This morning I read this article on 538:
http://fivethirtyeight.com/features/whats-so-wrong-with-insider-trading-anyway/
And in this world, there would be much less reason for the insider to provide information to his brother-in-law. People complain about the unfairness... why does this guy get quicker info than I do, just because he is related to some banker? Well this would solve that problem too. Everyone would be one the same playing field, or at the very least, the playing field would be evened out quite a bit.
So this is what I really mean when I say I tend to agree with that statement. I agree that information is good, and I wish I lived in a world where the delineation between insider information and outsider information didn't exist.
Arguments against:
http://fivethirtyeight.com/features/whats-so-wrong-with-insider-trading-anyway/
For a while I have been of the opinion that insider trading is perfectly fine - it's a meaningless term with a blurred line. Aren't traders collecting and sharing information all the time? Who's to say when information transitions from "inside" to "outside"?
It seems to me that the most common understanding of this term (in a layman's idea) is that companies withhold information that is private or proprietary, and one day, maybe a quarter-year fiscal announcement, aggregate that information and present it to the public. Before that day the information is classified as "insider" and after it is "outsider" information.
Then, therefore, anyone who is privy to the insider information can provide a tip to someone outside of the company (either with compensation or without - this is an interesting and probably meaningful difference) and leak the information to the outside.
This provides the person on the "outside" with information that no one else (or, at least, few others) on the outside hold. They can then leverage that to make a trade under the guise of being an outsider, knowing with much higher certainty which direction a stock price may go.
This fits with the scenario presented in the article, Salman v. United States, where an investment banker tipped his brother-in-law with information regarding the bank's clients.
The article presents some basic arguments for and against insider trading, none of which are really gone into much detail.
Arguments For
"...insider trading is benign, or even useful, because more information makes the stock market more efficient and accurate — no matter how the information has been acquired"
I tend to agree with this, though it's not the language I would use. What is the purpose of the stock market? (An often overlooked question, many people just seem to accept the fact that it exists without understanding why it exists) Well, a big problem in the economy is lack of information. I could go on for a long time about this, as it gets into interesting questions about what a stock even is and how it helps provide information about a company. But for this discussion I think it suffices to say that stocks help people properly evaluate the worth of companies and their prospects. Maybe I'll link to a future discussion on this topic.
Assuming that stocks (and bonds, and other securities too) help provide information, somewhat mitigating the lack of information problem in the economy, then I think it is safe to say that a more accurate evaluation of companies worths (and therefore, more accurate pricing of stocks) is good for the economy. Inaccurate information tends to lead to great swings in the economy: bubbles (when prices are way higher than they should be, which in good cases lead to a slow decrease in prices and in bad cases lead to a crash) and panics (when prices are way lower than they should be, which in good cases leads to a gradual regain in confidence and prices, and in bad cases leads to a recession or a depression).
Both of these are obviously bad. But, on a small scale, bubbles and panics happen all the time. For every stock there are people invested in them, and those people might be overconfident in it with respect to the "true price" (some Platonic price ideal if perfect information existed) or those people might be in a panic with respect to the "true price." The stock market's job is to aggregate all this information, all the people's opinions and valuations, in order to come to a better understanding about the "true price" of stocks.
Often, it does a pretty good job. Sometimes it fails miserably.
In an "ideal world" I suppose everyone would have perfect information and that would make trading impossible, as there would be nothing to gain from trading.
But let's take a step back from even that, and consider a world where there is still a lack of information but the market is so good at figuring out the prices that it never over or undervalues a stock by more than 1%.
Well, this would be a pretty good world I think. I don't think we'd be seeing many bubbles or panics, and confidence levels would be very high. I think the result we would be a steady increase in many stocks, and people would get richer quite consistently. This world would also greatly reduce the demand for people of the investment banker profession, as a "professional" would have fewer ways to differentiate them selves over an ordinary person. (You can judge for yourself whether this consequence is a good thing or a bad thing.)
This world might not be possible, but it is a helluvalot more possible than the "ideal" world, and I think it is something that we should be striving for as a community and an economy.
But how to get there?
Well, this is where the insider trading bit comes in.
