Archives For insider trading

Today’s WSJ, in an obvious effort to grab readers seeking more insider trading titillation in the wake of the Galleon verdict, has a story about a new supposed scandal — investment banks offering hedge fund traders special access to dealmakers at exclusive lunches in order to get more trading business from the funds.

The article makes the following silly statement:

Under insider-trading laws, it is generally illegal to buy or sell securities based on “material,” or significant, information that isn’t publicly available.

No.  It’s generally legal to trade on non-public information, even if it’s material.  The exception is when the trader knows the information is obtained illegally, as the jury found in the Raj trial.  Indeed, there’s a question why a non-expert would trade in an efficient market on public information that’s presumably already in the price.

The article discusses situations that might present issues under Reg FD, which doesn’t regulate trading but restricts firms from privately disclosing non-public information without then publicly disclosing it.  But there’s no indication of illegal insider trading in connection with this meeting.  Indeed, there’s a question about how much non-public information is being disclosed.

The WSJ article aids the SEC’s project to, as I said recently, turn the molehill of illegal insider trading into a mountain that oppresses efficiency-enhancing trading.  We expect more from a top financial journal.

Rajaratnam stands convicted.  What, exactly, did he do wrong?

Holman Jenkins, writing in today’s WSJ, appropriately mocks the notion driving the Rajaratnam prosecution that insider trading “law’s purpose is to protect the public from informed stock prices.” As Jenkins notes:

There is no level playing field. Nor does there need to be one for the stock market to be an acceptable place for the public to park its savings. The efficient-markets hypothesis may not be in the best of odors these days, but its signature piece of advice is as good as ever: Stock trading is a mug’s game. Use an index fund.

On the other hand, Jenkins says, the Rajaratnam trial is properly based on the corruption by which Rajaratnam’s acquired his information: 

In the noses of any sane jury, the whiff of criminality arising from these actions would have been stronger than any forlorn assertion that investors generally were harmed by Rajaratnam’s trading.

That may be true. But it’s still the case that the seasoning of non-harm to investors with a “whiff of criminality” does not turn this bland prosecution into tasty public policy.

The wrongs that gave rise to these prosecutions were solely to the companies that owned the stolen information.  What makes this illegal insider trading, complete with Draconian criminal penalties, is that the misappropriation became the basis of stock trading, which as Jenkins says does not harm the market whether it’s based on criminality or not.  Unlike conventional securities fraud, the market is not deceived.  If anything it is enlightened by trading that helps make stock prices more accurate. 

The only deception, according to the Supreme Court in U.S. v. O’Hagan, is by the information thief to the information owner.   The federal government gets to prosecute these actions only because of a Rube Goldberg contraption by which deceiving your employer in New York into thinking you’re keeping information confidential is magically converted into fraud on a day-trader in Omaha who benefits by trading the security without realizing that its price reflects the stolen information. And of course most of us in the market aren’t affected at all because instead of foolishly day-trading we’re buying and holding index funds.   

Jenkins says the jury properly dismissed the defense’s theory that the defendant’s trades were motivated by a mosaic of legitimate information rather than by the illegal bits.  But the mosaic theory is no nuttier than the rest of this jury-rigged legal theory.  Again, Rajaratnam committed a federal crime only because the theft of information is a kind of deception, which in turn is what makes the trading illegal under present securities law.  If you steal information but don’t trade it’s not a federal crime.  If you trade on legitimately acquired non-public information it’s not a crime.  Why, then, should it be crime if you steal information but trade on other information?  

And while we’re at it, what about the other questions raised by this wacky theory and discussed in my Federalism and Insider Trading, 6 Sup. Ct. Econ. Rev. 123 (1998):  1. What kind of deception is necessary?    2. What if the information owner consented to use of its information?  3. What kind of breach of duty amounts to actionable misappropriation to justify an insider trading charge?  4. If the information owner is not harmed, does it matter if the information traded on was material to investors?  5.  If the information owner is harmed, does it matter if the information was immaterial to investors?  6.  What does materiality mean in this context?  7.  How much knowledge of all the elements of wrongdoing must the defendant have?

