How much is too much? Voices in the media are beginning to challenge the seemingly interminable number of insider trading cases. There are risks and opportunity costs to the insider trading juggernaut. Yet the cases have created a momentum which carries prosecutors forward irrespective of concerns or criticism from commentators.
Expanding Cases = Expanding Definitions
Charles Gasparino recently reported comments made by an SEC enforcement official during a conference as signs that regulators may be expanding the definition of insider trading. David Rosenfeld, associate regional director and co-head of enforcement in the SEC’s New York office, in remarks during a panel at a conference sponsored by Directors Roundtable Institute, was “surprised” that Wall Street analysts have private conversations with public company officials, and found one-on-one meetings between analysts and corporate officials “troubling.” Rosenfeld also reportedly suggested that no corporate executive should ever work with an expert network.
Some attendees of the conference had the view that Rosenfeld was simply trying to convey the risks associated with these activities, rather than suggest that the activities should be banned. Nevertheless, Gasparino’s article highlights the level of concern among market participants about whether the frontiers of inside information are expanding.
Analysts are concerned that research which was previously considered legitimate, will now viewed as illegal. Channel checks have clearly become more risky, as any breach of confidentiality could result in prosecution risk. Mosaic theory formerly provided some protection if each bit of information collected during a channel check was not material in itself, but the recent Fleishman trial suggests that conviction simply requires evidence of non-public and confidential information, while materiality is moot.
Impact on Markets
Some commentators worry that the fears surrounding the potential for inside information will have a detrimental effect on market efficiency. Stephen Bainbridge, a law professor at UCLA, recently wrote of his reservations about the insider trading prosecutions: “…I still wonder whether the current crusade is overdoing it and thereby chilling legitimate market analysis. If so, the crusade may do more damage to market efficiency than any of the alleged insider trading activity.” Bainbridge has written extensively on insider trading law and, while he is not an opponent of insider trading regulation, has expressed healthy skepticism about the ways insider trading regulation has evolved.
Maybe it is no accident that hedge fund performance has been suffering. Cynics will say it is because they are no longer using illegal information. Yet many of the buy side analysts we speak with are more fearful of doing primary research, their own channel checks or speaking with knowledgeable experts. This makes it harder for them to find anomalies from market consensus which result in investment opportunities. Now with prosecutors’ attention purportedly shifting to sell side analysts, these fears will likely spread.
Other commentators have wondered why regulators are putting so much effort into insider trading, rather than more direct causes of the recent financial crisis. A recent article in Institutional Investor suggested that mortgage markets might be a better area for investigation: “But many observers are still waiting for the U.S. Attorney and SEC to prosecute, with the same ferocity and obsession, individuals responsible for the mortgage and financial markets meltdown in 2007 and 2008.”
The zeal of the insider trading investigations also raises questions about cause. Why are the Feds pursuing insider trading so obsessively, and why now? A full treatment of this question is beyond the scope of this article but its ferocity, as II put it, suggests that it is powered by the recent financial crisis, partly as a way to recapture regulatory mojo.
Questions and criticism have shown little effect on prosecutors. Inertia has set in. John Kinnucan is a loose end which has been dangling since October 2010 (making threatening phone calls to prosecutors is probably not a good strategy when you are under investigation.) The wire taps on Kinnucan led to Donald Barnetson, a SanDisk employee who was allegedly supplying confidential information to Kinnucan, and will be used as evidence against Anthony Chiasson of Level Global. Tidying up loose ends leads to more cases, which in turn lead to still more cases. The process shows no signs of slowing down.