acquitted were insider trading charges. --Christofurio 23:15, 31 May 2006 (UTC)

Wasn't the difference between the 9 insider trading counts that Skilling got off on, and the 1 he didn't, being that the first 9 covered sales he made throughout 2000, while the count he was convicted of was in mid-Sept. 2001? Seems like the government charged Skillings with insider trading on every trade he made after he started cooking the books, while the jury convicted him of only that sizable trade he made after it became obvious to him that the company was about to collapse. I think it's silly to say jury nullification had anything to do with it, unless you believe every acquittal is jury nullification. 162.138.184.71 23:31, 5 June 2006 (UTC)

Frankly, I don't know what the difference was, that was apparently crucial to the jury. I simply found the 9-to-1 ratio of acquittal on this subject remarkable, and so far I haven't seen that any of the reporters who have interviewed jurors have focused on this point. Have you? I'd like to hear from the horses' mouth, so to speak, what they thought they were doing, that's all. As you'll see if you scroll up a bit, I brought up nullification only by way of raising a possibility. There's a question mark there and everything. --Christofurio 11:54, 13 June 2006 (UTC)

Stock Option Back Dating

We should probably think about adding something about stock option back dating. It's a very news worthy thing in the investors press. Rbcwa 02:38, 30 May 2006 (UTC)

The question is whether it's insider trading or not. Legally, it's not as I understand it, but it seems parallel in its causes and might result in some insider trading later. But is this stretching things too far? Smallbones 07:37, 30 May 2006 (UTC)

There was an article on the FT about it a couple of days ago. It goes more with the Corporate scandals article though. _└ ^VodkaJazz / _talk ^┐ 16:43, 1 June 2006 (UTC)

Arguments section is far, far, far too long

Although it's true that there are a few economists who take issue with insider trading laws, at the end of the day the debate is not particularly high-profile, nor are insider trading laws particularly controversal in the larger field of economics or within society as a whole. Two or three paragraphs noting that there are some people who dispute the need for insider trading laws with a sentence or two summarizing the gist of their argument would be sufficent. This is an encyclopedia article, not an economics journal; we aren't supposed to present the entire debate here. --Aquillion 01:41, 28 June 2006 (UTC)

I think most of the editors of this page agree, but a few vigorously disagree. I'll just ask them to keep it short, avoid repetition, and do please at least address the arguements of the majority view that this is against the law, a violation of fiduciary duty, theft of corporate property, etc. Smallbones 20:10, 28 June 2006 (UTC)

Well, articles can change over time. Nobody seems to have objected to my suggestion, so if nobody objects in the next few days I guess I'll go ahead and start cutting. --Aquillion 16:58, 10 July 2006 (UTC)

Please go ahead, maybe I'll start a little bit. Smallbones 17:20, 10 July 2006 (UTC)

I think it's about half its original size. Comments, additions, deletions, etc. welcomed. Smallbones 09:10, 12 July 2006 (UTC)

2 questions on fiduciary duty

"For example, if a journalist who worked for Company B learned about the takeover of Company A while performing his work duties, and bought stock in Company A, illegal insider trading might still have occurred. Even though the journalist did not violate a fiduciary duty to Company A's shareholders, he might have violated a fiduciary duty to Company B's shareholders (assuming the newspaper had a policy of not allowing reporters to trade on stories they were covering)." i'm not following how this is violating a duty to company B's shareholders. assuming the paper had such a policy, then it would be a violation of company policy - the only legal duty would be for employees to follow policy, as far as i know - and if the paper had no such policy, then would there be anything preventing the purchase? either way, this doesn't seem like an example of insider trading to me. anyone with more (any) knowledge want to comment?

also, one of the classes of people that kept getting mentioned by this article as potential insider traders were "stockholders owning more than 10% of a firm’s shares". i can see why they might be more likely to get insider information, but what fiduciary duty could they owe to anybody? if i buy 10% of a store's hot dogs, i don't owe anything to the store's other customers. --dan 23:43, 23 September 2006 (UTC)

Regarding your first question, that actually comes from a real case involving a Wall Street Journal columnist and bought shares of a company based on insider information before writing about it in his column. You can read the case here (U.S. v. Carpenter, 484 U.S. 19 (1987)). Bascially, the argument is that the reporter committed fraud by denying his employer first use of the material (which the employer, Company B, would use to write about and make money selling newspapers.) There also is another theory (perhaps less of a logical stretch, if more controversial) called "fraud on the market." This approach is basically the theory taken in Basic v. Levinson, 485 U.S. 224 (1988), and is also the approach used in the recent European Union Market Abuse Directive (discussed in summary form here at the UK Financial Services Authority's website. The basic idea for this theory is that trading on any type of information "that is precise, non-public and likely to have a significant impact on the price of a financial instrument" (to use the UK FSA's language) is harmful to the efficiency of the market, because an efficient market is predicated on there not being insider trading. (After all, who wants to bet on a rigged game?) The argument is purely utilitarian--it's not a matter of "fairness," but effect. Of course, it's also pretty damn hard to outline the limits to what is permitted and not permitted under this theory (hence the controversy).

Regarding your second question, the 10% figure is defined by statute (the Securities Exchange Act of 1934) and what it requires is that anyone with 10% or more of a company's shares must file disclosures when they buy or sell company shares. (You also have to disclose when you buy only 5% of a company's shares, but that's more of an anti-takeover mechanism added later.) The idea is that someone who owns 10% or more of a company (as a practical matter, many public companies can be controlled by someone owning only 10% of the shares) might have access to inside information, so you want to see when they buy or sell. If it turns out someone with 10% or more bought or sold based on material non-public information, the company can sue the shareholder under the theory that those profits belong to the company (the SEC and Justice Dept. can also go after them, but that's a separate violation). More generally, a lot of traders look to these Form 4 reports (which also cover company officers and directors, not just big shareholders) to see whether "insiders" have faith in the company or not. Hope this helps. Epstein's Mother 02:19, 25 September 2006 (UTC)