ASIC propaganda: Insider Trading

Belinda Gibson – deputy chair at ASIC – has a warning against insider trading in the AFR masquerading as an op-ed. Basically a don’t-do-it-because-we’ll-catch-you piece. Okay. Not sure why that is an op-ed and not just part of an interview in the news section. But this bit caught my eye:

Our intolerance to insider trading is fundamental to ASIC meeting its priority of ensuring markets are fair and efficient.

But here is the thing – insider trading makes markets more informationally efficient. For that reason many free marketeers are suspicious of anti-insider trading laws. That’s on the assumption that increased market efficiency is a ‘good’ thing. But there is a trade-off. Insider trading also makes markets less operationally efficient. So the question is – what is the net effect of insider trading?

This is an empirical argument because it is possible to generate theoretical arguments for and against insider trading.

Laura Beny has done some very interesting empirical work on the issue and finds that those markets with stricter anti-insider trading laws also tend to have more dispersed ownership, more informative stock prices and greater levels of liquidity.

Utpal Bhattacharya and Hazem Daouk have found that enforcing anti-insider trading laws lowers the cost of equity to firms.

So at the margin there is a trade-off between informational efficiency and operational efficiency. Anti-insider trading laws add value to investors and market participants.

Having said all that, however, it isn’t clear that having a dedicated government agency enforcing anti-insider trading laws is the most effective way of enforcing those laws. Nor is it clear to me that insider trading should be a crime as opposed to a tort.

Henry Manne still makes some powerful arguments against criminalising insider trading.

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40 Responses to ASIC propaganda: Insider Trading

  1. I’m not fully across this, but if there were no laws against “insider trading” would that not create incentives for everyone to become an insider? Or to get as close to the action as possible? And how could that be a bad thing?

  2. Up The Workers!

    There’s nothing wrong with insider trading!

    Just ask “Honest Eddie” Obeid, half-owner of the A.L.P.

    (Or his sons. Or his wife. Or his nephews. Or his nieces.
    Or his cousins. Or his uncles. Or his aunties. Or any of his other relatives and dependents, bookcookers, beancounters, corrupt A.L.P. politicians, corrupt A.L.P. bureaucrats, etc., etc.).

  3. As I recall, insider trading is legal in New Zealand.

    That might offer an opportunity for an objective comparison.

  4. Nor is it clear to me that insider trading should be a crime as opposed to a tort.

    In that case, Sinc, you lack the most basic ethical sense. It’s completely clear to me.
    AFAIC, any spiv who engages in this practice should be treated exactly the same as the thug who ram-raids a liquor store.
    They’re both thieves – the difference is only in the colour of the collar.

  5. I am the Walrus, koo koo k'choo

    People tend not to want to participate in processes that are rigged against them, as markets rife with insider trading are. Especially when their hard-earned is at stake.

    So if you wanted to encourage popular participation in securities markets, you would want laws against insider trading, regardless of consequences for informational efficiency.

    Given that continuous disclosure laws require companies to make inside knowledge public as soon as practicable anyway, the benefits for informational efficiency of allowing insider trading are likely to be tiny. So the case for allowing some to profit from their privileged status, in order to boost informational efficiency, is quite weak.

    Don’t know how you could bring a complaint about someone profiting from insider trading under a tort. ‘He made money out of knowledge that I didn’t have’ is not a winning argument, especially when doing so is entirely legal.

  6. Pedro

    numbers, if you offer to sell some shares and I buy them at your offer price, how can you be a victim of a theft?

  7. .

    Insider trading is rarely worth the effort, even if legal, and seeing it is a crime just shows innumeracy and a lack of understanding of finance.

    The last high profile Australian case netted two young women aged about 24 – a whopping 25k all up.

    For pete’s sake they could earn more by putting in a bit more overtime through the year and earning a bigger bonus. No doubt the insider operation caused them to spend more time at work, with a lot of extra effort and stress.

    Insider trading can be explained in the context of portfolio management.

    However, this is simply picking on one industry.

    Real estate is rife with insider trading, as are airline seats.

  8. Harold

    There’s many different examples.

    A takeover is mounted and the insiders of the shark buy the minnow while it is low. The TO is aborted the insiders dump while it’s still high.

    Then you have the executives using the company – someone elses’ company – to make themselves money in the market. Their decisions are motivated by their own profits rather than what is best for the company they work for. Not simply insider trading but how do you prove their motivations?

    Markets are a shambles with insider trading free for all (insiders).

  9. numbers, if you offer to sell some shares and I buy them at your offer price, how can you be a victim of a theft?

    Providing we have equal access to information about their value – no problem. If this is not the case, it’s theft.

  10. Providing we have equal access to information about their value – no problem. If this is not the case, it’s theft.

    No, its an information deficiency. The only way I can see you can approach theft is if there is deception involved.

  11. Youngster

    I’m almost finished reading “The Hellhound of Wall Street” about the Pecora Hearings into the great stock market crash of the late twenties. I think it would be very difficult to conclude that insider trading had a net positive impact on the operation of the market in those days. It was not the only problem, but it certainly contributed to the bubble that developed prior to the crash.

