Saturday, May 14, 2011

The "Crazed Pursuit of A Level Playing Field"

"For 30 years, [stock market] regulators have been driving themselves and the markets batty with their crazed pursuit of a "level playing field"—the weird idea that the stock market should be some kind of informational potato-sack race in which all boys and girls have an equal chance to win.

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."

~Holman Jenkins in today's WSJ on the Raj Rajaratnam case.

26 Comments:

At 5/14/2011 6:16 PM, Blogger James said...

Raj Rajaratnam

 
At 5/14/2011 6:31 PM, Blogger Mark J. Perry said...

See full article, it's about the Raj Rajaratnam case.

 
At 5/14/2011 10:16 PM, Blogger Buddy R Pacifico said...

This comment has been removed by the author.

 
At 5/14/2011 10:18 PM, Blogger Buddy R Pacifico said...

From Jesse at Jesse's Cafe Americain blog:

"Rajaratnam Guilty On All 14 Counts of Insider Trading - Faces 19+ Years In Prison



"The tapes show he didn't believe the rules applied to him. Cheating became part of his business model."

"He" is a microcosm of a financial system in which the currency of fraud drives out honest price discovery and displaces productive activity, and large institutions game the markets on a daily basis with near impunity, while the public underwrites their steady gains and occasional but spectacular losses.

Sentencing will be on July 29"

 
At 5/15/2011 1:09 AM, OpenID Sprewell said...

Eh, the guy's worth almost $2 billion and is accused of making $45 million on this questionable charge. If you're going to make insider trading a criminal charge- I don't think it should even be illegal- at least make the punishment reasonable: make him pay back 5 times the amount as a fine. I guarantee that a billionaire like him only cares about the money anyway, and you don't waste money putting him in jail. It's not like he was going to kill people if left on the streets, like some common street thug.

 
At 5/15/2011 10:05 AM, Blogger Methinks said...

Making insider trading legal again would strengthen the market. It would allow relevant information to be released more quickly.

If people could pay to receive a newsletter telling them relevant information, they would (and they do). The objection here seems to be the fact that insiders are payed for the their information. This makes no sense to me. Why would you object to paying an insider but not, say, Mark Skousen (he publishes an investor newsletter)? Particularly, since the insider has much better, stock moving information usually.

There is no such thing as a level playing field and retail traders are not better off because insider trading is illegal. They are worse off.

 
At 5/15/2011 12:26 PM, Blogger DL said...

“There is no such thing as a level playing field and retail traders are not better off because insider trading is illegal. They are worse off”
. . . . . . . . .

I agree that there is no level playing field with regard to mark-moving information, but I don’t see the harm in aspiring to achieve one.

Regarding the question of whether retail traders are better off as a result of insider trading being illegal, I would say that illegality by itself means nothing; what matters is enforcement.

Those with access to inside information have an unfair advantage. As for the “harm” to the individual investor, those who have inside information will, by their collective buying (or selling) cause the stock price to move. Gains achieved by those with inside information do indeed come at the expense of someone else, just as government spending programs for one group of people come at the expense of others.

I fully support the notion of imprisoning people who trade on inside information, even as I realize that for every person caught and successfully prosecuted, there will be hundreds of others who are never caught.

 
At 5/15/2011 12:44 PM, Blogger Methinks said...

Those with access to inside information have an unfair advantage

so do:

Those who are smarter
Those who are better educated
Those who are more talented
Those who develop better models
Those who have better technology
Etc.

As I said in my original comment (and you have once again repeated in your comment), your only complaint is that the insider is paid for his information (the profit he makes by trading on it). That's a strange complaint.

However, if you're so opposed to it, then you should want legalization of insider trading as the value of that information to any given insider can be reduced if insider trading is not illegal.

Removing the restriction means that the insider trader will have competition from other insider traders, reducing the expectancy of trading on insider information. Companies will still have their own insider trading restrictions and they are both better able to punish and monitor insider trading than the SEC.

SEC enforcement costs far more than any benefit you may wrongly perceive you're getting. You're paying for the SEC to maintain a less information efficient market structure. Do you enjoy paying to have less information than you could have when making a decision?

 
At 5/15/2011 2:44 PM, Blogger juandos said...

