Saturday, May 16, 2009

Real Insider Trading and the SEC

Economist Henry Manne has made a strong case that what the SEC generally prosecutes as insider trading should not be illegal.

Argues Manne:

It's very important in the world of finance that shares be accurately priced. There are many things that turn on that -- compensation does, the whole takeover field turns on it, people's investment decisions turn on it, so it's very important that we have actual reflection of what's going on. Well, how do you get that? The SEC says, well, we'll get reports that come out three or six months later, and that will inform the market of what's going on. That's baloney. The way the market works is that informed people do their trading, and every time they trade on good news, they drive the price up -- every time they trade on bad news, they drive the price down.
I completely concur.

The case is different, however, when government employees are accused of insider trading. I wrote last October:

I have always contended that real ugly insider trading can only be done by government officials who are in a position to influence government escapades, and also take positions to profit from such.
I bring this to the forefront as news of potential insider trading by SEC enforcement attorneys is developing.

The facts at this point suggest serious breaches by three SEC enforcement attorneys, one male and two females. Two of the three cases have been referred by the SEC's Inspector General (IG)to the Justice Department and FBI.

Female A according to a report from the IG:

...hadn't received clearance from the ethics office for 10 of the 247 transactions...
It is going to be very interesting to learn about these 10 transactions. Was it simply a case of sloppy follow through that resulted in the failure to report the 10 transactions, or were the transactions such that if they would have been reported they would have sent out red flags to insider trading?

Some clue as to what the inspector general suspects is that this case was referred by the IG to the DOJ and FBI.

The male involved appears to have decided to play "catch me if you can" with the IG. During questioning by the IG, he told the IG is "heart was pure". What kind of comment is that?

According to WSJ, this male: in the enforcement division's chief counsel office, a key position that vets all cases, ensures consistency across the division, and often offers advice to attorneys...
Talk about a power positon from which to influence enforcement. Yet, he told the IG that he didn't keep a list of matters he has reviewed in the chief counsel's office. A bureaucrat, and a lawyer at that, not keeping CYA records, how likely is that?

This sounds an awful lot like an enforcement attorney who knows his trading (and a linked brother and sister-in-law) involved stocks where enforcement activities were ongoing, and he is not going to provide a list of what enforcement items he had been working on, to help the IG incriminate him. The IG will have to find other means to determine what enforcement actions the attorney was working on (and how they related to this attorney's trading and that of his brother and sister-in-law). And the IG has done just that since he has also alerted the DOJ and FBI to this case.

Also curious is female attorney B who told the IG that in weekly meetings with female attorney A and the male attorney that she

...learned there were at least three open investigations into [a] company...adding that she told the inspector general she had shared this information with her colleagues at lunch and by email. The report says the other two owned the stock at some point but doesn't say when. The two deny having been told of the investigations, the report said.
This sounds to us as though there are also Martha Stewart obstruction of justice elements to the case, we have the male attorney and the female attorney A denying being informed of investigations on a particular company, but female attorney B told IG that she did inform the other two and there are corroborating emails. Are the male attorney and female attorney A lying to cover up the fact that they were trading on inside information?

Now that this much information is out, the rest will leak out over time, including the identities of the SEC attorneys involved. There will be too many reporters working the story. The SEC will have a tough time burying this one. Get your popcorn ready.

1 comment:

  1. Walt Williams did some interesting critique of the whole idea of "insider trading" some years back.

    But much more important is this recent study, discussed by 'Marginal Revolution' here.

    US senators' personal stock portfolios outperformed the market by an average of 12 per cent a year in the five years to 1998, according to a new study.

    "The results clearly support the notion that members of the Senate trade with a substantial informational advantage over ordinary investors," says the author of the report, Professor Alan Ziobrowski of the Robinson College of Business at Georgia State University.
    Here's more...

    A separate study in 2000, covering 66,465 US households from 1991 to 1996 showed that the average household's portfolio underperformed the market by 1.44 per cent a year, on average. Corporate insiders (defined as senior executives) usually outperform by about 5 per cent.

    The Ziobrowski study notes that the politicians' timing of transactions is uncanny. Most stocks bought by senators had shown little movement before the purchase. But after the stock was bought, it outperformed the market by 28.6 per cent on average in the following calender year.
    So who are the real inside traders?

    Mark Twain wrote in Pudd'nhead Wilson's New Calendar...
    "It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress."Now we have the facts and figures.

    (BTW.. Slate reported last year that recent studies by forensic economists found that "people who knew about secret, CIA-led coups used that information to game the stock market". See here.

    My guess is that similar results could be unearthed concerning every kind of government policy activity, foreign or domestic, dramatic or mundane.

    The great sustaining myth of modern big government is the illusion of fairness. Over time as government control widens and deepens corruption grows.

    It was the advent of laisser faire in the 19th century that enabled civil service reform to progress in the UK. Prior to that era government jobs were purchased for their graft revenue. Social reformers would no more think of using the unreconstructed state to advance their agenda than entreating to the mafia. Thus classical liberals and "Benthamite utilitarians" made common cause in seeking laisser faire, for both allies it was a step forward, even if their paths would diverge after victory.

    Now as the utilitarian state expands and expands apparently unquenched, it seems likely (as Milton Friedman first suggested in 1962 [see here) that the old vices would return, perhaps finally putting a brake on big government.

    The figures and studies referred to above indicate that the first part of Friedman's thesis has so far come to pass.)