As long as everybody loses money, nobody's hurt

As Rick Barton notes below, Judge Cedarbaum has thrown out the charge of securities fraud against Martha Stewart—the one charging that, by publicly denying that she was guilty of a crime, she was committing the new crime of falsely trying to keep her company's stock price high. From a Bloomberg report:

"The government has offered no evidence that Stewart evinced a concern for the price of MSLO stock at any time during the relevant period," Cedarbaum said. "I have concluded that no reasonable juror can find beyond a reasonable doubt that the defendant lied for the purpose of influencing the market for the securities of her company."

I have no problem with her honor's wisdom on this point, but something seems pretty ironic. The one really compelling argument I know for criminalizing "insider trading" is that you want to avoid situations where an officer of a company makes decisions that damage the company and its shareholders while selling off his own stock. (The other argument, that you shouldn't be allowed to benefit from having information other people don't have, seems like something Lenin would have thought up.) Here you have a situation where, on a tangential charge related to insider trading, Stewart was charged with making an effort to help the company and its shareholders. The judge states specifically here that she is innocent thanks to her indifference to her company's performance. That is, as long as the head of the company doesn't care how the stock's doing, she's not breaking the law. I may be missing some nuances here.

Comments

[Rick Barton]

Wasn’t it the government?s contention, in this charge, that Martha proclaimed her innocence to boost the share price of her company?

The judge earlier had tipped her hand in this matter when she called the government’s use of securities fraud law in this way as “novel”.

It would be a pretty severe abridgment of Martha’s freedom of speech to disallow her to proclaim her innocence on the grounds she might benefit financially from doing so.

[Walter Wallis]

Insider trading is a breach of faith with the stockholders and should not be a crime.

[Phil]

Tim,

I don’t think you are correct that it is the CEO’s job to support the stock price. The CEO’s job is to run the company properly and build intrinsic value for the shareholders. The stock price is secondary.

If the CEO of one of those bubble stocks had said, during the bubble, “hey, our stock price is too high — there’s no way I see our business growing enough to justify such a high valuation” — he would not be doing anything wrong, because his fiduciary duty to the stockholders does not include propping up the stock price on false pretences (or even true pretenses).

IIRC, Warren Buffett said something similar about his own company at one point a few years ago, that it was overvalued and he wouldn’t buy at the current price.

Not sure if this is true legally, but I’d bet that it is. Either way, it is certainly true morally.

Phil

[StMack]

Actually it was an amazingly clever ploy to create a whole new class of business criminals. Accuse a CEO of any crime you can imagine and when they proclaim their innocence nail them for tryng to manipulate the stock price.

Collect a fine.

[KentInDC]

Rick is right. The judge was looking for a way to get rid of a bogus charge. Someone is trying to build a career at Martha’s expense just as Rudy built his name railroading Milken. Martha is fortunate that Kimba Woods is not presiding. Advancing one’s career by inventing new “crimes” to accuse unpopular rich people of is not a good thing.

[Mo]

Wlater,
Yes, but those shareholders should be able to take your ass to court and collect their money. It shouldn’t be criminal, but civil. It’s fraud plain and simple.

[Russ D]

“The CEO’s job is to run the company properly and build intrinsic value for the shareholders.”

No, the CEO’s job is what the shareholders say it is.

If you want instrinsic value, invest in companies who already behave that way. If you want a high stock price, invest in companies that behave that way. Or you can start a company and run it financially however you see fit. Who says all shareholders have to have the same goals?

[ntr wlater]

How is it “their” money when they exchanged it for somthing else? It’s an investment in a corporation, not a bank.

[Mo]

Wlater (or Walter … heh),
I buy a share of a company where the rules of the corporation forbid insider trading. If you break those rules and diminsh the value of my share, I and the rest of the shareholders get to take the profits you made from that indiscreation as payback for our losses. No need for the government to get involved because most companies have policies that forbid insider trading (yes, yes I understand that most are because of the laws, but it’s not unreasonable to believe that quite a few would have those rules even without the laws.

If I take my car to the mechanic and he breaks off a mirror (diminishing the value of my investment) he has to pay to fix it (unless he states otherwise beforehand, in which case I’ll take my business elsewhere). You diminish the value of my share of property through means that are against the rules of the company, then you have to pay for it.

What’s w/ the libs that believe that theft by a different name isn’t theft?

[Warren]

I still say we need to stant AG Asshat up against a wall.

[the diddy]

“Accuse a CEO of any crime you can imagine and when they proclaim their innocence nail them for trying to manipulate the stock price.”

From there, it’s not too far to get to the point where it is a crime to plead innocent to a crime of which you are eventually found guilty.

[the diddy]

Not to mention, the US Atty’s office stood on its head to make MSLO out to be a “cult of personality” stock whose value was inexorably linked to the public profile of its CEO. In other words, the NYSE is just a grown-up version of that Hollywood Stock Exchange website. Never mind the fact that they actually manufacture and sell a quarter billion dollars worth of media and merchandise per year. Frankly, I’m surprised it didn’t get laughed out of court on day one.