Let us not forget that these are criminal charges which could send Rajaratnam to jail for a very long time.  Shouldn’t we be a little clearer on exactly what he was doing wrong?  The Supreme Court ultimately may think so.

Dave Zaring asks whether the Rajaratnam trial, now doomed by a sick juror to start deliberations all over again, is headed for a hung jury. 

Dave suspects the jury is more likely hung 11-1 to convict than vice versa.  But there’s another possibility:  there are a lot of charges in this cases which occupy a wide space in terms of likelihood of illegality.  The jury may be divided every which way on these charges.

As I discussed last week, the case is complex because the government wanted it this way. But this leaves a lay jury with the huge task of sorting out legal theories, mountains of factual evidence, skilled expert testimony and a sophisticated defense by a top trial lawyer.  Now we see why the government prefers to frighten defendants into caving in.  This tactic didn’t succeed with a billionaire defendant who had little to lose from a trial. 

Before this is over, the government may come to regret its approach to insider trading prosecutions.

Jon Macey insightfully wrote in the WSJ that the Galleon case illustrates the need to distinguish “trading on the basis of information that was legitimately ferreted out from trading on the basis of information that has been wrongfully obtained through fraud or theft.”

Macey notes that the SEC’s refusal to clarify the distinction between the mountain of trading on non-public information from the molehill of stolen information (which could include the information about Clearwire Rajaratnam paid Rajiv Goel for in violation of the latter’s duty to Intel) fosters an ambiguity that “increases the SEC’s power and allows government lawyers to pick and choose among prosecution targets.” He concludes that “the government should be compelled to provide clear guidance as to what constitutes illegal insider trading and what constitutes legitimate, albeit aggressive, research.”

That’s true for all insider trading cases, but especially true for criminal cases.  Business people will stay a long way from conduct that has any chance of being characterized as criminal.  Indeed, that deterrence is why we use powerful criminal sanctions.  But the avoided trading, including the industrious digging that characterized much of Rajaratnam’s activities. could bring valuable information into the market that enhances its efficiency.  Moreover, empowering prosecutors with vague laws invites a host of abuses in cases against corporate agents that sully our criminal justice system.

The SEC might argue that clarifying the scope of illegal insider trading could limit its ability to catch the really bad trading based on theft or fraud.  The government needs to sweep broadly in order to bore down into the facts that reveal serious misconduct.  But even if this is true, we need to balance the benefits of catching a few more theft cases against the costs of compromising market efficiency and encouraging prosecutorial abuse. 

In balancing costs and benefits, we should keep in mind that illegal insider trading is basically just another type of agency cost, like any fiduciary breach.  This sort of conduct is generally handled by firms’ contracts and discipline, as I noted recently regarding David Sokol’s trades and discussed at more length in my Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998).  Intel has ample incentive to punish Goel if he’s profited from personal use of information that is essentially a corporate asset.  And if the managers disregard shareholders’ interests in failing to impose discipline, the shareholders can sue derivatively as has been done in the Sokol case.

It’s no wonder that the SEC would want the public to see Rajatnaram sitting in the dock day after day to show that the SEC is protecting public markets.  But this spectacle is not a substitute for the work the SEC should be doing in guarding against future Madoffs.

Steve Bainbridge discusses a Delaware chancery suit by a Berkshire-Hathaway shareholder against former B-H executive David Sokol for profits he earned by buying Lubrizol stock ahead of his former employer. Steve analyzes state law, concluding

I am unaware of any Delaware precedent holding that a state law cause of action for breach of fiduciary duty lies when the facts fit within the misappropriation framework. It would not be surprising if such a cause of action existed, however. In effect, when an executive misappropriates information and uses it to make a profit by trading in the stock of a potential takeover target the executive has usurped a corporate opportunity. 

Steve explains why this could be true even if Buffett knew about the trades because Sokol should have gotten board approval.

I basically agree with Steve’s analysis.  But this raises another question, as I noted when Sokol’s trades were disclosed:

[W]hat should federal law have to do with all this?  The “hook” for federal securities liability is the trading in Lubrizol — but the breach of duty that triggers liability has to do with the details of Sokol’s dealings with Buffett and Berkshire.  This, as I’ve said before, is appropriately a matter of state law.  See my article, Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998).

