Kenesaw Mountain Landis, the legendary baseball commissioner, once said that every boy builds a shrine to some baseball hero, and before that shrine a candle always burns. Growing up a Baltimore Orioles fan during the franchise’s glory days, my shrine had many heroes, including central figures Cal Ripken (HOF 2007), Eddie Murray (HOF 2003), and John Lowenstein. Not central but still part of the shrine was Doug DeCinces, a good glove/solid bat third baseman who manned the O’s hot corner for nine of his 15 major league seasons.
And so I was saddened to read that last Friday DeCinces was convicted of 14 charges of insider trading.
Back in 2008, his neighbor, James Mazzo, then CEO of an ophthalmic surgical supply company, told DeCinces that the firm was about to be acquired by medical giant Abbott Labs. DeCinces owned stock in the firm and purchased more after he learned of the deal. He also shared the tip (though apparently not its provenance) with some friends, including Murray. DeCinces ultimately profited about $1.3 million on the deal according to press reports.
His maneuver seems inoffensive if shrewd; after all, who wouldn’t buy something that he can then sell at a profit? That is fundamental to the marketplace, and it typically makes all participants better‐off.
But in DeCinces’ case it’s a crime, and a very serious one. He can receive as much as 20 years in federal prison for each of the 14 charges he was convicted on.
The question is why. Remember that all an inside trader does is act on private information that more accurately reflects the future value of some financial asset than the current price does. He buys or sells that asset at a price that someone else voluntarily accepts. He does nothing that damages (or falsely props up) the ultimate value of the asset. Nor does he hurt the broader financial marketplace; if anything, his trading slightly pushes the asset price toward a more appropriate value.
This week the New York Times reports that the Supreme Court has refused to review the ruling of the Second Circuit Court of Appeals in the case United States v Newman. The Second Circuit, in December, overturned the insider trading conviction of a pair of hedge fund managers because nothing of value was exchanged in return for the information and thus the managers could not have known that the information they received was improperly disclosed to them by the information source. The Supreme Court decision would seem to block insider trading prosecutions in the absence of clear financial gains to those who leak the information.
This, in turn, has energized some members of Congress to introduce legislation to make it illegal to trade on insider information regardless of how one obtains it. This standard would define insider trading far more broadly than the standard laid out in Newman, or, for that matter, even before Newman based on the precedent in Dirks v SEC.
In his article in the current issue of Regulation, Villanova University law professor Richard Booth explores the Newman ruling. He argues that ordinary diversified investors neither lose nor gain from insider trading because they own all stocks and don’t trade very often. The only investors who have an interest in the prosecution of insider trading are “activist investors – hedge funds and corporate raiders – who stand to benefit from slower reaction times as they buy up as many shares as possible before anyone notices.” “… [H]edge fund managers have a distinct interest in seeing other hedge fund managers prosecuted for insider trading.” They rather than ordinary investors are the beneficiaries of insider‐trading prosecutions. Thus ordinary investors should applaud the Newman ruling and oppose the attempts by Congress to adopt a European‐style law against all insider trading.
For more Cato work on insider trading, see these links.
Research assistant Nick Zaiac contributed to this post.
From the Washington Post:
Hedge fund executives and other investors are increasingly interested in the timing and nature of health‐policy decisions in Washington because they directly affect the profits and stock prices of pharmaceutical, insurance, hospital and managed‐care companies…
[Former Centers for Medicare & Medicaid Services] director Thomas Scully, who served during the Bush administration…said he thought that it was useful for CMS officials to have more communication with Wall Street investors as a way for regulators to learn and “explain what an $800‐billion‐a‐year agency” does with its money.
So long as someone is still making a buck, it’s not socialized medicine…right?
Washington has been buzzing for the past 48 hours over revelations that some of Capitol Hill’s best‐known lawmakers have been making fortunes speculating in the stocks of companies affected by official actions, typically while in possession of market‐moving inside information. Rep. John Boehner (R‑OH), Senatorial wife Teresa Kerry and others made bundles trading in health companies’ stocks shortly before Congressional or executive‐branch action affecting the companies’ fortunes. After closed‐door 2008 meetings in which Fed chairman Ben Bernanke briefed Congress on the gravity of the financial collapse, some lawmakers dumped their own stockholdings or even placed bets that the market would fall. Rep. Nancy Pelosi (D‑CA) got access to highly desirable IPO (initial public offering) stock placements, some in companies with business before Congress. And so on. Studies have found that lawmakers as a group reap far above‐average returns on their investments — suggesting either that these politicians are among the world’s cleverest investors, or else that they are profiting from inside information. All this has been turned into a front‐page issue thanks to Throw Them All Out, a book by Hoover fellow Peter Schweizer, whose findings were showcased the other night on 60 Minutes.
So the question is: is all this legal? While there’s some difference of opinion on the issue among law professors, the proper answer to that question is most likely going to be, “Yes, it’s legal.” As UCLA’s Stephen Bainbridge points out, existing insider trading law, developed by way of a long series of contested cases under the Securities and Exchange Commission’s Rule 10b‑5, assigns liability to persons who are not corporate insiders if they are violating a recognized duty of loyalty to those for whom they work. As applied to the investment whizzes of the Hill, this implies that trading on inside information might be a violation if done by Congressional staffers (since they owe a duty of loyalty to higher‐ups) but not when done by members of Congress themselves.
It is tempting to approach the new revelations the way an ambitious prosecutor might, trying to stitch together a test‐case indictment from, say, the penumbra of the mail and wire fraud statutes bulked up with a bit of newly hypothesized fiduciary duty here and a little “honest services” there. But that’s not how criminal law is supposed to work: for the sake of all of our liberties, prohibited behavior needs to be clearly marked out as prohibited in advance, not afterward once we realize it doesn’t pass a smell test. But we are still free to deplore the hypocrisy of a Congress that has long been content to criminalize for the private sector — often with stiff jail sentences — behavior not much different from what lawmakers are happy to engage in themselves.
- How Washington’s plans may result in even higher executive pay.
“In 1993, Congress intervened in corporate compensation and messed things up. Now it’s the White House’s turn.”
- The case for allowing insider trading: “Want to keep companies honest, make the markets work more efficiently and encourage investors to diversify? Let insiders buy and sell.”
- Cato v. Heritage on the Patriot Act, Round III: “In hindsight, did Congress and the president react too hastily in 2001 by passing the Patriot Act just weeks after the 9/11 attacks?”
- Instead of fixing the Patriot Act, President Obama is protecting it.
- Twenty years later: Why the Berlin Wall fell.
- Podcast: “Financial Privacy and Freedom” featuring Prince Michael of Liechtenstein.