[Rich]

I don’t think you are correct that it is the CEO’s job to support the stock price. The CEO’s job is to run the company properly and build intrinsic value for the shareholders. The stock price is secondary.

It’s a bit more complicated than that. This may be true if the stock price were just some scorecard seperate from a corporations finances but it isn’t. Any notice by a company’s officers to the market that the price of the stock is overvalued will likely lead to a decline in the stock price which will lead, of course, to a decline in the amount of capital which the business has available to finance future growth. Of course, if the stock is indeed overvalued and the CEO decides to take advantage of the situation by using some of that value on capital expenditures in order to grow the company he is taking a big risk that his new investment will pay off enough to cover the current overvaluation. If it doesn’t then that CEO is in a bit of trouble having leveraged an overvalued asset to build something of less value (sort of like a margin call gone bad). In reality it is a very very fine line the CEO has to negotiate, good CEOs do this well and build stockholder value.

So, I do agree with the general sentiment that it isn’t the CEOs job to “prop-up” a company’s stock price but rather build value for the shareholder. I just disagree with the notion that this mission can be detached so easily from the stock price.

[ntr wlater]

All I’m sying is insider trade/theft should be a GIVEN when investing money. It’s your due dligence to invest in companies with honest officers, why should that responsibility be anyone else’s? Fool me once, shame on you; fool me twice shame on me.

Theft is one thing, but when you willingly spend money on shares of a company run by a rat bastard, that’s not theft but stupidity.

[Tommy_Grand]

“The other argument, that you shouldn’t be allowed to benefit from having information other people don’t have, seems like something Lenin would have thought up.”

As long as any smart, dilligent researcher could get said info, then sure. No problem.

Or, as long as all potential investors are told that insiders may use inside (read: unavailable)info – then sure. That’s fine too.

But if the system sez: “No one is allowed to benefit from inside info. It is a ‘level paying field’ and those who do good, thorough research can learn everything the insiders can use.” Shouldn’t we enforce that?

It bothers me when an investor complains about a (technically) illegal trade and is told: “Are you kidding? Of course they used inside info. You didnt know people did that? Come on. Eveyone knows…”

[jon b.]

Thanks Tommy. I?ve never understood the argument that insider trading is good because you should be able to profit from any information you have. Says who? I work in a hospital and could profit from all kinds of information I come in contact with during the course of my job. But I have a responsibility to my clients to see that their privacy is protected, even from me. Lots of other jobs deal with information that must be protected and thus are off limits to being used for profit. Why is insider trading different from any of that? Knowing what cards everyone holds is cheatin?, padner.

[Russ]

ok jon,

If profiting from insider info is cheating, whom exactly are you cheating?

Let’s assume that Martha did, in fact, have misappropriated, material, non-public information. Let’s also assume that this was her motivation for selling her stocks.

Whom did she harm?

The people who willingly bought Imclone at 60? Nope. They were doing that anyway, in fact, by entering the market as a seller, she lowered the price and reduced the magnitude of the beating they would evenutually take.

How about the people who already owned Imclone and took huge losses when the stock eventually dived? Whether she traded or not, they were going to take exactly the same losses. No harm done here.

The only people she might have harmed were the people whe happened to be selling at the same time as her and got their orders filled at a lower price because there was one more seller in the crowd. In a stock that trades several millions of shares per day, a few thousand extra sales has a pretty tiny price impact.

More importantly, when insiders trade (regardless of their motivations) they send signals to the market with their actions. These signals improve market efficiency. If person x hears that insider y is selling, the added info is a benefit and improves market efficiency. Prohibiting insider y from trading on what they know eliminates another market signal and makes everyone else worse off.

[Tim Cavanaugh]

I work in a hospital and could profit from all kinds of information I come in contact with during the course of my job. But I have a responsibility to my clients to see that their privacy is protected, even from me.

False analogy: Martha didn’t work at the hospital, and had no responsibility to any of its clients. She’s (almost, but not quite) charged with insider trading on Imclone, not MSLO. She had no position with Imclone, other than being friends with the CEO, and no responsibility whatsoever to the shareholders, the employees, or anybody else.

To repeat, the insider trading charge had nothing to do with MSLO. And with regard to MSLO, the one entity to which she did have a fiduciary responsibility, all I can see is that she tried to discharge her duty to that company’s shareholders by enhancing share value. To reply to Phil above: I don’t believe there is such a thing as “intrinsic” value, but assuming for argument’s sake that there is, she was certainly trying to enhance that too-if Martha’s reputation suffers, the “real” value of the company will also decline, since people will buy less Martha Stewart stuff, watch and read less Martha Stewart media, etc.

As for fair information that can be gathered by proper due diligence, who decides what’s fair and proper due diligence? If you hear a tip at a cocktail party, is that somehow less legitimate information than what some guy finds out by reading 10ks? Why?

[Mark Fox]

The morals of some may proscribe acting upon asymmetrical information. Some, not all. That others will use that “insider” information seems a revealed fact of human behaviour. If law descends from morality, the FMA will sail onto the Constitution.

