There seems to be an epidemic of insider trading cases these days. First we started with the Galleon indictment alleging that Galleon profited from receipt of material nonpublic information from a variety of sources, including an investor relations firm working for Google, corporate executives at IBM and Intel, and a partner at the McKinsey consulting firm. This has been followed by criminal charges being brought against an additional fourteen people including hedge fund managers, a trader, a broker and a M&A lawyer, with five of them already agreeing to guilty pleas.
All of this raises some interesting questions ranging from, “Where have prosecutors been for the past several years?” to “What have compliance officers been doing at these firms?” but what I want to focus on is the bigger picture, insider trading itself. As you would expect, a number of commentators have expressed opinions about insider trading, and some people have gone so far as to suggest that the penalties for insider trading should be abolished because it’s common and impossible to police. Even beyond that, a number of noted academics have argued that insider trading is good for the markets because it makes the market more efficient.
Let’s start with the basics; the case law and the statutes surrounding he use of material non-public information are, with a few exceptions, pretty clear. To greatly oversimplify: If you are in possession of such information and you received it as a result of a duty to the corporation, or from someone who has such a duty, or if you have misappropriated the information in violation of a fiduciary duty, you can’t buy or sell that security.
The insider trading laws in the U.S. really get to the issue of fairness in our securities markets and go all the way back to the Pecora Commission hearings following the stock market crash of 1929. The result of those hearings was that the public was outraged that bankers and stock market insiders could manipulate company information for personal gain. The Securities Act of 1933 and the Securities Exchange Act of 1934 were a direct result of those hearings and the U.S. emerged with the most transparent market system in the world. The prohibition on dealing in insider information has served our markets well over the years.
In sum and substance, you cannot allow people to benefit from information simply because of their position, nor can you allow them to leak that information to a select few. To do so would mean that the markets were a rigged game, and people’s faith in the markets would take a severe blow.
Because of the large sums of money at stake over inside information that traders can benefit from, there will always be a few people willing to test the system, from Dennis Levine and Ivan Boesky in the 1980’s to the Roomy Khans of today. But let’s be clear – these are not close calls. Everything I have read about the current series of cases involves people who knew they were going beyond normal everyday information gathering and into the realm of the illegal. The use of disposable cell phones to avoid detection and payment to sources of information are not things one normally sees in the normal information gathering process of analysts.
This is not a victimless crime – activities that bring disrepute on the fairness of the markets impact all of us because people will be less willing to commit capital to unfair markets. I have absolutely no sympathy for this type of crime and hope that prosecutors continue to bring cases where appropriate. Fortunately, I think we will continue to see these cases, as good prosecutors can make their bones on them – after all, look at what it did for Rudy Giuliani.