Battling Insider Trading Is Hard--but Essential
Ivan F. Boesky’s illicit profits and the Securities and Exchange Commission’s widening investigation of insider stock trading have raised a couple of broader questions: What is inside information, and can the use of it be controlled? “A civilized nation should not pass a law against rain, the Rockies or inside trading,” George Stigler, Nobel Prize-winning economist at the University of Chicago, said last July in an article he wrote for the Chicago Tribune.
Even in the wake of the SEC’s disclosure that it had caught investment banker Dennis Levine profiting from his inside knowledge of takeover deals, Stigler argued that there’s really no way to stamp out such activities. Too much supposedly secret information is known to too many people with too many ways to profit by it, he said. Hence, the best the SEC can hope for is to catch the clumsy few who get too greedy. Moreover, when people trade on inside information, they are, in effect, part of the process of letting the market know what is going on, he concluded.
More recently, after the SEC’s investigation led to Boesky, the Wall Street Journal ran an editorial cautioning the agency against trying to broaden the definition of insider trading too much.
These are not isolated views. Many Wall Street experts contend that inside information is simply part of the game. Investors are always trying to get a jump on buying or selling a stock based on knowing more than the next guy.
Nevertheless, the criticism the SEC is getting for its assault on insider trading is unwarranted. In fact, based on problems the agency has in making cases stick, Congress would be wise to toughen some of the rules.
It is true that the term insider trading is imprecise. A corporate executive working secretly on merging a company with another is clearly an insider, and it would be illegal for the executive to trade in the affected stocks before the merger discussions are made public. But what of people outside the company with whom the executive comes in contact? So far, the SEC’s most celebrated cases can hardly be said to test the outer limits of what is an insider. Levine was involved in deal-making. Boesky, a major stock trader, agreed to buy information from him.
Among the biggest fish the SEC netted earlier was W. Paul Thayer, who had been chairman of LTV before becoming deputy secretary of defense. Thayer received a prison term for passing information about LTV to his broker and others and lying about it. The SEC also went after the recipients of Thayer’s information. It argued, and rightly so, that if these individuals knew that the information they received was from an insider and not yet divulged to the public, then to trade on the information was illegal. Thayer’s broker received a prison term along with his client.
Making an insider trading charge stick isn’t easy. In one major case, the SEC wrung an agreement from Thomas C. Reed to repay profits he made allegedly on tips from his father, a director of Amax. Reed also resigned from the National Security Council. In a later criminal trial, however, Reed was acquitted when the prosecution failed to convince the jury that Reed’s stock market profits weren’t based on his own research.
Another case shows the fine distinctions that can be made over what’s insider trading and what isn’t. The SEC brought charges against a printer who profited on information he discovered in documents he was printing for a company. The Supreme Court, however, threw out that case.
Stigler is right that the SEC isn’t going to be able to stop insider trading. That is no reason, however, to slow the effort. To do so would be like softening the rule against holding in football on grounds that there’s so much more of it than ever gets penalized. The recent cases involving Levine and Boesky are chilling evidence of how much stock trading can be distorted by the use of inside information and how badly the practice needs to be attacked.
In addition to looking at insider trading, Congress should put more teeth into rules requiring companies, investment bankers and others on the inside to disclose in a timely manner any action or information that can affect the market. It is not inside information that makes a market healthy. It is fairness.