Scalping Next

Larry Ribstein —  9 April 2011

So Alinea’s Grant Achatz has a new restaurant, Next, which is the talk of Chicago and the nation.  You can buy transferable dining tickets which the NYT reports are being traded online up to $3,000.  So now we see that even chefs can be like Hannah Montana. Alinea caps sales at two tables/customer given a Web waiting list of 20,000.  Achatz comments: “You almost have to say, ‘Good for them,’ [the scalpers]. But we don’t make any more money off it.”

I’m proud of Achatz’s anything-goes Chicago attitude.  Compare my own California experience trying to land one of the French Laundry’s 16 tables in June:  you need to call precisely 60 days ahead, too bad if you don’t make it.  I suppose there may be some opportunity for scalping, but unlike Next there may be a problem trying to use somebody else’s reservation.

Of course, Chicago isn’t exactly a bastion of the free market, including when it comes to ticket scalping, as I wrote almost seven years ago regarding scalping Cubs tickets.  Back then I reasoned that “maybe the Cubs want to control the demographics of their fan base. The law gives the Cubs public enforcement of this business objective, since private enforcement by the Cubs might be impracticable.”  I compared this to insider trading.

In a later post I discussed Curry and Busch, Rock Concert Pricing and Anti-Scalping Laws: Selling to an Input, which supports my hypothesis by suggesting that scalping prevents sellers from selecting their audience.   This could apply to restaurants to the extent the chef wants discerning and not necessarily rich diners.

But I later questioned the audience-control rationale for anti-scalping laws beyond rock concerts and sporting events and wondered “why promoters don’t use the same sort of auction system the scalpers use to maximize ticket prices.” In other words, if Achatz doesn’t care about high-priced resales of his tickets, why doesn’t he try to collect the profits?

Indeed, Achatz does do variable demand-scaled pricing.  Maybe he really cares, as I also reasoned in my blog post, about “the high costs of running the market, as opposed to just selling out to a bunch of resellers.” And, in fact, the NYT article says Achatz likes “the labor savings that computerized booking allowed.”  But how much would it cost for him to add an auction feature to his own website?  He could avoid the risk of not selling out by using price floors.

I wondered (in the post just linked) if rock bands (and maybe rock star chefs) want to avoid “the censure of charging above a certain amount.”  Of course Achatz could add a ceiling to his floor if he’s worried about looking too much like a capitalist.

So, in the end, I’m still mystified by scalping, as well as wondering how I’m going to get into Next.

Sokol’s trades

Larry Ribstein —  31 March 2011

Per the WSJ, Buffett associate David Sokol bought shares of a potential Berkshire target, Lubrizol, the day after expressed interest in the company on behalf of Berkshire. He sold those shares a week later, but soon bought more around the time the Lubrizol board met to discuss Berkshire’s interest.  Sokol told Buffett about the deal and the fact that he owned Lubrizol shares a week or so later.  Buffett initially wasn’t keen on the deal, but bit ten days later. Buffett learned the details of Sokol’s purchases only after the Berkshire board offered to buy the company.

Based on these facts, Sokol may have had material information when he bought his second batch of shares: i.e., that he was going to pitch the company to Buffett.  Although he didn’t know whether Buffett would go for it, a company’s just being pitched to Buffett by a trusted insider likely increases its value. [Update:  See Sorkin: “though he had no control over Mr. Buffett’s ultimate decision, he was one of a select few who were in a position to influence such a transaction.”]

But did Sokol breach a duty to Berkshire?  The company policy says employees should ask “themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper—to be read by their spouses, children and friends—with the reporting done by an informed and critical reporter.”

On the other hand, Buffett knew.  On the third hand, did Buffett know the extent of Sokol’s ownership, or the fact that he bought the shares knowing of Berkshire’s possible interest?  On the fourth hand, it seems highly unlikely Sokol thought he was doing anything wrong.

Berkshire might be hurt if Sokol had a conflict of interest in pitching the deal.  But that conflict was disclosed.  It also might be hurt by revelations of a breach of integrity by top executive, though its stock decline on the revelation is probably because of Sokol’s resignation.  

