Do you know what insider trading is? Are you sure?
Insider trading is illegal. It’s part of our regulatory landscape. If you’re a corporate insider and have material, nonpublic information about a company’s prospects, you’re not supposed to profit from that information. This applies to insiders and anyone to whom they’ve provided information.
This seems straightforward, but the devil is in the details. What’s material? What’s information? Who’s an insider? Common sense isn’t always that common. The law is based some troubling court cases.
The first one is Dirks. Ray Dirks was a stock analyst who received information about a big insurance company: they’d been selling spurious policies to reinsurers and pocketing the cash. Dirks told the SEC and the press about the fraud, but they did nothing. He then told some institutional investors, and the stock fell over 40%. That got the SEC’s attention—they promptly censured Dirks. He fought the sanction all the way to the Supreme Court, which cleared him and noted that for folks to be guilty of insider trading, they need to try to profit from the information. Dirks never made a dime.
But the precedent was set: insider trading law isn’t based on a statutory definition but on aggressive action by the SEC. And that’s how they want it. Recently a worker at a company noticed a bunch of limousines at the headquarters and figured a buyout must be happening, so he bought some options on the stock. Most people would say that limos in the parking lot isn’t material, but not the SEC. To them, “material” is anything that could move the stock price. They went after him for insider trading. Again, they lost, but the employee had to time and money defending himself.
A vague law allows the regulators to bring as many cases as possible to burnish their own reputations, through settlements and sanctions, without ever having to go to court. Insider trading is wrong. It’s fraud. It shouldn’t be that hard for Congress to define.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!