The WSJ reports that:
On the morning of March 15, stocks stumbled on news that a key reading of consumer confidence was unexpectedly low.
One group of investors already knew that. They got the University of Michigan's consumer report two seconds before everyone else. ...
The early look at the consumer-sentiment findings comes from Thomson ReutersCorp. TRI.T -0.18% The company will pay the University of Michigan $1.1 million this year for rights to distribute the findings, according to the university. Next year, it will pay $1.2 million.
In turn, Thomson Reuters's marketing materials say the firm offers paying clients an "exclusive 2-second advanced feed of results…designed specifically for algorithmic trading."
The Journal found a law professor to criticize this activity:
This is a "blind spot" in U.S. law, said Richard Painter, a former Republican White House ethics lawyer. Groups, he said, should "not be allowed to selectively disclose market-moving data to people who pay more money—that is not right."
Sadly, however, the Journal failed to find a law professor to defend the practice. Accordingly, I will step into the breach.
At the outset, I should acknowledge that Prof. Painter and I are old friends. He's a very, very smart guy with a vast store of knowledge of both ethics and securities law. But I think he's wrong here.
First, this sort of trading activity is clearly legal. The Supreme Court long ago rejected the argument--which seems implicit in Painter's objection--that insider trading regulation should seek to ensure that all investors had equal access to information. As the late Supreme Court Justice Lewis Powell explained in Dirks v. SEC:
We were explicit in Chiarella in saying that there can be no duty to disclose where the person who has traded on inside information “was not [the corporation’s] agent, ... was not a fiduciary, [or] was not a person in whom the sellers [of the securities] had placed their trust and confidence.” Not to require such a fiduciary relationship, we recognized, would “depar[t] radically from the established doctrine that duty arises from a specific relationship between two parties” and would amount to “recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information.”
Here, the people who trade on the basis of the information they bought from Thomson Reuters are not agents or any other species of fiduciary with respect to the corporation in whose securities they trade or the investors with whom they trade. (This is even more so where they trade in derivatives based on the whole market rather than individual corporate stocks.) As the Journal thus correctly reported:
Even as securities rules bar companies from selective data disclosure, and as authorities vigorously pursue insider trading in all its forms, no law prevents investors from trading on nonpublic information they have legally purchased from other private entities. Trading would be illegal only if the information was passed through a breach of trust, said securities lawyers.
"If someone gives you permission to use the information, then there is no problem," said Steve Crimmins, a former Securities and Exchange Commission enforcement official now at law firm K&L Gates LLP.
Painter knows this, of course, which is why he called it a "blind spot." But is he correct in implying that the law should be changed? No.
If you believe, as I do (see this article), that the law of insider trading is a species of property rights in information, then insider trading ought to be illegal only where the inside trader's use of the infiormation involved a breach of fiduciary duty, misrepresentation, or theft. Where the source of the information voluntarily sells information to end users, there has been no violation of the source's property right in that information and, hence, no basis for liability.
As Judge Ralph Winter explained in his separate opinion in United States v. Chestman:
Information is ... expensive to produce, and, because it involves facts and ideas that can be easily photocopied or carried in one’s head, there is a ubiquitous risk that those who pay to produce information will see others reap the profit from it. Where the profit from an activity is likely to be diverted, investment in that activity will decline. If the law fails to protect property rights in commercial information, therefore, less will be invested in generating such information.
Conversely, if the law does not allow producers of information to profit from the sale of that information, there also will be less invested in producing such information. The Supreme Court recognized this point in Dirks, where it explained that insider trading law must be carefully applied so as to avoid punishing market analysts:
Imposing a duty to disclose or abstain 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, which the SEC itself recognizes is necessary to the preservation of a healthy market. It is commonplace for analysts to “ferret out and analyze information,” … and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts obtain normally may be the basis for judgments as to the market worth of a corporation's securities. The analyst's judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation's stockholders or the public generally.
Precisely the same analysis applies here. If this so-called "blind spot" were to be patched with legislation banning such transactions, the effect will not be to ensure that all investors have equal access to this sort of information. Instead, the effect will be that nobody will have access to it because such information simply won't be produced:
Richard Curtin, an economist who runs the university's survey, said he knows the deal gives an advantage to select investors.
"Hardly anyone would pay for it if they didn't see a profit motive," Mr. Curtin said. Later, he added: "This research is totally funded by private sources for the benefit of scientific analysis, to assess public policy, and to advance business interests. Without a source of revenue, the project would cease to exist and the benefits would disappear."
And that would help nobody.
