Non-Insider "Insider Trading": Time For A Civics Lesson For Journalists

Several weeks ago I wrote two articles (here and here) trying to do my small part to educate the world about the law, or lack thereof, regarding non-insider insider trading.  The one-line version is that prosecutors for years have been systematically charging and imprisoning dozens of people for a crime that doesn't exist.  Thankfully, the Second Circuit has finally intervened (after many years of gross prosecutorial abuse) in the case of Newman and Chiasson to impose a small degree of lawfulness on our government, although in my view the court did not go nearly far enough.

Meanwhile, of course, nobody pays any attention to my efforts to educate them and the level of ignorance on the subject among those who should know better is truly appalling.  Many examples could be cited, and I don't mean to pick specifically on Bloomberg News, but an editorial there today attributed to "The Editors" is a particularly egregious example of the genre.  The editorial is titled "Insider Trading: There Oughta Be A Law."

The editorial starts from the most fundamental misconception of the very nature of our criminal law.  Check this out:

[T]he best way to clear away the confusion and mistrust this [Newman/Chiasson] decision has created is through legislation. Ideally, Congress would pass a law that defines and bans insider trading. More realistically, the Securities and Exchange Commission could clarify its rules on the subject.  The SEC issued rules long ago to prohibit trading on the basis of material nonpublic information revealed in violation of a fiduciary duty. Its authority is based on one provision in the Securities Exchange Act of 1934, which broadly bans frauds on the market.

Where do these people possibly get the idea that something that has not been made a crime by Congress can be made a crime through a process of an administrative agency, the SEC, "clarifying" its rules?  This is not something you need to be a fancy lawyer to understand.  Did anybody around here go to high school?  When I was in high school (admittedly a long time ago), they went through multiple times teaching us "how a bill becomes a law" (actually, I think the first time was in junior high school), and on the subject of crimes they definitely put in there that it's not a crime unless a duly passed statute says it is.  Could it be that they don't even teach this kind of basic civics in high school any more?  And how about that line in the Bloomberg editorial that the "SEC issued rules long ago to prohibit trading on the basis of material nonpublic information"?  Don't they even think to ask the question, how could the SEC assert a right to do such a thing when Congress has not passed such a statute?

To be fair to Bloomberg, they do advocate here that the preferred solution would be for Congress to pass a statute.  But they leave out what they think such a statute should say, other than this whopper:

What the U.S. needs is a proper statute -- one that doesn't shift shape depending on who is heading the SEC or who is the U.S. attorney for Manhattan. It must reach conduct that strikes the average investor as wrong and feeds the impression that the markets are rigged.

If they gave the subject even ten minutes thought, they would realize that no such statute can be formulated without making a huge swath of legitimate stock market activity prosecutable, including lots of trading by Aunt Millie and Cousin Betty.  Not just Wall Street professionals, but all kinds of people, regularly buy and sell stocks based on some combination of public information plus various amounts of rumor, unsourced information, misinformation, speculation, educated guesses, idle or semi-idle talk, and the like, often with no way of knowing where the information came from or how good it is.  Allowing humans to make judgments on all this very imperfect information and then to trade on those judgments is what makes our stock market relatively efficient, and it is highly important that the process continue to be legal.  Some people who participate in this process will make a lot of money, maybe through skill, maybe through luck, and maybe through schmoozing information out of a corporate insider that the insider should not have given away.  Why is that bad?

The thing that "strikes the average investor as wrong and feeds the impression that the markets are rigged" is generally that someone made too much money too quickly -- a terrible basis for making a statute.  This is about nothing more than jealousy.  Trading by stock market tippees does not impose losses on other stock market investors in the aggregate.  If somebody gets inside information and buys the stock, perhaps that drives the price up a little; but as to other investors in the market who don't have the information, for every one who was buying and could have bought a little cheaper without the leak (therefore suffered a theoretical loss), there is someone else who was selling and was able to sell for a little more as a result of it (therefore had an offsetting gain).  If you are a non-professional investor and invest for the long term, getting no tips and buying and selling at random times, then for every time insider trading allegedly "hurt" you, there will be another time when it benefited you.  I myself invest in the market (generally through mutual funds) and I am not offended at all that others get tips and sometimes make money off them.  The fact is that I incur no loss, and I am benefited by having a more efficient market.

And besides, stock market trading by non-insiders on the basis of tips cannot be effectively prohibited in a free society.  Congress should not waste its time chasing the hopeless ideal of equal information on both sides of all securities trades.   Down that road lies nothing but less efficient securities markets and hundreds of thousands if not millions of unwitting "criminals."