My question:  what should federal law have to do with all this?  The “hook” for federal securities liability is the trading in Lubrizol — but the breach of duty that triggers liability has to do with the details of Sokol’s dealings with Buffett and Berkshire.  This, as I’ve said before, is appropriately a matter of state law.  See my article, Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998).

Nevertheless, the WSJ article says SEC is investigating.  Let’s hope nobody at the SEC has stock in Berkshire.

Update:  More on Sokol’s potential insider trading liability from Bainbridge, Bradford, and Davidoff.  I’ll stick to my initial post re materiality.  Bainbridge has a point that Sokol’s disclosure of his conflict may not be exonerating on state law, as I said recently.

The SEC has civilly charged an FDA employee under 17(a) and 10(b) with violating his duty of trust and confidence to the FDA and misappropriating drug approval information by using it to make $3.6 million in trading securities. The WSJ story summarizes:

The SEC and the Justice Department said the men traded shares dating back to 2006 of companies whose drugs were used for colon cancer, schizophrenia, insomnia, severe constipation, osteoarthritis and heart disease. Some of the FDA announcements at issue involved delays in the approval process due to the drugs’ safety or efficacy tests. Mr. Liang allegedly bought stock for profit before positive announcements, bet on shares falling after negatives ones and sold shares to avoid losses. * * *

[One] of the companies whose stock he allegedly traded was Momenta Pharmaceuticals Inc., a small biotechnology company from Cambridge, Mass., which was vying with two other companies to make a generic version of the blockbuster blood thinner Lovenox. The FDA unexpectedly told the companies in November 2007 that they needed to do further testing, holding up the approval process. The SEC claimed Mr. Liang made $130,000 by trading shares a day before the news was made public, cutting Momenta’s stock nearly in half. When the drug was finally approved, in July 2010, Mr. Liang made another $85,000 buying shares three days ahead of the announcement, the SEC alleged.

Well, I suppose we should be happy somebody’s benefiting from the FDA’s unpredictable and overly careful policies.  Holman Jenkins writes today about how the FDA is toying with approving, or not, a process for spotting melanomas which could cheaply and reliably save lives.  An FDA advisory panelist said, “I believe that MelaFind is going to help a few less people die and that’s why I voted yes.” But the FDA has the final say.  And Jenkins notes that while “[m]any lives will be saved, if the FDA will let them” “nobody at the FDA is ever fired for failing to approve a device.”  But apparently some do make money from the FDA’s waffling.

Finally, Liang should be sorry he’s not a Congressman, because they can trade on political information. As I noted several years ago, the solution to this trading by government agents is to “decrease government involvement in the economy. That is, after all, the source of the insider trading problem.”  Certainly that’s true in the FDA case.

More on Gupta-gate

Larry Ribstein —  19 March 2011

I first addressed what I call “Gupta gate” a week ago in a post on “the SEC’s shrinking credibility.” There I noted:

Guptagate is the SEC’s decision on March 1, the eve of its big Rajaratnam case, to file an administrative order against Rajat K. Gupta, former Goldman Sachs and P & G director, for tipping Rajaratnam about nonpublic information at the two companies.  Gupta had responded to a Wells notice only four days earlier, and the SEC made the decision after an unusually short weekend review.

I suggested that the SEC might be “in league with Justice to patch a gaping hole in its case against R by tainting a key witness.” 

Three days later I reported more evidence for this explanation.  I quoted John Carney’s story based on unnamed sources that the SEC evidently had rushed ahead with the Dodd-Frank proceeding because “[t]he evidence that Gupta seemed willing to provide was friendly toward Rajaratnam* * *The SEC, which views Rajaratnam a thoroughly bad guy, viewed this as an alarming development[.]”

