When insiders trade

By Felix Salmon
April 4, 2011
audience at Thomson Reuters how he was buying "shadow equity" in Pimco on SecondMarket.

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On Thursday, Pimco CEO Mohamed El-Erian told an audience at Thomson Reuters how he was buying “shadow equity” in Pimco on SecondMarket. On Friday, John Carney put up an intriguing post alleging that deals done on SecondMarket are subject to insider-trading laws. If he’s right, it seems to me that almost anybody buying or selling shares of a private company on SecondMarket would be breaking the law, at least if that company puts out little or no public information about itself. And then today, on Sunday, Zero Hedge picked up on a passing comment in David Sokol’s CNBC interview, where Sokol said that Charlie Munger owned 3% of Chinese auto and battery maker BYD before recommending the stock to Berkshire Hathaway.

We can certainly assume that El-Erian knows material information about Pimco: he is the CEO, after all. And that such information is non-public. Should that then bar him from buying Pimco stock through SecondMarket? And as for Munger, assuming that Sokol’s allegations are true, first read Nocera on Sokol:

How is this not, on its face, evidence of insider trading? A guy buys stock in a company and then talks his boss into buying the company. The fact that his boss is Warren Buffett makes it even more “material,” to use the word the S.E.C. favors when it investigates insider trading. If a company executive trades on material information, knowing that he is privy to stock-moving news that hasn’t yet been divulged to other shareholders, he is likely to be committing a crime. When Warren Buffett buys a company, the stock price goes up. Everybody knows that.

If you apply this logic to Munger, with his monster personal 3% stake in BYD, he looks significantly guiltier than Sokol. Maybe this is why Buffett went so easy on Sokol: he didn’t want to set a precedent which would drag down Munger.

The SEC, when it goes after insider-traders, nearly always looks for trades in which third parties — people like Raj Rajaratnam — trade on information they’ve carefully cultivated from insiders, often taking great care to ensure the utmost secrecy of what they’re doing. But there’s a case to be made that much if not most insider trading is much more overt, and simply never punished. In this sense, pretty much every stock trade by any CEO is a trade done with knowledge of material non-public information. Those trades might well end up being disclosed, but that doesn’t make them any less insidery.

I’m not for a minute saying that all these trades should be prosecuted, although a zealous prosecutor wanting to make a name for himself might well feel like giving it a try. I do think though that people like David Sokol and Charlie Munger should ask themselves why they’re trading stock for their personal accounts in the first place. Is any profit they make ever going to be worth the possible downside in terms of public embarrassment?

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