Suzi Ring & Matt Robinson
Bloomberg.com Updated May 10, 2016 10:22 AM UTC
It seems obvious on first glance: Insider trading is cheating and ought to be a crime. Ivan Boesky and hedge fund billionaire Raj Rajaratnam famously went to jail for doing it and George Soros paid a big fine. Actually, though, it’s not obvious at all. In the U.S., where prosecutors have vigorously pursued insider trading cases, there’s no law defining it. Courts are split about where to draw the line between legal and illegal use of private information in pursuit of profit. Some scholars think it shouldn’t be illegal at all, reasoning that outlawing it restricts information flow in markets. There’s also a huge variance in penalties, with a maximum two years’ jail time in France versus 20 in the U.S. and South Korea.
The U.S. Supreme Court will consider a California case that could resolve what sort of benefit a defendant must receive to make insider trading a crime. In 2014, a federal appeals court decision had narrowed the definition and made it harder to prosecute. It was a confusing coda to one of the biggest insider-trading events in U.S. history, when the hedge fund SAC Capital Advisors pleaded guilty and paid a record $1.8 billion fine after a fund manager squeezed tips from doctors involved in a clinical drug trial to net $275 million. In all, federal prosecutors in New York dismissed or lost on appeal 14 of 91 convictions from August 2009 to December 2015. They had convicted Rajaratnam after wiretaps showed that his firm used insiders to trade ahead of public announcements about earnings, forecasts and mergers. The U.K. convicted a high-profile ex-Moore Capital trader, while billionaire Paul Singer’s Elliott Management was assessed $22 million in civil penalties in France. In 2015, a French court blocked a trial of Airbus executives who sold shares when they knew about costly production delays. Meanwhile, hedge funds are snooping on their own employees, using keystroke-reading software to spot rogue traders.
Source: BloombergThe BackgroundThere’s no U.S. law specifically barring insider trading. It became a crime through judicial interpretation of a 1934 law aimed at cleaning up markets after the 1929 stock market crash. Not until the 1980s did prosecutions really take off. One of the most famous cases made household names of financiers Michael Milken, Dennis Levine, Martin Siegel, and Boesky. He’s thought to be at least part of the inspiration for the character Gordon Gekko in the 1987 film “Wall Street.” Insider trading rules are murky and complex. What’s clear in the U.S. is that traders can’t use information they obtain by paying tipsters to pass along secrets. Less clear is what happens if a trader doesn’t pay, or doesn’t know whether a tipster received some benefit. In the U.K., insider trading became illegal in 1980, but only 14 convictions were secured in the next 26 years. Spurred by the financial crisis, the U.K. markets regulator produced 30 convictions from 2009 to May 2016. Legislation against insider trading wasn’t enacted in Germany, India and China until the 1990s. Japan tightened insider trading laws in 2013 after scandals embroiled prominent firms including Nomura Holdings. The country made it a crime to give out inside information even if nobody trades on it.
The ArgumentThere are two schools of thought about the uses of insider trading. One holds that it allows information to be incorporated into stock prices quickly, making them more accurate. By that reasoning, insider trading helps investors and criminalizing it hurts them. The contrary view is that access to non-public information allows a select few to make big bucks while other investors are kept in the dark, damaging the integrity of markets. To complicate the issue, corporate employees — the real insiders — are allowed to trade their own stock so long as the information they’re trading on is generally available. That’s hard to define and regulate. Insider trading can be difficult to prove and prosecute but it generates headlines that regulators have come to depend on as a deterrent to market abuse. Does it work? That’s up for debate.