The latest development is Gupta’s filing yesterday of a declaratory judgment action against SEC seeking to block the Dodd-Frank proceeding against Gupta.  The complaint notes, among other things:

  • The alleged conduct happened before Dodd-Frank, and there is no indication that the relevant provision (§929P) was to be applied retroactively.  [It is worth noting that this is no mere technicality.  Before Dodd-Frank, only broker-dealers knew they could be hauled in front of the securities industry’s main regulator in a non-judicial proceeding.  You might take this into account in deciding, among other things, whether you wanted to go into this line of work.  You did not take this risk merely by being a public corporation director like Gupta.  After 929P you might quit being a director if you thought your conduct might be subject to this extra level of scrutiny, or at least seek extra compensation for the extra scrutiny. Retroactivity denies regulated individuals this opportunity.]
  • The SEC’s order doesn’t allege that Gupta profited from tipping inside information or identify direct evidence that he conveyed material nonpublic information.
  • The first 27 Galleon related cases were filed in federal court.  This is the first administrative proceeding and the first use of the above Dodd-Frank provision against a non-broker dealer.
  • Procedures under the Dodd-Frank provision include an accelerated hearing schedule, no depositions, and the use of multiple layers of hearsay evidence.  This reduced level of procedural protection is especially critical in case like this which lacks direct evidence (i.e., a phone tap) that there was even a tip, and where it is especially important to be able to delve into the circumstances surrounding any allegedly culpable conversation.
  • Gupta emailed his Wells submission at 10:45 on Friday February 25, 2011 and delivered hard copy to the SEC the following Monday.  The Commission emailed a copy to the US Attorney’s office for use in Rajaratnam’s prosecution by Saturday and authorized proceeding against Gupta by Monday afternoon.  This haste suggests that the SEC could not be bothered with fine questions about Gupta’s guilt or innocence.  The only thing that mattered is the fact he wasn’t caving in.
  • Gupta was not informed before his submission of the possibility of administrative proceeding and had no opportunity to address this issue in his submission.

Gupta’s complaint states that “[t]he only plausible inference is that the Commission is proceeding how and where it is against Mr. Gupta for the bad faith purpose of shoring up a meritless case by disarming its adversary.”

The complaint not only makes a strong case for dismissal against Gupta, but raises a significant issue as to whether the Rajaratnam prosecution has been tainted by this extraordinary proceeding against a potentially important witness.

And on a more general level, it’s past time to take a very hard look at the agency that Congress has entrusted to police our financial markets post Dodd-Frank.

Friday I wondered whether the SEC’s hurried decision to administratively charge former Goldman director Gupta with insider trading suggested it was “in league with Justice to patch a gaping hole in its case against R by tainting a key witness.” 

Then I updated with John Carney’s story that Justice actually opposed the SEC over these charges, and they seemed rather to be a power play by the SEC in its struggle for supremacy over Justice.

Now Carney reports that the SEC “pushed ahead with its insider trading case against Rajat Gupta because of his status as a sitting board member on public companies” “which made him a continuing threat to shareholders of those companies.” 

But I wonder:  since Gupta was denying wrongdoing, how did the SEC know he was a danger to shareholders?  Why couldn’t it take a little longer than a weekend to consider Gupta’s reply to the Wells notice? 

Carney’s story hints at an answer: 

When Gupta responded to the Wells Notice in February, his response raised additional red flags with investigators at the SEC. The evidence that Gupta seemed willing to provide was friendly toward Rajaratnam, according to a person familiar with the matter who is not at the SEC. The SEC, which views Rajaratnam a thoroughly bad guy, viewed this as an alarming development, according to a person familiar with the thinking inside the SEC. From their point of view, Gupta was continuing as a co-conspirator with Rajartnam. They were determined to take action quickly.

In other words, apart from all that “guilty until proven innocent” stuff that the SEC apparently doesn’t believe, the real problem seems to be that Gupta — why he was a “thoroughly bad guy” — is that he might help Raj, who the SEC is totally convinced is guilty despite the fact that he’s still on trial.

Maybe I was right in the first place. Stay tuned.

With all of the attention being given to insider trading by hedge funds and malfeasance by corporate executives, it’s worth reminding ourselves that the politicians who seek to impose discipline are themselves no angels.

An important study published seven years ago revealed that U.S. senators were reaping returns from stock trading that strongly suggested they were trading on an informational advantage. Profits depended on their seniority, and therefore, presumably, power to influence legislation.