"SEC enforcement costs far more than any benefit you may wrongly perceive you're getting. You're paying for the SEC to maintain a less information efficient market structure. Do you enjoy paying to have less information than you could have when making a decision?"...

Hmmm, makes me at least wonder how a buyer into the market knows what he or she is going to get for their money...

None the less methinks I think you're totally on target regarding the usefulness of the SEC...

 
At 5/15/2011 5:16 PM, Blogger Methinks said...

Juandos,

You do not have to have a trading account to pay for the SEC. It's part of the deadweight loss of regulation.

Theft of information is an issue. Trading on information should never be an issue.

 
At 5/15/2011 6:48 PM, Blogger DL said...

Methinks,

“your only complaint is that the insider is paid for his information (the profit he makes by trading on it)”.

. . . . . . . .

The profit that the insider makes occurs at the expense of others. If a group of insiders knows that that company “X” is going to be taken over (by another company), they will, by their collective buying, push up the price of the stock. By the time the takeover is made public, much of the rally has already occurred. This hurts potential buyers of the stock, relative to what would have happened had the insiders not acted on their information.

Actually, I think the more interesting question here is what to do about members of Congress who sell information about pending legislation that will affect the stock prices of certain companies. Then there’s the question of what to do about government officials who sell information about upcoming economic data (payroll numbers, inventories, factory utilization, ISM, etc.), and how to "catch" them in the first place.

 
At 5/15/2011 9:55 PM, Blogger Methinks said...

The profit that the insider makes occurs at the expense of others.

All profits in trading come at the expense of others. Every individual trade is zero-sum even if trading in its entirety isn't. What of it?

....This hurts potential buyers of the stock, relative to what would have happened had the insiders not acted on their information.

First of all, you overestimate how long an insider has to take advantage of his information and how much he makes from it. The very moment an insider shows his order to the market, he has given up his information in the same way that a decision by a poker player gives up some of his information to the other players. This is not a small point, but let's roll with your example as is.

How is your statement in any way true? If you were not already long at the time of the public announcement, then you are not getting in at the lower price after the announcement. If you were already long, you benefited from the run-up. More importantly, the guy SELLING is less hurt because the information is out quicker and he's not selling his stock at the previously low price. So, where and how were these potential buyers hurt by insiders releasing information rather than a press release?

Actually, I think the more interesting question here is what to do about members of Congress who sell information about pending legislation that will affect the stock prices of certain companies.

Actually, they are exempt from insider trading prohibitions. Completely exempt. I think it is very interesting that our "public servants" are exempt from the rules that govern us serfs. Very interesting indeed. Are they our masters? What's up with that?

But, you are incorrect if you think that the insider trading prohibition is not an interesting and worrying.

First of all, the SEC is expanding is terrifically expanding the definition. Secondly, what you don't see is what firms have to go through to prove that there is no insider trading BY PEOPLE WHO HAVE NO ACCESS TO INSIDER INFORMATION. That's right. It's insane. The cost of compliance with this idiocy is astonishing. The price of not having this idiotic law on the books? A more information efficient market. A no brainer.

 
At 5/15/2011 11:13 PM, Blogger DL said...

MeThinks,

Thanks for your comments.

Since you took the trouble to write your 9:55 post, I'm acknowledging it.

 
At 5/16/2011 4:42 AM, Blogger Ron H. said...

Methinks

Thanks for the clear & well written comments. I have felt for some time, that insider trading wasn't really a bad thing. Now I am certain it isn't, and I know why.

 
At 5/16/2011 8:14 AM, Blogger save_the_rustbelt said...

The biggest proponents of the "level playing field" are the stock brokers and trading companies who work on behalf of Wall Street, selling investments to chumps who think they have a chance of competing with the flash traders, quants and hedgies.

 
At 5/16/2011 9:27 AM, Blogger morganovich said...

