How and whether to fight insider trading
Jim Surowiecki has an excellent column on insider trading this week. He claims — without hyperlinks it’s hard to judge this, but I do trust him — that the increase in insider-trading prosecutions isn’t just a reflection of increased prosecutorial zeal, but actually reflects a real uptick in insider trading itself.
Surowiecki sees three main reasons why this might be happening. The first is Reg FD, which made it unambiguously illegal to tip well-connected traders with inside information. The second is Sarbanes-Oxley, and the general “proliferation of consultants” which has both increased the number of places from which inside information can leak, and which has increased the amount of deniability that any leaker enjoys. Finally, there’s the fact that companies “have a much better real-time sense of how they are doing”, these days, which increases the amount of time that information has to remain secret before it is made public in quarterly earnings reports.
Surowiecki has a potential solution to these problems:
In a world where companies increasingly know about their business in real time, it makes no sense that public reporting mostly follows the old quarterly schedule. Companies sit on vital information until reporting day, at which point the market goes crazy. Because investors are kept in the dark, the value of inside information is artificially inflated… More consistent, if not real-time, data about revenue, new orders, and major investments would help investors make more informed decisions and, into the bargain, would diminish the value of insider information.
This makes a certain amount of sense to me. Indeed, it wouldn’t surprise me to learn that Google, or Amazon, could quite easily provide daily rather than quarterly financial statements, with the quarterly statements basically just being a reprise of information the company had already made public over the course of the quarter. Doing so would be quite Googley, actually.
But there are two reasons why most companies would never go down such a road. The first is just that they’re not technically capable of doing so. And the second is that most companies reflexively seek to keep control of their financial information. Reg FD has stopped them from picking and choosing who gets the information, but they can at least control what information they disclose, and when. Most of the time, they err on the side of disclosing less rather than more, since information is power and the company wants to keep power for itself rather than make it public.
In fact, companies don’t really care whether there’s insider trading going on in their stock. Indeed, as Surowiecki says, in the days before Reg FD they would actively encourage such trading, by dropping tidbits of information into favored analysts’ laps. So long as the information is going to come out anyway, the company should try to curry some favors from it somehow.
The point is that insider trading is a pretty victimless crime: the main damage it does is just to trust in the level playing field of the stock market, and that trust has been damaged much more greatly by various high-frequency algobots than it has by insider traders. If you’re a buy-and-hold investor, you won’t be hurt by insider trading; if anything, the broad knowledge of its existence will just make stocks that much cheaper for you to buy.
So why go to such great lengths to try to stamp it out? The SEC seems to be concentrating on insider-trading prosecutions almost to the exclusion of everything else, and it would cost corporate America billions of dollars to move to Surowiecki’s world of continuous data dissemination. I do understand that we should prosecute things which are illegal, and that there’s something deeply unfair about people making money from insider trading. But let’s not lose sight of the big picture. We’re already spending too much money and effort fighting insider trading, and, as Surowiecki shows, it’s a fight we’re losing anyway. My guess is we’d be better off if the SEC trained its considerable resources on fraud and real abuses of small investors, in the knowledge that there might be a bit more insider trading at the margin. It wouldn’t be an ideal world, but I think there would be more real benefits for the cost expended.