The Need to Define Insider Trading

Gordon Crovitz in the WSJ argues:

Rather than the end of the story, however, the Galleon case is just the latest chapter in a drama about the proper role of information in driving markets. In a world where accurate information is usually considered an unambiguously good thing, the U.S. regulatory view has become that too much information is a bad thing. ...

Information flows these days are increasingly about networks, including information about markets shared by members of various communities. Traders use Web sites to compare notes on companies and use social media like Facebook to share information, looking for an edge. Sophisticated traders such as hedge funds draw on more selected networks such as their investors. As these networks expand, including online, it will become harder to know whether market-moving information originated improperly through an insider's breach or properly through gathering of information in other ways.

Or as one banker put it last week, "The hedge fund guys all have their windows open and one leg over the ledge," wondering if they also violated the insider-trading laws, even unintentionally. This uncertainty has its costs. In one of the few insider-trading cases decided by the Supreme Court, the focus was on the need for aggressive research. In Dirks v. Securities and Exchange Commission (1983), Justice Lewis Powell wrote that imposing insider-trading liability "solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts."

Stephen Bainbridge, a UCLA law professor, described on his blog this growing conflict between the need for more information to make markets more efficient and prices more accurate versus a regulatory focus on equal access to information. "The SEC has always wanted a rule of equality of access: If you have more information than anybody else, you can't trade." The issue: "Can the SEC prove not just that Rajaratnam had better access to information than the market generally, but that he got that information by being a participant after the fact in the tipper's breach of fiduciary duty?"

Until recently, the vagueness of the insider-trading laws were more of an academic topic than a core issue for how markets operate day to day. In today's world of immediate, global flows of information, markets need greater clarity about how information can be gathered and used. The lesson so far is that knowing when insiders violate their duty is easier than knowing when outsiders go too far in bringing accurate information to markets.

Comments

[save_the_rustbelt]

Jim "mad dog" Cramer says on his CNBC program that the hedgies can and do manipulate stock prices pretty much at will.

So where does that leave the integrity if the market?

I trade no individual stocks, I cannot compete with the hedgies and insiders for information.

(If you walk into a business conversation and you cannot spot the sucker, you are the sucker.)

[Mark]

One expects Gordon Crovitz to next author author a Journal missive on the need to accept that the sun rises in the east and sets in the west.

For a buck, Crovitz would clearly argue that east is west, west is east, and the sun merely a product of anti-Semites and Communists who want to rain (or is that reign?) on Milton Friedman's parade.