Saturday, December 18, 2010

Judge Needs a Lesson in Finance and Economics

U.S. District Judge Richard Sullivan on Friday sentenced former Jefferies Paragon Fund money manager Joseph Contorinis to six years in prison for insider trading.

During the sentencing, the Judge remarked:
This is a crime that does damage to the national economy.
Actually, it does no such thing. Indeed, if anything, it made the market, in the stocks Contorinis was buying on inside information, more efficient. Anyone selling at the time Contorinis was buying actually got a better price than they would have otherwise. Further, it may have signaled to some traders who watch price and volume action that something was up, and they would have pushed the stocks even closer to the eventual takeover price.

What Contorinis did actually benefited sellers in the stocks he bought on inside information. If those sellers knew now  that Contorinis was pushing the stock up closer to what its future price would be, they would be grateful.

Indeed, traders every where who buy stocks thinking they are undervalued should hope for insider trading in the stocks (if their analysis is correct) since it will mean more efficient markets where prices move sooner to their ultimate price.

One part of the statement by Judge Sullivan was correct:
It’s very important to send a message through the sentence imposed on you. You will become a poster child for what happens.
Not that it is important to send a message, but that it will. That Contorinis is going to prison at all for this is an outrage, that he is going to prison for six years is mind boggling. It will send a chilling effect on many who may consider insider trading in the future. It thus will make markets less efficient, and it may cost you money down the road when you personally sell a stock even a day to early before a takeover, because an insider who could drive the stock up for you closer to its takeover value is afraid to act because of sentences handed out like those by Judge Sullivan.

This is a further example of the failure of the public, including the educated, to understand how markets function and how markets are distorted by laws and regulations. There should be no insider trading laws and no insider trading police. The only place an ethical problem comes into the picture with regard to insider trading is when a client that plans to takeover a firm seeks advice from lawyers or investment bankers. Those lawyers and investment bankers have a duty to provide confidentiality and also not trade the stock. If they break that ethical obligation that should be worked out between them and the client. No police or public judges necessary.

Contorinis was not in such position of servicing a client and had no obligation to not act on the information he received. The sentence is a terrible tragedy for him personally, but also will cause the stock market to be less efficient and that is a tragedy for the rest of us.

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