Insider Trading, Or Not

I actually kinda like talking about insider trading because it's a topic that can have a lot of gray areas in it and requires some legitimate careful thought.  Despite having worked on Wall Street for many years, I'm well aware that insider trading questions are frequently not cut and dry, which is why we were usually trained on the maxim "If you have to ask, don't do it."  I wrote a few posts on this topic earlier, but it's come back into play with a vengeance this week, with the crackdown on "expert networks."

Uninformed populist ragers will act shocked, and scream "OMG!  So wall street takes all of these industry insiders, re-labels them "experts" and then sells inside information?!!!  How unfair!"  Now, I just want to clarify one thing - the point of expert networks is to allow people who want to do real due diligence to get the information they need by talking to people who know what they are talking about!  The vast majority of the information in these sessions is almost certainly perfectly legal to share.  It's also entirely possible that there are people who mistakenly disclose information that they should not be disclosing and are guilty of misappropriating material non-public information - but I'd guess that they are a minuscule minority.  My point is only that expert networks are positively not inherently evil.  In an ideal world, this is how everyone would do research - talk to experts.  Instead, we rely on greed, the desire to make a quick buck, penny stock touts, and Cramer.  But I digress. (Here's a pretty decent description of Expert Networks)

Let me just give a few quick examples:  If you want to know about how ETFs work, you might pay to have a conference call with me, and I would explain it to you.  Talking to me, an expert in the field, is a great way for you to quickly get a grasp of a concept or industry in a short amount of time, without the journalist or mutual fund industry bias that you'll get reading white papers on the 'web.    

If you want to know about the effect the expiration of Apple's exclusive AT&T contract might have on the mobile phone industry, you might contact Gerson Lehrman (one of the "expert network" pioneers), who would (for a fee)  put you in touch with the former VP of sales for Sprint, who could explain the entire process to you.  Nowhere in the chain is the goal supposed to be to get the current VP of AT&T to comment on material nonpublic information about his company's subscribers or business plans.  The expert you are talking to knows this (or is supposed to know this!) also - and doesn't want to go to jail  or get fired just to make you rich and get $200 an hour for himself.    

If you want to understand the effect that higher fuel prices might have on Wal-Mart's distribution costs, you might talk to a shipping company about the number of miles they drive each year, and how that might change with economic conditions and higher commodity costs.  

If you want to understand the process by which BP will have to close down its leaking well, you contact an expert in the field who could explain to you in an hour what you might otherwise spend 2 weeks researching on your own. (A friend of mine actually mentioned that he talked to some Gerson Lehrman experts on this very subject, and they ended up being wrong about their prognosis!)

Is it possible that one might encounter a policy-ignorant industry insider who shares material non-public information?  Of course it's possible - but it's positively not the goal of expert networks.  The goal is to allow investors to gain an in depth knowledge of a business from people who understand that business.  Increased due diligence is a good thing, and  insider trading is a bad thing - but the two are not even close to synonymous.

Amazingly, in the wake of this week's FBI activity on insider trading, the boys at Themis, Sal Arnuk and Joe Saluzzi wrote and absolutely embarrassing article attempting to liken high frequency trading to insider trading.  Sal and Joe are not idiots.  I don't generally agree with their view of the use of technology in the markets, and view them as victims of the progress in technology, trying desperately to cling to their niche by maligning their opposition - but at least they usually try to make well reasoned, factually sound arguments.

Their piece today, however, was utter nonsense.  It's so bad that I hate to call attention to it, but it needs to be corrected, and it touches on insider trading topics I've addressed on this blog previously.  Themis writes (emphasis theirs):

"We believe that if the FBI and SEC feel that information that investors are getting  from some “expert networks” is defined as inside information,  then a case can be made that the data that the exchanges are providing could also be considered an “expert network”.  The question becomes is the information that the exchanges provide in their private data feeds considered “material, non-public information”?  It is certainly not widely disseminated but is it non-public information?  We realize that anybody can subscribe to the data feeds and this is most likely the defense the exchanges will use.  But is it realistic for most investors to subscribe to these data feeds and then establish the computing capacity to analyze this information.  The fact of the matter is not all investors are looking at the same information.  Whether this is technically inside information is not for us to decide."

