I came across an interesting article on NYT’s DealBook section the other day that documented the on-going appeal against insider trading convictions on behalf of two former hedge fund traders, Todd Newman and Anthony Chiasson. The two men were prosecuted by the office of Preet Bharara’s, who has a perfect conviction record (80 for 80) in insider trading cases.
DealBook notes that the court hearing the appeal is hinting that a reversal may be in the works, noting that: “In an hourlong hearing, a three-judge panel hinted that it might overturn the convictions, the first real threat to Mr. Bharara’s sweeping campaign as a United States attorney to root out insider trading on Wall Street.”
The case is being watched carefully on Wall Street, of course:
The appeal by Mr. Chiasson and Mr. Newman, which could take months to decide, has captivated the white-collar bar. A victory for Mr. Chiasson and Mr. Newman would offer a blueprint for traders to defend future insider trading cases and would imperil at least one other milestone conviction: Michael Steinberg, of SAC Capital Advisors, the once-giant hedge fund that Mr. Bharara indicted last year. When Judge Sullivan presided over Mr. Steinberg’s trial late last year, he provided a jury instruction similar to the one for the trial involving Mr. Chiasson and Mr. Newman.
Reading the story brought to mind the group of people who think there is nothing wrong with insider trading and prosecuting it is, at best, a waste of time and resources and, at worst, a harm to the market’s efficient price discovery function. Writing in 2009 in the WSJ, for example, Donald Boudreaux made the following argument:
Parsing the difference between legal and illegal insider trading is futile—and a disservice to all investors. Far from being so injurious to the economy that its practice must be criminalized, insiders buying and selling stocks based on their knowledge play a critical role in keeping asset prices honest—in keeping prices from lying to the public about corporate realities.
James Altucher, writing in the Huffington Post, also 2009, gave several reasons for which insider trading should be legal:
- The more information in a market, any market, the more efficient prices become. If informed investors start buying or selling based on privileged information, asset prices will rise to their “correct” level.
- Fraud will be exposed earlier. This is a very key point to the argument. Enron is an example where tens of thousands of investors got burned because they were piling into the stocks during the later stages of its fraud. If insiders were selling we would’ve seen a much swifter move down, and probable fraud exposed.
- Companies will either become more transparent, to keep the retail investor happy, or will themselves enforce secrecy rather than being complacent with the idea that the law somehow protects their secrets.
- One concern is that there will be a flight of liquidity because people will be concerned about the legitimacy of our markets. Rather, the opposite will occur. More enforcement dollars will be used to uncover actual frauds such as the next Enron or Worldcom. Arguably, these frauds are a thousand times more dangerous for the retail investor than what is probably a victimless crime such as insider trading.
- Insider trading is almost impossible to prosecute and the government wastes countless dollars trying.
I have written a lot about all the ills of modern Wall Street, but insider trading is not one of them. I happen to agree with Boudreaux and Altucher and think it should be made legal, primarily for the reasons that it would (a) move the market towards correct pricing more quickly and (b) further remove the illusion that retail stock prices really reflect the true value of a company. After all, which of the following scenarios is better?
- The CEO of a corporation who knows the company’s share price will take a major hit in a year quietly resigns, sells off his stock and waits patiently for the company to fail, even as outsider investors continue to support the stock.
- The CEO sells as soon as he gets the news, signals the market something is wrong, which allows the outsiders to avoid the stock in the first place.
For me, the latter is preferable, and so I have no issue with executives moving equity prices based on non-public information. Not only that, I think making insider trading legal would forces shareholders to require greater transparency, demanding to know what execs know at the same time. This would be good for business and investors.
Bottom line: it’s time to rethink the inefficient use of legal resources prosecuting a crime that should not even exist.