Outside the law, at a poker game, it is each player’s duty to protect his cards, expecting that all other players are seeking that priviliged information in his hand. A cheat may make some substantial wins, but when exposed faces grave consequences. These days a gutshot under the table is less common. The cheater becomes blacklisted, unable to play in that game, and through an amazing system of communication, unable to enter most of the games in the poker world. The cheater’s one-time gain removes the opportunity for any future gains. The poker world enforces “insider trading” standards without state involvement.

Insider trading is neither “good” nor “bad”. It is one of the factors a player will wisely consider before entering the game. Let each assess the risks, and abide by the consequences of their choice.

[Mo]

ntr wlater,
So I guess you wouldn’t mind if I robbed your house then? Risk of robbery should be accounted for in the purchase price of the house. If you don’t do the due dilligence to set up a strong security system, it’s your own fault. Humans steal, so it should be a given that your house will be robbed. Just don’t buy a house in an area with criminals.

I do my due dilligence and didn’t get screwed over by those CEOs. If they merely mismanage the company, fine, I don’t care, shit happens. If they “mismanage” the company solely for their own benefit, they are stealing from me to line their own pockets and I will get mine. Besides, how do you know who is a crook until they steal?

[dj of raleigh]

The heart of this case is trust in the market.
Whether she made money or lost money
doesn’t correct the loss of confidence
suffered by the market of the public trust.
This is also a case of bad timing, coming after,
and to trial before, Enron, cable, etc.
I think she lied during the investigation,
and that she had something to lie about.
I really hope it costs her a fortune,
even more than it has, but not jail time.

[Skip Oliva]

Much of modern “competition” law is predicated on a company’s officers acting against, or remaining indifferent to, the company’s self-interest. Just look at the Oracle-PeopleSoft debacle. PeopleSoft essentially begged the Justice Department to shut down Oracle’s takeover bid before PeopleSoft’s shareholders could consider the deal. In most contexts, PeopleSoft’s officers would be condemned for thwarting their shareholders; but because it met a popular regulatory objective, there was little objection.

[alkali]

I can imagine that if CEO of company X was under indictment and wanted to push up his company’s stock right before trading a whole pile of it, his holding a press conference touting how innocent he is and how the indictment is nonsense might be market manipulation. That said, there was nothing like that alleged here.

I don’t agree that the directors of a company should be condemned for trying to stop a shareholder vote. Shareholders vote on public information; directors have confidential information. Accordingly, directors may have good reasons for opposing a shareholder vote.

[R C Dean]

Fethchet’s account of insider trading isn’t bad, but is perhaps short on a key emphasis. He states:

Insider trading based on special knowledge, in common law terms, is called breach of fiduciary duty, Timbo.

Which is true, but begs the question of who has a fiduciary duty, and to whom they owe that duty. Martha had no fiduciary position at Imclone, as she was not a director, officer, or employee. She could, therefore, not owe a fiduciary duty to anyone at all relating to Imclone stock, whether that person was a buyer, seller, or holder of Imclone shares.

The traditional, narrow reading insider trading limits it to genuine fiduciary insiders. The SEC has been trying for years to get it extended to so-called “tippees” who receive non-public information from a fiduciary insider and trade on it. If Martha had been charged with insider trading of Imclone, which she wasn’t, it would have been as a tippee. Tippee liability is controversial, as it quickly becomes a prohibition on trading based on asymmetrical knowledge, which prohibition is a very bad idea.

Now, Martha is an insider for MSLO, but hasn’t been charged with insider trading at MSLO, but rather with securities fraud for holding that press conference. Fraud and insider trading are quite distinct charges, although people tend to run them together. You can commit fraud without being a fiduciary; you should not be considered an insider unless you are a fiduciary.

Yes, this will be on the test.

The judge, BTW, seized on the lack of evidence of intent as a way of avoiding the more difficult issue of whether what Martha said at that press conference (that she was innocent) was true or not.

[David Nieporent]

Stephen Fetchet, thanks for that long essay, but it completely misses the point. Martha Stewart did not have a fiduciary duty to Imclone, and for that matter didn’t have “inside information” as that term has always been understood.

(Which, perhaps, is why prosecutors are trying an end run by only charging her civilly, not criminally, with insider trading.)

TheDiddy:

From there, it’s not too far to get to the point where it is a crime to plead innocent to a crime of which you are eventually found guilty.

As a general principle, this isn’t new; you can “take the fifth” if you’re asked if you’re guilty, but you can’t lie. In Brogan v US, 522 US 398 (1998), the Supreme Court specifically upheld 18 USC 1001’s application to the “exculpatory no.” It is illegal to lie to the federal government in the course of its official duties. You can’t falsely deny guilt, any more than you can falsify an alibi or present forged documents to them when they ask. It’s an overbroad use of the law, but not an absurd one.

(Now, that’s different than the issue you raise; pleading not guilty is not actually a denial of guilt, oddly enough, nor does 18 USC 1001 apply.)

What Martha Stewart is accused of doing goes far beyond the exculpatory no, though; she’s accused of manufacturing evidence, not merely saying, “I’m innocent.” There’s nothing dubious about _that_ portion of the prosecution. The dubious part was/is trying to link it to insider trading and/or securities fraud.