"Stock trading is a mug's game. Use an index fund."

while this may be true for the majority of folks, a significant number of professional investors can beat the market very consistently.

far from being a "mugs game" it's a game for the smartest and most diligent..

claims about mutual funds under-performing indexes are just negative selection bias.

if the managers were good enough to want to be paid for performance instead of marketing, they'd be running hedge funds.

try running this "mug's game" nonsense by greenlight, SAC, paulson, highfields, or any of 100 other funds.

regarding "level playing field", if anything, we have been heading in the wrong direction.

reg FD was a disaster.

it was intended to prevent managements from given preferential information to favored investors and give retial investors equal access.

in effect, it has given everyone less information. managements are terrified of disclosure and having to file an 8k if they answer your question. as a result, they just do not disclose information. this makes the whole market less efficient. now we all have to play like retail.

this is a huge advantage for a guy like me who spends his day doing fundamental due diligence, but it's a disaster for the market as a whole.

it also does not stop insider trading or preferential info, it just narrows the circles. you cannot call a company out of the blue and expect to get the straight story any more, but if you golf with the chairman, he's still telling you what he always did.

 
At 5/16/2011 9:30 AM, Blogger morganovich said...

ps.

the galleon clowns deserve everyhting they are going to get.

it was a deliberate, calculated break of trading rules.

they cheated, they got caught, and now it's jail time.

it's not clear that insider trading laws make a market work better (many markets don't even have them), but we have them and this was about as clear a breach as can be imagined.

say hi to bernie raj...

 
At 5/16/2011 10:01 AM, Blogger Methinks said...

Morganovich,

As you probably know, I see "cheaters" all the time. They reveal information and that's great for the market.

However, in defending the right of companies vs. the SEC to set and police insider trading rules, I am in no way defending these clowns as freedom fighters.

Most of us who are against the insider trading law are unwilling to break it and suffer the effects on our firm and our family. These clowns broke it not as an act of civil disobedience but because they don't think law - any law - applies to them. In that way they have much in common with Eliot Spitzer and Bernie Madoff.

So, in rejecting the current insider trading laws, I want to be clear that I am not viewing the current crop of violators as poor innocents.

Also, I agree with you wholeheartedly WRT Reg FD. I was an equity analyst before it passed and an analyst for a while after. It's a disaster. Very little of what the SEC does actually strengthens markets - mostly because markets work best without a politically motivated entity turning them into Frankensteins.

 
At 5/16/2011 11:50 AM, Blogger juandos said...

"The biggest proponents of the "level playing field" are the stock brokers and trading companies who work on behalf of Wall Street...."...

LMAO!

You have something credible to back that 'stuff' up rusty belt?

 
At 5/16/2011 11:57 AM, Blogger morganovich said...

methinks-

"As you probably know, I see "cheaters" all the time. They reveal information and that's great for the market. "

i fear you are presuming that i know more than i do.

in what context do you see cheaters all the time?

i can definitely see the merits of you "let companies set their own standards" argument as it does maximize the information in the market.

you could also add in a simplicity argument as the current insider trading laws are byzantine, nonsensical, and deliberately vague.

so, if the CFO tells me they are going to miss the quarter, it's insider trading, but if he tells his golf pro and that guy tells me, it's not? what an odd way to structure the rules.

but, on the other hand, there does seem to be a solid anti nepotism argument, especially for insiders.

if a ceo is allowed to dump shares in bulk ahead of announcing that he is under investigation for an accounting scandal or because they are going to miss a revenue target, that seems to fly in the face of ideas about fairness and reasonableness as well as allowing him to avoid the consequences of his actions.

hell, if we let him buy puts he could PROFIT massively from running the company into the ground.

this creates some pretty perverse incentives.

even if we don't let him short, he could use cookie jar accounting or even just contract timing to sell stock, miss a q, buy it back cheaply, then blow out the next quarter. repeat as needed.

even if we prevent him from trading, he could tell his son or his wife, or his friend who agrees to split the money with him.

unfortunately, insider trading is just not a simple issue. it gets pretty complex and thorny either way.

i'm not sure there is a really good, consistent answer.

 
At 5/16/2011 12:00 PM, Blogger morganovich said...

"The biggest proponents of the "level playing field" are the stock brokers and trading companies who work on behalf of Wall Street...."

um, no.

they were the beneficiaries of the slanted playing field.

the last big leveling was sarbox and reg fd. these were pushed through by populist politicians to the great detriment of all.

the brokers and banks opposed this plan. so did most funds.

you are mistaken in your view.

you seem to be arguing that the beneficiaries of a slanted field were arguing to end their advantage.

 
At 5/16/2011 12:09 PM, Blogger Mike said...