Readers should have no confusion on this matter:  this is not non-public information.  In fact, it's quite public - it's available to anyone who wants to subscribe to it - for a fee.  Remember from my prior post - "public" doesn't mean you can get it online in 15 seconds via a Google search for free.  I've tried to repeatedly make the point that this is another reason why high frequency trading is a better model than the old NYSE specialist model:  the specialist model was a tight Old Boys' club - you couldn't become a specialist just because you wanted to and had the ability to - you had to crack the club.  It was positively non-public in terms of opportunity.  Today, however, the process has become democratized - anyone who has the ability and the means can compete in the world of high frequency trading, using PUBLICLY available data that doesn't cost millions of dollars a month.  It's not just the rich, it's not just men, it's not just certain ethnicities - it's democratized.

So when Sal and Joe write "whether this is technically inside information is not for us to decide,"  I can only hope that they are being intentionally disingenuous and that they in fact are fully aware that this is not anything that can even be intelligently debated as inside information, and are simply trying to write a fear/hype piece to mis-educate the masses.   Just because John has access to information that Jane doesn't have does not mean that John's information is non-public, or that he has some unfair advantage.  All investors are rarely looking at the same information - the important point is that investors have the opportunity to have access to the same information.  If you still don't understand this, please read PeterPeter's comment on Themis's Business Insider post, which reiterates a number of points I've discussed on this blog previously.

-KD

NOT Material Nonpublic Information

I opened up a high yield savings account with American Express Bank.  I mention it because I finally decided that there's no reason not to earn 1.30% with them instead of a few basis points at Etrade and Citi where the balance of my money is/was.   Anyway, I mention it because I've been absolutely bombarded with their ads everywhere I go online.  It's rare that I get hammered with advertisements for products which I may actually care about.

I called customer service today to ask about some electronic transfers I'm setting up, and after the agent answered my questions, I asked her if they'd been really busy lately.  She said that this high yield savings account campaign was the biggest ad-blitz they'd ever undertaken, and that they were extremely busy opening up new accounts.  I have no position or opinion on AXP stock, and I don't know what sort of deposit gathering The Street's analysts are looking for, but I'd expect AXP to garner a metric crap-ton of deposits this quarter.  I'm not sure what the implications of that are for them, but anyway.

note: for prior posts about the intricacies of identifying insider trading, see this and also this - good comments in those threads too.

-KD

Insider Trading Redux

Last week I wrote a post about potential difficulties in identifying insider trading.  The post and the comments are worth a read - if for nothing more than to illustrate how cloudy the topic can be.

Today, NYT Dealbook's Andrew Ross Sorkin visits the subject, with another interesting case:

"Have you heard about the railroad workers charged with insider trading?

Late last month, the Securities and Exchange Commission brought an unusual and colorful insider-trading case: It accused two employees who worked in the rail yard of Florida East Coast Industries and their relatives of making more than $1 million by trading on inside information about the takeover of the company.

How did these employees — a mechanical engineer and a trainman — know their company was on the block?

Well, they were very observant.

They noticed “there were an unusual number of daytime tours” of the rail yard, the S.E.C. said in its complaint, with “people dressed in business attire.”

The case is raising eyebrows — and some important questions — about what constitutes insider trading at a time when the government is taking a tougher line against Wall Street and white-collar crime."

later:

"The S.E.C. claims that Mr. Griffiths and Mr. Steffes acted on more than a hunch. The commission says that “shortly after the tours began, a number of F.E.C.R.’s rail yard employees began expressing concerns that F.E.C.R. was being sold, and that their jobs could be affected by any such sale.”

