Lenore joins Judge Napolitano to discuss Insider Trading and Federal Subsidy Programs
Like many things in life, the issue of insider trading is very complex with many shades of gray. Even at Meritas Advisors opinions differ. Our Chief Operating Officer, Michael Mink, believes that incarceration is appropriate while I do not. Here are our opposing arguments.
Mike
Criminal penalties for those convicted of insider trading is one area where I will have to respectfully disagree with my colleague and partner, Lenore. Stock trades do not happen in a vacuum, and for each share of stock bought or sold by Mr. Rajaratnam and people of his ilk that is based on their access to material, nonpublic information, there is another party on the other end of that trade without access to that same information. Now, I realize that this goes on every day in the capital markets to some degree. However, that doesn’t mean that these laws shouldn’t be enforced and the wrongdoers pursued to the fullest extent of the law. And unfortunately, most of those convicted of insider trading still have millions in the bank after they are released from prison even after civil penalties are paid. It appears that while we still have laws against trading on material, nonpublic information, the threat of prison time acts as the most effective deterrent.
Lenore
While Mr. Rajaratnam’s actions are morally and ethically repugnant, insider trading should not be treated as a criminal act. Criminal laws ought to be reserved for those actions that are unambiguously harmful and incarceration reserved for those who are a danger to society. I think it is unnecessarily costly to society to pay for the incarceration of an individual that could otherwise be a productive member of society, albeit no longer in the securities industry. A lifetime ban from the industry and significant fines ought to be a significant punishment and deterrent for unethical acts and does not put an unnecessary burden on society.
The harm done to the counter-party is typically negligible as the “insider’s” trades have no impact on security prices, thus the insider’s information advantage would be material only if
(1) the information would have altered the counter-party’s decision to buy or sell AND
(2) if the decision to not engage in the trade would have lead to better returns AND
(3) if those returns from not engaging in the trade were superior to the transactions that would have occurred if the trade in question had been executed.
Clearly this is not unambiguously harmful for the counter-party, thus the complexity of the issue.
The enforcement of insider trading laws is inherently flawed as it can only patrol one side of the transaction, actual trades. It is impossible to identify the “non-trades”, meaning the trades that did not occur as a result of insider information. The law is simply unenforceable for the non trades, resulting in it being essentially perfectly legal to not trade based on inside information while illegal to trade, with both actions having equal meaning thus an inequality before the law.
The use and communication of inside information should be controlled through corporate bylaws, contracts and licensing. Violations are either a civil matter between the individual and the firm, or treated in a manner similar to a doctor losing his medical license. There is something intuitively incorrect with societal rules that allow medical malpractice which results in someone’s death to be addressed through fines and/or loss of license while insider trading that is of questionable harm results in jail time.
Bottom Line: This is a complicated issue, with valid points on both sides of the argument. At Meritas we believe it is important to respect differing points of view and seek to learn from each other’s perspectives.
