New York – When I was a kid, there was a show on television called Canon Ball 500, or something like that. The star of the show was Casey Jones and it featured all of the exciting things that can happen on a train. As you might imagine the plot was limited. One show Casey would have to pour on the coal to get a sick person to the hospital. The next, there might be something wrong with the tracks and Casey would have to use all of his skills to pull the brake. I can’t really think of any other plot variations: there was no chasing of bad guys, unless they were running straight down the tracks, and the only romance was Casey’s love of Cannon Ball.
Imagine now that Casey’s route took him through the heartland. From his train Casey begins to keep track of the crops that all the farmers are growing and how they have changed from the previous year. This year he notes that there is a ton of corn being grown, but the soy bean crops are much less prevalent than they were over the past two years. Because Casey’s pension plan is not going to land him in the lap of luxury, he decides to invest in soy futures. As it turns out, soy futures rise sharply and Casey makes a tidy profit on his investment (utilizing the Chattanooga Channel Check). Is Casey trading on insider information? Is it a level playing field?
The current means test of insider trading is whether an investor traded on material, non-public information and made a profit. Casey’s observation set is certainly material and actionable. However, is it non-public? Some might interpret it to be non-public, since Casey is the only one that has the information. As such, it is not fair that Casey has all this information that the average investor does not.
Casey has information that other folks do not, by virtue of working harder at gathering that information. Casey is no more in possession of non-public information than a PhD Economics is. Both have information that is difficult to gather and that the average investor does not possess. Both have actionable, material information (and tools). But neither have non-public information.
But wait, don’t Casey and our PhD have information that means that the playing field is not level for all investors? Here is where the press gets confused. There is some implication that insider trading is wrong because it is not fair. This confuses criminality with issues of fairness.
There is no level playing field, and there never will be. Just take a look at your old finance text book in the chapter on efficient markets and you will get the drift. The weak form of efficiency reflects investors having all historic information on which to form opinions. The semi-strong level of efficiency means that all investors have all publically available information, including costly databases, industry consulting reports and the like. The strong form of efficiency reflects investors with access to all public and non-public information, including insider information.
No one (well almost no one) is condoning that insider information should be used in the investing process. But we do need to be acutely aware that ham-handed regulations will dampen market efficiency, distort price discovery and cripple our ability to compete with international financial centers. Remember the IPO exodus after the SOX legislation?
So as we craft new regulatory guidelines, let’s try to find ways to catch the crooks and keep the market as efficient as possible.