Defining Insider Trading

Recently there have been a slew of insider trading probes and lawsuit against Wall Street traders.  The recent surge of cases has lead to some interesting questions regarding what is and isn’t insider trading.  The case at the center of the questions is a 2012 case against two traders, Todd Newman and Anthony Chiasson, who were convicted of insider trading.  They have since appealed their conviction on the grounds that they received their non-public information not from the original leaker, but indirectly through a network of analysts.  They claim that since they didn’t know the the original source personally benefitted, they didn’t commit true insider trading.  There are other cases waiting on this appeal to provide more legal clarity about what should be counted as insider trading.

The above case is certainly not a cut-and-dry case of insider trading.  Some cases are easier to determine.  For example, a BP employee recently agreed to pay over $200,000 to settle an insider trading charge relating to the 2010 BP oil spill.  In this case, the employee had access to private information on how much oil was leaking, and responded by selling off a large amount of shares anticipating a huge drop in BP’s stock price.  BP stock lost 48% following the oil spill crisis, saving the man and his family hundreds of thousands of dollars.

The presence of intermediaries between he original leak and  Newman and Chiasson acting on the information makes their case more foggy when it comes to determining right from wrong.  When a trader gets a piece of information from an analyst, how are they supposed to determine if that information was truly private.  Firms have been known to intentionally leak information, and therefore it can be difficult for a trader to determine what is really private information and what isn’t.  If the trader doesn’t act, they are mission out on lost profits on information that wasn’t actually “insider”.  Not to mention that if many people know about a leak, the information ceases to really be insider.  As one organization put it, “At some point, a leak of nonpublic information about a company’s anticipated results…becomes just one more piece of market intelligence that is circulating among analysts and portfolio managers.”  When does proprietary information become public?  If that line isn’t clearly drawn, I believe that honest people search for profits could be punished for something that isn’t insidious at all.

On the other hand, if a trader know they have information that is non-public, one might argue that they just simply shouldn’t use that information to their advantage because it is wrong.  However, I don’t really think that this is a plausible solution.  Once someone knows a piece of private information, they know it, and cannot un-know it.  Regardless of their desire of whether or not to use that information to their advantage, that information can guide other decisions they make without them really even knowing.  I think its not too far of a stretch to believe that a lot of traders make a lot of indirect insider trades without realizing it.

Furthermore investing, at its core, is about having a more accurate idea about a firm that the next person.  But at some point, the government has said that having too much information should be illegal.  I agree that there are many instance where insider trading feels wrong and that a select few are talking advantage of a much larger shareholder base, I’m not sure I believe that insider trading is as odious as some make it out to be.


2 thoughts on “Defining Insider Trading

  1. ajsanna

    Nice read. Your point about the intermediaries was interesting. I believe that even if someone gets the insider information from someone without knowing that it is material non-public information, it is their responsibility to be skeptical or check and see if it does constitute insider info before they trade based on it.

  2. agolicz

    Wow, I had thought insider trading was pretty cut and dry; that it was illegal to trade on any non-public, material information about a company. Sounds like it’s a much more subjective definition. This raises a lot of other questions like: If you work for a company that you have information about, are you more likely to get nailed for insider trading than if you worked elsewhere? What if you got the information on your own (ie: a fisherman or marine biologist discovering an oil spill before it becomes public) where the criteria of “non-public” and “material” still stand, would this still be insider trading? Or more importantly, why is it fair that some can buy information before it becomes public (ie: HFT firms buying financial data a few microseconds before it’s released to the public) and not be prosecuted for insider trading? Seems to be an overly convoluted and flawed part of our legal system.

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