Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Wednesday, December 13, 2006

Material Nonpublic Information

RGE Economonitor on insider trading:

RGE - Hedge funds go to Washington: Insider trading is illegal mainly because it violates peoples' sense of fair play. People do know, of course, that in fact the prop desks and hedge funds and other institutions which drive the market are always going to have better access and information than Ed Kozin of Kalamazoo. They questioned this at the end of the 1990s, with the rise of the internet and sites like, when there was much talk about the leveling of playing fields. But then the dot-com crash happened, a bunch of day-traders lost their shirts, and now there's much talk about exchange-traded funds. So goes it.... Private markets are only going to become increasingly attractive if public markets make any kind of attempt to get an information edge illegal....

Cue David Vise in Breaking Views today:

For hedge funds, these waters may be treacherous. Secrets flowing to hedge funds from Washington often fall into a gray area that requires legal advice. There's nothing wrong with dispatching your own messengers to count the bodies at Waterloo, but paying someone else to count them for you could spell trouble.

For one thing, what are "secrets"? If I eat a hamburger, decide it's disgusting, and call my broker to sell my McDonald's stock, am I acting on the inside information of how my burger tasted? Not all information can be publicly available. And it's hard to see the logic behind Vise's Waterloo analogy: why is it a bad thing to buy or sell information of value? One imagines that's how both Breaking Views and the Wall Street Journal make their money. The financial markets have long operated on the assumption that the best way to deal with information is to ban its dissemination, unless and until it's disseminated in certain carefully-prescribed ways....

Maybe a better way to deal with information is to be much more laissez-faire about the whole thing. I wouldn't necessarily go as far as the WSJ's Holman Jenkins, who has argued... that insider-dealing laws should be abolished entirely. But worrying about hedge funds having access to Washington gossip just looks silly.

The goal is to encourage research, but to discourage corruption. A market in which it is accepted that corporate insiders are going to leak sales and technology information to their "friends" in return for preferential allocations of stock during the next wave of initial public offerings will not be an efficient market--it will not be a market that is very liquid, or one in which companies will have an easy time raising capital. A market in which nobody does any research because it is illegal for them to trade on what they have figured out is not going to be an efficient market either.

The problem, as I see it, is that the SEC has confused matters to an extent that nobody knows what is and isn't "material nonpublic information." The SEC has done this--perhaps unconsciously--because when they decide that somebody is a bad guy, they want to be able to take him down rather than have him wriggle away on a "technicality," so they want as expansive a definition of "insider trading" as possible when they reach the courtroom. But, they say, this trap will only snap shut on "bad guys." This line by the SEC does not encourage investment firms to do good research.

The solution, I think, is to make sure that the SEC Commissioners are people who come from the industry and understand the tradeoffs, rather than people who come from academia or enforcement or politics who may well not.


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