The S.E.C. also claims that Mr. Griffiths was asked by the company’s chief financial officer for a “list of all of the locomotives, freight cars, trailers and containers owned by F.E.C.R., along with their corresponding valuations, which she had never requested before.” Florida East Coast Railway, or F.E.C.R., was a wholly owned subsidiary of Florida East Coast Industries.

Is all of that material information? Clearly, it is all nonpublic. But without being told directly that a deal was in the works, did the men actually have inside information?

Sorkin relates a good rule of thumb, pretty much the same as the one I proffered in the comments of my previous thread: "A safe maxim might be: “If you have to ask if it’s right or wrong, it’s probably wrong.”

EDIT: thanks to commenter UrbanAnalyst for pointing me toward the official SEC complaint.  It's a must read for anyone wanting to comment intelligently on the details of this case.  

-KD

Insider Trading and Material Non-Public Information

One of the first things any new hire on Wall Street, or any executive in a publicly traded corporation, learns about is the laws pertaining to insider trading.  Individuals are prevented from trading on material non-public information, and from tipping off their friends to trade on such information as well.  The cases aren't always crystal clear in terms of legality, but this one seems pretty easy, and I would have gotten in wrong (although, on the correct side - the side that says "don't do it!")

From Bloomberg:

"Your senator learns that a much- maligned weapons system now has enough votes for funding. Before the news gets to a reporter, he buys shares in the arms manufacturer for a quick, handsome profit.

What’s wrong with this picture? Nothing, according to the law. Nor would it be illegal for him to tip someone else, say, his largest campaign contributor"

Now, it seems pretty clear to me that this is material non-public information.  What's the "reasoning" behind the legality of it then?

"Laws that criminalize insider trading cover corporate insiders and those they tip, but not specifically Congress. And while scholars differ on whether existing law could be applied on Capitol Hill, it hasn’t been."

I never really thought about the fact that insider trading laws cover only corporate insiders.  Congressmen are not corporate insiders, thus they are not covered!  Pretty surprising - if there are any securities lawyers in my audience, make your opinions known in the comments - could the existing law be applied to Congressmen?  There is another article linked to from the Bloomberg article that says that the answer is "no." (of course the whole point of the article itself is that the answer is "no!"  Actually, let me talk for just a second about the claim that linked article makes:

"This Comment argues against prohibiting trading on political intelligence by outside actors  (lobbyists and hedge funds) because these actors are merely the Washington equivalents of market analysts, whose information gathering functions are perfectly legitimate, if not desirable."

Huh?  Market analysts?  No - they are getting material non-public information from policy makers!  Just like it's illegal to trade on this information when it comes from company insiders, it should be illegal to trade on this information when it comes from policy makers.

It seems impossible to me that one could make the argument that if Congress is holding confidential talks about a bailout of the big banks, that it should be legal for Congressmen to trade on that information - or even that it is legal!  As the article notes, "scholars differ whether existing law could be applied on Capitol Hill."

“This is an area in which the public is quite justifiably suspicious about dual standards,” says Representative Brian Baird, a Democrat from Washington state. 

Along with New York Democrat Louise Slaughter, Baird has been trying to apply insider trading law to Congress through the Stop Trading on Congressional Knowledge bill..."

...

"But when it comes to forbidding members of Congress from using access to secrets for financial enrichment, Slaughter and Baird have gotten nowhere on their bill. Now Baird’s retiring. 

He says Congress could solve the problem without a new law or a repeal of an old one. 

“It’s not that we have laws protecting us,” Baird says. “We don’t have laws applying it to us.” 

All it would take is a change in ethics rules, which now generally forbid conflicts of interest and using official influence for personal gain.

EDIT - how about this from the SEC's website:

"Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information." 

Examples of insider trading cases that have been brought by the SEC are cases against:

-Employees of law, banking, brokerage and printing firms who were given such information to provide services to the corporation whose securities they traded;

-Government employees who learned of such information because of their employment by the government;"

I guess they are talking about something else other than policy makers?  Maybe, like, it's illegal for the Chairman of the FDA to short the stock of a drug company whose drug his administration is about to reject?

-KD