  12. Pedro

    Harold, that is a fiduciary duty problem and covered by centuries of law.

    Nonsense numbers. It would be a rare purchase transaction in any area in which the parties have equal access to relevant information, which is why the idea of caveat emptor has been around since julius was a boy.

  13. Pedro

    Sure, Harold, but you don’t need specific insider laws to fix the particular mischief you identified, got it?

  14. It seems to me that any exchange should make its own rules; and decide who it wishes to attract, and how much it wishes to spend on enforcement. What business is it of the government’s?

  15. This is an empirical argument because it is possible to generate theoretical arguments for and against insider trading.

    So where is the empirical evidence that allowing financial markets to become an ethical free for all has any benefit in terms of informational efficiency?

    I find it difficult to see how a broker fronting running their client’s trades has any benefit at all in terms of informational efficiency. Or company executives trading on inside information ahead of the release of quarterly earnings statements.

    In both cases it only really serves to transfer wealth from counter-parties to those violating their ethical obligations with respect to the proper release of price sensitive information.

  16. Paul C

    Sorry? Is the original writer saying that one person having inside information is a more informed market? Surely that’s wrong. Either everybody has the information or no (traders) body has the information. A perfect market means a perfect level of information.

  17. Pedro

    Increased trading of a stock indicates that something is on thus increasing informational efficiency. That’s not so hard is it?

  18. Harold

    You’re pulling a long bow Pedro. There’s bugger all information about the underlying business in trading activity.

  19. Pedro

    Harold, what do you think is mainly driving prices, people reading the company reports or the existing movements in prices?

    Are you a lefty? Cause the ultimate lefty problem is that they’re not clever enough to realise nobody can be that clever.

  20. Harold

    Pedro have a look at BHP’s last hour of trading and come back and tell me what information was behind the trading decisions of that period.

  21. brc

    Allowable insider trading is like a tobin tax. Theoretically, the market will still function just fine. Actually, those with the cash will bugger off and find somewhere where they are less likely to have their cash taken from them for no reason.

  22. Pedro, where is the evidence of the size of the gain in informational efficiency?

    How does it benchmark against the gain in informational efficiency that would flow from more rigourously enforced continuous disclosure requirements?

    Continuous disclosure requirements enhance both informational efficiency and operational efficiency. Doesn’t that make it a policy no-brainer?

  23. Pedro

    So you don’t think people watch price movements Harold? You don’t think there’s something to be learned from a betting plunge or a sudden trading surge? Is that what you’re saying?

  24. Pedro


    1 Surely you can understand that price movements are information.

    2 Irrelevant to the question. Arguments about whether insider trading is imoral or theft are irrelevant to the question of whether there should be stronger continuous disclosure.

    3 No, you still have to ask the question whether the burdern of the disclosure rules is worth the benefit to market efficiency. The point of business is to make money for shareholders. Some of which will bne stock prices. Disclosure and other market rules like mark to market will also impact on management efficiency. So the balance is a fine one. I think you have to such that stuff and see.

  25. .

    Anyone who thinks offloading shares you are recommending to buy is necessarily corrupt simply doesn’t understand portfolio theory, and should shut up.

    What is worse is actually trading your risk against your own sales book to the detriment of your customer – such as shorting your clients who are long shares on margin.

  26. Harold

    Price movements are the equivalent of grunts and snorts Pedro they’re not even close to the rich information insiders are privy too.

  27. Robert Crew

    Sinc, this idea of insider trading as a tort rather than a criminal act has got me curious. Who would have standing to bring a case under such a situation? Wouldn’t it be better placed under contract law, e.g. the ASX sets its trading rules, which could exclude insider trading, but other markets might choose not to ban insider trading – then let the market decide which approach is better?

  28. Sinclair Davidson

    Robert – those shareholders who believe that they have been disadvantaged by the insider would bring the action. I also have no problem with individual markets setting their own rules. (The drive for anti-insider trading legislation is a push from the US).

  29. I am the Walrus, koo koo k'choo

    Robert, there wouldn’t be any trading on the ‘insider trading’ market because everyone would be suspicious of the other person’s reasons for buying or selling. ‘If she’s buying/selling, she must know something that I don’t – best not to be on the other side of that trade’.

    You can only trade on inside information if you can find someone who doesn’t suspect you if having that information. That’s why inside traders like current arrangements – the ban on insider trading gives punters enough confidence to trade, while the government’s indifference to its own laws means that it’s rare that anyone is prosecuted for the crime, despite its being quite widespread (from what I can see when following my own portfolio, anyway).

    Sinclair’s idea of tort law, rather than criminal law, as a remedy won’t fly. The problem with insider trading is that it damages public confidence in the integrity of the securities markets, without necessarily causing a loss to any individual or group of individuals. In such cases, and in the absence of any private-sector solution, it is sensible for the government to act in the interests of the community – which is exactly what it has done by criminalising insider trading.

