There is no very good intellectual case to be made for the present state of the law on “insider trading” in the United States.
I say this because Iāve been attending (too closely) to the predicament of former hedge fund manager Ralph Cioffi. Allow me to summarize that predicament briefly: Working within the Bear Stearns fold, Mr. Cioffi founded two hedge funds with absurdly long names, both of which sought to make money in the structured credit markets. In late March 2007, according to prosecutors, Mr. Cioffi transferred approximately $2 million of the money he had personally invested in one of those funds to another hedge fund. That transfer is the basis of the insider trading charge.
Please ignore the other charges against Mr. Cioffi for the moment and focus on that one. Wouldnāt a rational response to news of that transfer be: So what? After all, the transfer didnāt mean that he no longer had, as they say, skin in the game. He still had $4 million worth of skin in that particular game!
When I talk to people about such issues, one common response is: all market participants know that the prohibition on insider trading is the rule, so they ought to respect the rule. This implies that the reason āinside tradersā make such unsympathetic figures isnāt because the prohibition makes any sense, itās simply because the rule exists.
But so did the old rule against going 55 miles an hour on the highway. It, too, existed. It came about as a knee jerk reaction to the first oil shock in the early 1970s and never made a lot of sense. In time, enough people questioned its wisdom so that, on much of our highway system, the rule has since changed. Drive up to 65 without fear of the patrol car! Surely if we decide that a criminally enforced ban on insider trading (understood as including such acts as Mr. Cioffiās) doesnāt make a lot of sense either, we can and should change that one, too!
Furthermore, it is very clear when weāre going more than 55 or 65 miles per hour. Either we have a functioning speedometer or itās easy enough to get one. It isnāt always so clear what constitutes āinsider trading.ā
Some cases of insider trading do, it is true, imply some breach of fiduciary duty. But the law already has a name for the breach of fiduciary duty. It is ā¦ ābreach of fiduciary duty.ā When a particular trade by an insider fits that description; it can be treated under that heading. There is no need for a separate category of thing, an āinside trade,ā which only very imperfectly overlaps with that.
The prohibition came out of the collective noggin of the judges of the second circuit in the Texas Gulf case, in 1968, on the basis of nothing better than the vague idea that buyers and sellers should be equally well informed. This is a worthless idea, and although the courts have since retreated from the extreme statements of that unfortunate start to this line of precedent, they havenāt retreated nearly far enough.
A more-or-less incidental passage within Joe Noceraās recent book, Good Guys & Bad Guys, makes a related point. Itās in a reprinting of a story Mr. Nocera wrote for GQ in December 1992, concerning Drexel Burnham and Michael Milken. [Mr. Milken was still in prison when the column was written].
For the record, Mr. Nocera occupies a āmoderateā position on the spectrum of reactions to Mr. Milken: he argues that the infamous financier was guilty of some crimes, but not of the worst of those of which he has been accused, and that his sentence was excessive. But what intrigues me about this article is one incidental comment about an unnamed subordinate of Mr. Milken: āāWhen a Drexel salesman heard that the corporate-finance department was buying a stock ā for what reason he didnāt know ā and then advised a client wanting to sell that same stock that he might be better holding on to it, was that an example of insider trading? Or was it something more innocent?ā
Good question. Indeed, itās a better question than Mr. Nocera (who soon drops the query) may understand. Because there is nothing extraordinary about such an instance, and because if there is no good answer to that question, then the courts and prosecutors who punish insider trading are in effect telling traders, brokers, bond salesmen, etc. that they have to drive 55 miles per hour or below ā and that they canāt use a speedometer, because none are available.
Personally, when I use the phrase āfree markets,ā I donāt mean the word āfreeā as an adjective. I mean it as a verb. Letās free markets.