Insider Trading is Very Damaging to Markets and a Terrible Crime, Unless Your Job with the SEC Forces You to Do It

Interesting bit from Slate (via Business Insider) from last week tracing the shockingly good record of Securities and Exchange Commission (SEC) employees when it comes to making trades at the right time in stocks of companies the SEC investigates.

Turns out reseachers found "SEC employees tend to sell a company's stock before the SEC takes enforcement action against the company" leading to:

abnormal returns of about 4 percent for the market in general, and about 8.5 percent for the U.S. stock market. That's significant....60 days before an enforcement action, when the market is selling at a rate of about 50 percent, SEC employees are selling at a rate of 71 percent. The SEC employee rate of sales increases as the enforcement action approaches, while the wider market's pretty much stays the same.

Nothing wrong with this though, says the SEC. It's a feature, not a bug, of working for them:

Before an employee works on a case, they must divest themselves from any interest in the company. So it makes sense that employees sell their stock in a company before enforcement action. It just happens to also be profitable.

I am not implying that SEC employees should face legal sanction for their trading on very material information that only they are in a position to know. It's a fact that every trader (and every non-trader) may in the nature of reality of life on Earth know things that other people don't or can't easily know, and indeed markets couldn't work without this fact. They work most efficiently when those who know true things that might affect value get to act on and have market prices reflect that knowledge.

It just should make you wonder about any criminal action based on one's choices about when to buy or sell (or not buy or not sell!) stocks. 

I have written in the past about the weird crime of insider trading, and Michael McMenamin wrote for us in 2003 a feature on "St. Martha" when Martha Stewart was bedeviled by those laws.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of Reason.com or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Plàya Manhattan.||

    Before an employee works on a case, they must divest themselves from any interest in the company. So it makes sense that employees sell their stock in a company before enforcement action.

    Holy shit. Is there any case in history in which an SEC investigation increased the value of a stock?

  • ||

    Why would it ever increase the stock? Investigation means the government is potentially about to bring its incredibly heavy hand into play. There's basically no way possible for that to be positive.

  • Plàya Manhattan.||

    That's what I was getting at. These guys find are told what they are about to investigate and required to dump the stocks. There is no way they can lose, and they do it in the name of "transparency".

    SEC employees and their relatives should be required to have their shit in a blind trust.

  • ||

    It's not illegal when the government does it. Never forget that. Remember, cops can possess illegal drugs and firearms and explosives. SEC employees can profit from the most insider of insider trading. And so on.

    Fuck you, that's why.

  • Cdr Lytton||

    SEC employees and their relatives should be required to have their shit in a blind trust.

    The state lottery here bans employees and their immediately family from playing games including scratch offs. Make SEC employees liquidate any stock holdings on hiring. Blind trusts aren't blind enough.

    Next article Slate does should be post-SEC employment for these guys. Wonder what the reveal would be on that one...

  • NotAnotherSkippy||

    Or force them to only own broad index funds. Do that over a lifetime, and you'll do just fine and avoid the corruption.

  • Cdr Lytton||

    Yes. If you mean a competitor's stock.

  • Fist of Etiquette||

    So keep an eye on what SEC employees dump and when.

  • Grand Moff Serious Man||

    What we need to do is create a new bureaucracy ad infinitum to keep watch of the other bureaucracies.

    Full employment!

  • cw||

    This will undoubtedly be the solution.

  • Sevo||

    The picking of the nits:
    No fan of Ms. 'Put Glitter on Everything', but she wasn't busted for insider trading.
    Stewart was busted (and went to JAIL!) for 'lying to a federal officer' ( or some such) NOT under oath.

  • ||

  • Death Rock and Skull||

    Fuck the SEC.

  • Agammamon||

    Doherty, markets don't need one party to have more information than the other, they'll work perfectly fine even if both parties have perfect information - including perfect information about what the other party knows/wants/can afford. You just can't find a bargain in such a situation.

    Neither do they work 'more efficiently' with an information imbalance - they simply work to *remove* information imbalances through adjustment of prices by people with special information selling/buying based on that info. Ie, a market with an information imbalance works to correct that imbalance, contrasted with a system where information is not allowed to spread through the system (through price controls, etc).

    An information imbalance allows (and incentivizes) the person with information to spread that info through the system. Obviously, in the system where everyone has perfect info (which doesn't, can't exist) this is unnecessary.

  • TKList||

    #60 Abolish Insider Trading Laws

    Let the market get the most up-to-date information as quickly as people get it.

    See the rest of the U.S. To Do List here: http://tklist.net/?p=478

GET REASON MAGAZINE

Get Reason's print or digital edition before it’s posted online

  • Video Game Nation: How gaming is making America freer – and more fun.
  • Matt Welch: How the left turned against free speech.
  • Nothing Left to Cut? Congress can’t live within their means.
  • And much more.

SUBSCRIBE

advertisement