  30. Robert Crew

    Walrus, I think it would be an interesting experiment. Investors are used to estimating risk, and if the choice were between a market with a higher level of informational asymmetry, but more accurate pricing, or the reverse, are you so sure everyone would prefer to trade in your preferred market? Maybe a majority would prefer the “wading pool” to the “shark tank”, but I doubt that preference would be universal, more another avenue for investors to decide the level of risk they were comfortable with? After all, Rene Rivkin discovered the hard way that insider information can be wrong, too.

  31. Leigh Lowe

    I suspect the biggest problem with “insider trading” is not those making a fortune, but rather those losing money on a hot tip which turns out to be a dud, either through ill-informed rumour mongering or deliberate ramping.

  32. Robert – those shareholders who believe that they have been disadvantaged by the insider would bring the action.

    So I loose say $10 000 how exactly am I going to sue a billion dollar hedge fund without being able to investigate whether or not they cheated me? We need the policeman on the beat and in reality they can only catch a few with their investigational powers so an individual shareholder that can’t investigate has no chance.

  33. I am the Walrus, koo koo k'choo

    Certainly an interesting experiment, but I don’t think it would get past that stage.

    People don’t want accurate pricing – they want pricing which favours them! Only the government and economists want accurate pricing, because the economists know how important it is, and they have managed to convince the government – in Australia, at least – of its importance for productivity and growth.

    But presuming people were brave enough to wade into the illiquid, shark filled waters, they would want to take out insurance against being traded against by better informed insiders. The way they do that is to lower their bids, if they are buying, or raise their offers, if they are selling. This has the effect of widening the bid-ask spread – increasing the costs of trading, and creating the operational inefficiencies that Sinclair mentioned in the post.

    Worst of all, from the perspective of efficiency, the widening of the spreads reduces the volume of trades, and makes the price jump about more than otherwise. That is, your market becomes illiquid and volatile – the absolute antithesis of the academics’ idea of an informationally-efficient market.

  34. Robert Crew

    Your argument makes a lot of sense to me, Walrus, but I’m keeping an open mind on this. I think there is quite a distinction to be made here between the psychology of an investor vs a speculator. The investor wants certainty – or at least a minimization of risk – so would welcome more stringent rules that impose a perception of fairness, while the speculator welcomes volatility and would prefer laissez faire. Doesn’t every speculator believe they know something the market hasn’t discovered yet? I think this is a key problem with one-size-fits-all (and that’s the only type government can do) market regulation – it doesn’t really fit anyone comfortably. As for insuring against the increased risk, that’s what hedging/diversification is for. If you go all-in on any investment choice, whether its a single stock, a single investment market, a single nation or a single super fund, you deserve to lose your shirt (and probably will!)

  35. I am the Walrus, koo koo k'choo

    Yes, I’m learning that lesson about going ‘all in’ on a ‘sure thing’ the hard way at the moment! I don’t think I deserve to lose my shirt, but I have to wear the consequences.

    It’s difficult to distinguish between speculators and investors. For example, Warren Buffett is seen widely as magnificent investor, but his secret is to take advantage of market volatility to buy low. Is he a speculator too?

    I think we’ve solved the problem of regulation. Set the rules for the market with the aim of reducing information asymmetries and preventing moral hazard and adverse selection, and in favour of encouraging informational, operational, productive and dynamic efficiency. Then let people work the rest out for themselves. That’s the libertarian way Robert, and it works brilliantly.

  36. How to get around insider trading.

    Broker “hey Bill (the client), the chart on sexy legs limited looks rather good.”

    Client “cool, buy me 100 gorilla’s at market.”

    Broker “done.”

    Impossible for ASIC to prove insider trading…

  37. It’s difficult to distinguish between speculators and investors.

    Most people are a bit of both. I have bought into the market now based on speculation that the market in Australia will do what it has done every other time and that is to reach a new high within 5 years. This means a roughly 35% gain in a year (even if it misses it, it will not be far off i my opinion). The other aspect is that the more it is seen as a certainty that the current Federal Government will be gone the market will rise. Does this mean I am a pure speculator, no. I have still chosen stocks I consider reasonable investments and the outlook for Australia is very good so long as we keep our AAA credit rating from all agencies without negative outlook. This means lower borrowing costs regardless of the RBA and is at least as large a positive as the currency being high is a negative for some local businesses. Access to reasonable priced capital or finance is number 1 for almost any business.

  38. .

    How to get around insider trading.

    Broker “hey Bill (the client), the chart on sexy legs limited looks rather good.”

    Client “cool, buy me 100 gorilla’s at market.”

    Broker “done.”

    Impossible for ASIC to prove insider trading…

    Hilarious. Talk about it in terms of technical analysis, and voila!

  39. Robert Crew

    But how can someone “lose $10 000” because of someone else’s insider trading? If I lose money buying a stock that someone else had inside information on, their inside information is not the cause of my loss, so I don’t think I would or should have standing to sue. The insider trader didn’t “cheat me”, I cheated myself by acting on inadequate information.

    Don’t get me started on Warren Buffett. He might once have been a great investor/speculator, but now he just seems to trade in government bailouts – he’s becoming more like Wesley Mouch every day.

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