Now, I'm not saying that insider trading is some panacea. The definition on what it even is is squishy at best (this is pointed out in the article, and this grayness is definitely a bad thing, totally agree with the article there). But I think a big thing contributing to the fact that we don't live in the 1% world is the fact that we have this pattern of:
- Company withholds information, select few are privy to it
- It may or may not get leaked to others
- This leads to much speculation and lowers confidence and increases guessing
- Company eventually releases information, and the market corrects
And in this world, there would be much less reason for the insider to provide information to his brother-in-law. People complain about the unfairness... why does this guy get quicker info than I do, just because he is related to some banker? Well this would solve that problem too. Everyone would be one the same playing field, or at the very least, the playing field would be evened out quite a bit.
So this is what I really mean when I say I tend to agree with that statement. I agree that information is good, and I wish I lived in a world where the delineation between insider information and outsider information didn't exist.
Arguments against:
"If stock market outsiders believe they have less accurate information than insiders, they’ll perceive prices to be inaccurate and be less willing to invest in a particular firm, driving down the share price."
This makes no sense to me. Information is a good thing for accuracy of prices. Even if people believe their information is less accurate than someone else's, well, that's the whole reason for the stock market in the first place. You look to the market to figure out, gaining higher confidence about the price in the process. This will make people more willing to invest since certainty will be higher.
I suppose you could them argue that the "outsiders" will have less to gain than the "insiders" and therefore will have less of an incentive to invest. I would argue this is not a bad thing. For overall economic stability, you want the people with the best information making the highest volumes of trades. And if an "outsider" gets left out, well, they either have to work to get their information faster and more reliably (thereby becoming an insider??) or just be content with lower margin trades. And I think, as a society, we should be happy with lowering the potential margin on our trades (this goes for the "insiders" as well, as more information effects them too), because it means that volatility is lower. I hope you are now starting to see why the delineation of insider vs outsider isn't very meaningful in a world that has significantly reduced uncertainty.
I suppose you could them argue that the "outsiders" will have less to gain than the "insiders" and therefore will have less of an incentive to invest. I would argue this is not a bad thing. For overall economic stability, you want the people with the best information making the highest volumes of trades. And if an "outsider" gets left out, well, they either have to work to get their information faster and more reliably (thereby becoming an insider??) or just be content with lower margin trades. And I think, as a society, we should be happy with lowering the potential margin on our trades (this goes for the "insiders" as well, as more information effects them too), because it means that volatility is lower. I hope you are now starting to see why the delineation of insider vs outsider isn't very meaningful in a world that has significantly reduced uncertainty.
"... for industries that produced intangible products like software, following through on insider trading laws spurred innovation. Because it’s harder to assess the value of tech firms than, say, a steel company, outside investors need to feel that they’re on close-to-level footing with insiders. If the outsiders feel their research is accurate, they can invest in the companies with the best products, which in turn promotes innovation."
This makes a lot more sense to me than the previous argument. The level-footing argument is a fair one, and it is true that some people will obtain info before others in any world. And if you feel others are on sturdier ground than you are, well, you may leave the investments to them, as you are less confident in your valuations.
However, I think this would be outweighed by the fact that, in the 1% world, or something approaching it, information would be so freely available (or at least, it could be purchased easily and cheaply) that if there is uneven footing, it wouldn't be very significant. And even then, you don't want perfectly level-footing anyway. Instead, you want the people closest to the genesis of the information to be the one's making the most investments, because they have the highest confidence and most up to date information possible.
To be fair to the article and those quoted in it, I don't think they consider the remote possibility of the free-information world that I imagine. I am sure there are legal reasons and company-instituted reasons that that world would be hard to come by. But it is this divide, where people want perfect information (or close to it) but there are mechanisms in society that provide hurdles to us to get there, that lead to the disagreement in my estimation. Some people are thinking of it in a bottom-up way "well perfect information is good, so we need more of it. Therefore, insider trading = OK!" and others are thinking top-down "well if we allowed perfect information, it would be immediately unfair and would lead to market downturns. Therefore, insider trading = BAD!"
The funny part is, both these arguments are perfect valid and sound. I agree with them both. It's just that there are mechanisms in society that separate the bottom-up and top-down approaches from meeting in the center. And it is only by removing those hurdles that we can get them to meet. In this case, it seems to me that whatever hurdles are causing companies to withhold their information, only bits and pieces leaking out until one big splash, are the problems. Whether they be regulations, internal company contracts, or just a society that is slow to adjust to the free-information world, they are holding us back from the "perfect" world economy, or anything close to it.
One day we may get there. For now, all we can do is try to break the hurdle.
Just a thought.
Your Friend,
Q
