Yesterday in criticizing a federal crackdown on insider trading I noted that “[a]ll of this theater can’t hide the dubious public policy underlying these prosecutions. Insider trading is, at worst, a breach of fiduciary duty which, like other such breaches, can be dealt with under state law.”
Steve Bainbridge, an expert on insider trading, responds:
I think insider trading is theft of information and is punished for precisely the same reasons that we punish other forms of theft of property.
Yes, that’s what I said. The question is whether we need federal criminal liability for this. On this point Steve quotes his book:
Where public policy argues for giving someone a property right, but the costs of enforcing such a right would be excessive, the state often uses its regulatory powers as a substitute for creating private property rights. Insider trading poses just such a situation.
Firms’ self-enforcement would be excessive, Steve says, because “the police powers available to the SEC, but not to private parties, are essential to detecting insider trading.”
Not “essential.” Private firms could track trading, just as they now extensively track much market activity. They may pick up less than does the SEC, but then the question boils down to the costs and benefits of the SEC’s extra enforcement powers. Moreover, this argument still doesn’t justify the penalties the government can bring to bear once the insider trading is detected, and which were at the heart of my criticism of these prosecutions.
It’s because of the weakness of the misappropriation basis of insider trading liability that I gave the government the benefit of the doubt and made the standard argument about increasing spreads. But Steve doesn’t seem to buy that argument.
In any event, it’s still necessary to determine whether any benefits of federal enforcement of insider trading liability are worth the cost. I noted the information benefits of trading on non-public information. Steve says “I don’t buy it,” and cites his book. But in the cited pages the book says:
it is significant that a more recent and widely-cited study of insider trading cases brought by the SEC during the 1980s found that the defendants’ insider trading led to quick price changes.231
231: Lisa K. Meulbroek, An Empirical Analysis of Illegal Insider Trading, 47 J. Fin. 1661 (1992).
The problem, according to Steve, is that the insider trading’s mechanism for affecting securities prices “functions slowly and sporadically. Given the inefficiency of derivatively informed trading, the market efficiency justification for insider trading loses much of its force.”
There’s no cite for the “inefficiency of derivatively informed trading,” and I don’t know what it means. If insider trading informs stock prices, the “force” of the argument depends on measuring this benefit against the cost of insider trading enforcement.
Finally, Steve agrees with my main point that “criminalizing this conduct and unleashing aggressive publicity-seeking prosecutors to enforce the criminal laws is particularly dubious.”
What this debate with a leading expert on insider trading shows is that we’re a long way from the kind of clarity on the wrongfulness of insider trading that would justify the harsh government rhetoric and tactics discussed in my previous post.