Milton Friedman on Insider trading

Discussion in 'Trading' started by Josh_B, Mar 12, 2003.

  1. I don't have time to pull out the legal cases to rebut this article, but suffice to say it is nonsense. The Supreme Court has ruled that insiders have no duty to reveal inside information, except in so far as there are normal SEC reporting requirements, but they have never ruled--at least since the Securities Exchange Act of 1934--that insiders can trade on the basis of such information. In other words, if they don't publish the info, they can't trade on it.

    The '34 Act prohibits fraud in connection with the purchase and sale of a security. It has long been the common law that selling something you know is faulty without disclosing it can be fraud if you have a duty tothe buyer. In this case the duty arises from the special knowledge available to executives of publicly held companies. They have a duty to existing shareholders because they work for those shareholders. They also have a duty not to buy on nonpublic information. One of the first cases involved exec's who bought with advance knowledge of a mining find.

    There are no such restrictions in the commodity markets. That's because commodity traders don't work for the other side of their trades. It is highly illegal for a commoidty fund manager to trade against his investors or front-run them however.

    The restrictions oin the '34 Act were very controversial when first enacted. (Incidentally, William O. Douglas, former Supreme court Justice, was Chairman of the SEC then) Exec's considered it a perk of the job to be able to trade on insider info. The only people who seriously object now are doctrinaire libertarians and the like.

    It is not even clear to me that allowing this kind of fraud would achieve what Friedman advocates. Insiders are allowed to sell their stock now. There is a whole cottage industry watching such buys and sales. Too much of it will move the stock, so most of what friedman wants is already happening. Allowing Waksal to get a one day head start by frontrunning an FDA announcement doesn't seem to add much in terms of market efficiency. More importantly, if the public realizes that the game is even more crooked than they thought, they have the option of not playing. Less liquidity equals less efficient markets.

    Martha Stewart is in trouble largely for lying to investigators. If her broker advised her to sell because Waksal was selling, that may or may not be a civil violation. At worse, the penalty would have been disgorgement plus a promise not to do it again. Lying to investigators and trying to persuade others to do so is obstruction of justice however, and first time offenders, particularly white collar crooks, normally get hard time for it.
     
    #11     Mar 13, 2003