Tuesday, June 17, 2014

Insider Trading is More than a Feeling

Insider trading, making stock market exchanges on information that has yet to be made public, violates US statute law (15 U.S.C. § 77a, 15 U.S.C. § 78a, SEC Rule 10b-5, & al), but more importantly, sanctions against jumping the queue, so to speak, have a common law pedigree. Nearly any statute that can be traced to English common law antecedent is likely to appeal to the inherited common sense of the median Anglophone.

Insider trading offends the sensibilities of even folks who otherwise have no direct interest in the goings-on of the finance industry. Poll your (non-economist) friends. Ask them to give one-word summations of insider trading. Don't be too shocked to hear words like "slimy" or "thieving" or "fraudulent" come up pretty regularly. We've got an idea of insider trading that well predates the Oliver Stone version of a greasy Gordon Gekko, and it's in the cigar smoke swirling round the head of the Mr. Moneybags plutocrat popularized by the should-be-banned-by-the-Geneva-Convention board game Monopoly. Insider trading is unfair, it's a breach of trust, it's greedy, profiteering. It's vile.

It's also information. If a firm is in trouble for whatever reason, active insider trading lets the market know ahead of time if the time is right to divest, maybe even convert the physical assets to a higher-valued use. But we block (and I can't stress this enough) through common law moral intuitions this information from being used. The Samuelsonian economist in me is aghast at the inefficiency.

But I'm bathed in the milk of euvoluntary exchange: I believe in the importance of examining morality without romance. Here, as in most instances of financial instrument exchange, folks' far-mode musings lead them to think of one and only one side of the exchange. Consider that for everyone who sells stock, there must also be someone to buy. If you're claiming that in an insider trading situation that the other side of the exchange is taken advantage of, you might consider asking how that happens.

Look, a contract is struck when there's offer and acceptance. If the GTM is offering to sell me his riding lawnmower from last year for five bucks, I might begin to suspect that something's up. If I investigate and find out that making the trade is still in my best interest, in what sense is he exploiting me? It's the same in the stock market. If Chrysler's management knows that production forecasts from last quarter were too optimistic and they attempt to take out a short position, who's being exploited? Production is weak one way or the other, it's got nothing to do with the paper claims against the firm. Nothing at all. the paper just lets management tell the market a little earlier. Prices, or in this case the offer of a price is information. No one says you have to actually buy the dang offer. Right?

My suspicion is that there's a confusion between intentions and incentives. The profit motive is icky, no matter how useful it might otherwise be. (Partially) overcoming this aversion was one of the finer upshots to emerge from the coffeehouses of London. Each time this hardy weed springs up it endeavors to choke the garden of prosperity. Keep your Roundup handy.

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Do you have suggestions on where we could find more examples of this phenomenon?