This led to a legislative proposal (the STOCK Act) aimed at prohibiting this trading.  Steve Bainbridge has written an article supporting this prohibition with some modifications.  He argues (footnote omitted):

Congressional insider trading thus is undesirable, in the first instance, because it creates incentives for members and staffers to steal proprietary information for personal gain. The massive increase in federal involvement in financial markets and corporate governance as a result of the financial crisis of 2008 has made opportunities to steal such information even more widely available to government officials. Second, it gives members and staffers incentives to game the legislative process so as to maximize personal trading profits. Third, inside information can be utilized as a pay-off device. Fourth, it gives members and staffers incentives to help or hurt firms, which distorts market competition.

It will not surprise the cynical that the act was not swept to adoption by the regulatory fever with which Congress has been seized in recent years. Congress apparently is so worried about corruption by corporate money it can’t be bothered with its own conflicts of interest

When STOCK was originally proposed I wrote:

Congress’s insider trading is bad because it gives our lawmakers the wrong incentives. Do we really want to give Congress more reasons to hurt and help particular firms?  In fact, Congress’s trading is worse than trading by corporate insiders, which at least might be rationalized as a way to let employees cash in on their productive efforts.

Indeed, one might even argue that trading on non-public knowledge is bad mainly when it’s done by politicians.  As long as this trading doesn’t interfere with property rights in information, it encourages socially productive investigation and monitoring, as Bruce Kobayashi and I have argued. If it does interfere with property rights, it can be handled by contract and state law rather than by a sweeping federal law (see my Federalism and Insider Trading, 6 Supreme Court Economic Review, 123 (1998)).

But should we ban Congressional trading?  It’s not really classic insider trading because it doesn’t involve theft of information belonging to somebody else.  Also, as I said in my original post, “it might even be a good idea to require them to own stocks (say, index funds) to encourage them to think like shareholders rather than politicians.”  I also noted in a later post that “[f]rom a purely market standpoint, we should actually want this trading, because it brings information into the market.” 

I added in this post that there would be severe problems with any regulation of Congressional trading, just as there is with insider trading generally:

our dynamic and liquid markets provide infinite opportunities to use information; and the information Congress has is so damned useful. Just about everything Congress does has some implication for some part of the market, and possibly the whole market. (Is a legislator who knows about an impending GM bailout ok if he trades in any stock but GM?) Congress people can decide not to act as well as to legislate.  

Even if we prohibited all trading by Congressmen, what about tipping?  Richard Painter notes that there will still be private briefings for campaign contributors: 

If for example, the government is going to help labor at the expense of bondholders in a particular bailout, should government officials be permitted to tell allies in organized labor this information before it is disclosed to securities markets? If so, labor leaders and investment funds they control have a potential to gain a lot more than preferential treatment in the bailout.

Hedge funds, of course, will want to nose around these briefings. Even after the current hedge fund insider trading trial has been concluded, it will still be legal for traders to fit together “mosaics” of immaterial non-public facts.  

And who will enforce the law?  The highly tainted post-Madoff SEC?  Congress itself?  Its inaction on the STOCK Act after five years indicates Congress’s zest for regulating in this area.

As if we needed more complications, along comes new evidence (HT WSJ) (Eggers and Hainmueller, Political Capital: The (Mostly) Mediocre Performance of Congressional Stock Portfolios, 2004-2008). Here’s the abstract (emphasis added):

We examine stock portfolios held by members of Congress between 2004 and 2008. The average investor in Congress under-performs the market by 2-3% annually, a finding that contrasts with earlier research showing uncanny timing in Congressional trades. Members also invest disproportionately in local companies and campaign contributors, and these “political” investments outperform the rest of their portfolios (local investments beat the market by 4% annually). Our findings suggest that informational advantages enjoyed by Congressmen as investors arise primarily from their relationships with local companies, and that widespread concerns about corrupt and self-serving investing behavior in Congress have been misplaced.

The authors explain the discrepancy with the prior study primarily as a “result of a reduction in the informational advantages of members of Congress between the period they study (1993-1998) and the period we study (2004-2008), a decrease in members’ willingness to act on these informational advantages (perhaps because of increased scrutiny applied to their investments), or simply a change in luck.”

The authors argue that Congressmen’s advantage regarding local companies results from their ability “to make judgments about the quality of senior corporate management and other hard-to-observe characteristics of local and other connected firms by virtue of their extensive interactions with these firms in the course of campaigns and lobbying.

