Let’s say that Rajat Gupta, former director at Goldman Sachs on trial for insider trading, is toss in the slammer for passing on information four years ago. Let’s say that he really did receive — and then let slip — a tip that Goldman would soon be getting a nice cash infusion from Berkshire Hathaway, and that information was used by others to generate a nice profit.
Where exactly is the justice in locking the guy up? I see none. What precisely are investors going to get out of this? Absolutely nothing. What will it deter? Nothing again, not for an industry that rewards intelligence above all else.
If Rajat languishes in jail like Martha Stewart and so many others before him, the markets will miss his intelligence, taxpayers will be on the hook for providing for him for years, and he will be denied his basic human right to know and speak.
No victims of his actions will ever be compensated. And that raises an interesting point: Even if the worst is true, there were no victims, only winners. The people who sold the stock that day would have sold in any case. The people who bought would have bought in any case.
Whether he is technically “guilty” of passing on information or not, no one was robbed. No one was harmed. His only crime was knowing more than he should and acting on it, in a business that rewards people for good judgment based on specialized knowledge.
At worst, Gupta is guilty of breaking a confidence related to his employment, which should be a matter dealt with by the firm itself. The government accomplishes nothing here except to persecute some of the world’s smartest people, letting them know who is in charge.
What’s more, the whole basis for insider trading regulation is preposterous, especially in the digital age, and more obviously so by the day.
In regular life, if you want to keep a secret, there is really only one way: Tell no one. Most people figure this out in about the third grade. The more valuable the information you have, the more likely it is to make the rounds. And in so doing, the information changes and mutates and comes out the end in strange ways that are never entirely trustworthy.
The whole business of markets is to generate information. Information is the only defense we have against that intractable foe, the uncertainty of the future. There are no guarantees. It’s not just that you can’t know for sure what is true and what is not; even if you do know what is true, you can’t know for sure what the implications of that information are for the future price.
The public availability of information is the “socialist” side of the “capitalist” coin. Information that the market generates is ubiquitous, multipliable and incredibly transportable. But information is never distributed evenly throughout society, nor acted upon with equal acumen.
Do traders seek and obtain “inside information?” Absolutely. There’s no stopping it. The war on insider trading is going to be as successful as other government wars on tobacco, pot, illiteracy, obesity and terrorism. In each case, the only obvious result is that the government has more power and we have less liberty.
People who make trading their lives process hundreds of thousands of data bits every day. They pass on just as many or more. Research of trading habits reveals that the more successful the trader, the more information he or she processes coming and going.
Notice that we’ve never seen the government prosecute people for trading on inside information and losing. That’s because it never comes to the attention of the regulators. But then it’s perverse to punish only profitable actions.
Making secrets (material nonpublic information) illegal creates a government-owned and operated sword of Damocles that the regulators hold over everyone on Wall Street and in the industry. It is the constant reminder of who is in charge.
As an active trader on Wall Street hunting for any and all nonuniversal information, you’ll find at any point the SEC can requisition all your phone records, emails, text messages and more and claim that your winning trades were fundamentally unjust. You then go to jail.
As scholars of the Austrian School have long pointed out, there is no clear line between what is and what isn’t insider information. And here is the thing. The whole business of profitable trading comes down to acting on information that is not universally known or acted upon by others.
That’s their job. To make successful insider trading illegal in security markets is like punishing beauty in the fashion world or good meals in the restaurant industry. You end up only establishing a basis for arbitrary enforcement.
Back when the movie Wall Street was made, the big attention was focused on mergers and acquisitions. Today, it is all about earnings reports. Starting the day before they appear, people trading markets are bombarded by speculations, promises, bluffs and oceans of rumors.
What is reliable and what is not? This is the job of the entrepreneurial trader. Regulators are looking at only notably successful trades, finding the information revealed just before and then naming the parties as criminals. In the most recent cases, the SEC was even targeting even excellent research that so happened to be correct.
As Felix Salmon writes in Reuters, “The markets should be a game of people using independently obtained information and analysis to make their own determinations about what various securities are worth — that’s the best way to maximize the amount of information reflected in the price of those securities.”
What insider trading regulation neglects is that no information in the world guarantees a profitable result. Salmon cites the case of the Facebook IPO. The stock was deliberately priced low to create an upward swing that turned out not to happen. As Salmon says, “pricing securities, especially stocks, is always more of an art than a science.”
All the experts were wrong about Facebook, at least as far as the public knows. Some people were right this time, and those same people will be wrong next time. No one individual is ever smarter than the markets over the long term. This is why traders are voracious for information from any and every source. They are constantly correcting and improving their knowledge. This is the business of markets.
I would go further than Salmon and agree with Murray Rothbard that there is no basis for the government to be involved here at any level. It’s up to the firms themselves to police what information is revealed and in what time frame. Putting the responsibility on them will encourage a greater degree of openness and less reliance on nondisclosure contracts that are untenable in any case.
As for the regulations themselves, to imagine a world in which all trades take place based on universal, equally known information is to posit a world of robots, not human beings scrambling for knowledge and making speculative judgments about an uncertain future. To punish a robot that has come to life and made a good bet is to kill the very thing that makes markets both human and wonderful.