3rd party attempts to create a level playing field don't seem to ever eliminate big losers and only serve to take the legs out from under big winners...making it harder for the average guy (who knows next to nothing about trading) to hitch his wagon to consistent performers.

 
At 5/16/2011 12:21 PM, Blogger Methinks said...

Morganovich,

In the products I trade daily I can tell who might have insider information by the size they trade relative to the average daily size (as just one example). That's the most common way in which they give up their information to the market. Most often, they show up in options and "cheater" is shorthand for "possibly trading on insider information". Of course, once that information is given up through trading on a national exchange, it's no longer inside information. Market makers immediately adjust their market - effectively reflecting the information read from the trade.

There is a good, consistent answer to insider trading. Allow companies to make and enforce their own rules. The most valuable information insiders reveal is fraud and that's not something the SEC should be helping companies cover up. The SEC should be out of the insider trading issue entirely.

 
At 5/16/2011 12:41 PM, Blogger Methinks said...

if a ceo is allowed to dump shares in bulk ahead of announcing that he is under investigation for an accounting scandal or because they are going to miss a revenue target, that seems to fly in the face of ideas about fairness and reasonableness as well as allowing him to avoid the consequences of his actions.

That's incorrect. His attempt to dump his shares immediately alerts the market - adjusting the price quicker and adding to the information efficiency of the market. If he's being investigated for fraud, the recovery of any profit he might have made by trading ahead of his own investigation can be part of the punitive damages. Don't forget that the firm may have rules against insider trading (even if the SEC doesn't) and can recover that profit.

BTW....buying puts is exactly what he'll do. But, he won't profit massively. His trading pattern will tell MM's something is afoot and we will change our market to reflect that information. Thus, his best bet is his first trade and he'll want to make it as massive as he can. The larger it is, the more we're likely to sharply move our market down. If he persistently offers smaller size, we will move our market down incrementally. If he continues to hit our lower bids, we might join him in selling and definitely take our bid WAY down. I've paid for the information, but I can make more money by reading the information he's making public by trading than the amount I pay for the information.

That's way more fair and decent than insider trading rules that aid WorldCom in covering up 5 years of fraudulent statements.

Implicit in your scenario is an assumption that market does not react to the information revealed in insider trading and that firms will not have their own rules regarding insider trading. They likely will - and that CEO will likely be fired.

I'm just saying it's not an SEC issue.

 
At 5/16/2011 1:39 PM, Blogger Methinks said...

work compels me to answer these in chunks....

even if we don't let him short, he could use cookie jar accounting or even just contract timing to sell stock, miss a q, buy it back cheaply, then blow out the next quarter. repeat as needed.

Aside from letting this be a company rule, you have to remember that the fact that insider trading isn't illegal means your insider immediately has competition from other insiders. This competition will drive down the potential profits from insider trading. So, your CEO is unlikely to make a killing (or even find it worthwhile) for that reason as well.

In short, SEC-imposed insider trading rules are a huge cost without a benefit.

 
At 5/20/2011 9:24 PM, Blogger VangelV said...

I agree that there is no level playing field with regard to mark-moving information, but I don’t see the harm in aspiring to achieve one.

Human beings are what they are. You will not change human nature no matter how hard you try. The idea that ignorance is better is plain stupid. If insiders knew that a stock was overvalued they would sell and by doing so would prevent degenerate gamblers who were buying shares on the basis of tips or incomplete information from paying a higher price. If the shares were undervalued they would start to buy and by doing so would increase the price to more reasonable levels. In both cases investors benefit from the extra information provided by the insiders' actions.

Those with access to inside information have an unfair advantage.

Again, I see no virtue in ignorance. Why shouldn't more information be rewarded?

As for the “harm” to the individual investor, those who have inside information will, by their collective buying (or selling) cause the stock price to move.

Yes, in the proper direction. They will drive undervalued shares higher and overvalued shares lower. How does that harm individual investors who buy and sell in an anonymous market?

Gains achieved by those with inside information do indeed come at the expense of someone else, just as government spending programs for one group of people come at the expense of others.

Do they? If I want to sell a stock that is really undervalued having an insider bid up the price gets me a higher return. And if I want to buy an overvalued stock having insiders selling will allow me to pay less. In both cases I am better off.

You may want to rethink the logic of your argument.

 

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