In other words, based on this study:

  1. Congress is making perfectly legal and efficiency-enhancing judgments about corporate management.
  2. “Our study does not inspire much confidence about the average financial savvy of members of Congress, outside of the performance of their local investments (which after all constitute only about 6% of the average member’s investments). Even considering the strong performance of members’ local investments, they could have conserved their own wealth, and insulated themselves from ethical questions as well, by cashing in their stock holdings and buying passive index funds instead.”

Based on all of the above, here’s what I would suggest:

  1. Let Congress invest. It not only gives them a stake in their regulation, but also takes advantage of their legitimate informational advantage.
  2. Educate Congress about the capital markets.  It would help their legislation and prevent them from dying poor.
  3. Protect against corruption by mandating disclosure not only of trades but also tips.  In other words, as little as I like Regulation FD, there might be some benefit to imposing something like it on Congress. It seems from comparing the two stock market study that Congress was deterred from the worst insider trading by the scandal of several years ago.  This indicates that disclosure will have an effect.  Moreover, a simple prohibition just drives the trading underground, inhibiting enforcement and losing the market efficiency benefits of the trade.
  4. Reduce opportunities for all kinds of corruption, including by trading.  In other words, as I said in my most recent post on Congressional trading, we should

decrease government involvement in the economy. That is, after all, the source of the insider trading problem, and it has been exacerbated by the government’s increasingly acting like a private firm in buying up huge chunks of the formerly private sector.

In short, the solution to this problem, like the solution to many other problems, is less government.

Peter Henning discusses “the SEC under fire”, specifically Beckergate, which I’ve already discussed, and Guptagate, which I’ve been mulling since Sorkin’s Dealbook column last Monday. Henning observes that “the questions being asked could undermine the agency’s credibility as an effective regulator of the securities markets.”

As for Beckergate, Henning notes (in addition to the issues discussed in my post earlier today) that ethics approval came 25 minutes after the request from an ethics officer who was supervised by Becker, and “did not consider whether there would be any appearance of impropriety even though work on the matter came within the letter of the conflict of interest rules.” 

Becker was involved in the SEC’s decision whether to clawback money from from a $1.54 million account in which he had an interest.  Does this seem like there might be an appearance of impropriety worth more than 25 minutes deliberation?  

Moreover, even if this is ok with the government, it might not be ok with the DC bar.  Henning points out that Becker’s judgment might well be “adversely affected by the lawyer’s * * * own financial, business, property, or personal interests,” and thus raising a question under DC attorney ethics rules.  

Guptagate is the SEC’s decision on March 1, the eve of its big Rajaratnam case, to file an administrative order against Rajat K. Gupta, former Goldman Sachs and P & G director, for tipping Rajaratnam about nonpublic information at the two companies.  Gupta had responded to a Wells notice only four days earlier, and the SEC made the decision after an unusually short weekend review.

Moreover, the SEC chose this as the first insider trading case (and the first of the 26 Galleon related cases) to be brought under a new Dodd-Frank provision that gives the SEC the benefit of a “home court,” a lower evidentiary standard, and the opportunity to avoid judicial review.  (Betcha didn’t know this was what Dodd-Frank was for).  Yet just a few days later the SEC filed an insider trading case against a lawyer in federal court that involved only $27,400, much less than R supposedly made off Gupta’s information.

Sorkin notes that despite its extensive phone-tapping, the Gupta calls evidently weren’t recorded.  Also, “you have to imagine that if the evidence was truly overwhelming against him, Mr. Gupta might have sought to become a government witness to save himself.”

So is the SEC in league with Justice to patch a gaping hole in its case against R by tainting a key witness?  If so, it wouldn’t be the first time the government has used its power to threaten and taint potential defense witnesses to smooth its path to victory.  Indeed, as I’ve written, such abuse is a foreseeable result of giving great power to lightly supervised government agents. 

If we’re going to keep passing financial laws that beef up the SEC’s power, we need to watch carefully how that power is exercised.

Update:  Carney reports the SEC was actually at odds with Justice over the Gupta charges and that they were actually a power play by the SEC. So less bad for Justice, but arguably even worse for the SEC.