Wednesday, May 11, 2011

Another Billionaire Democrat in Trouble

In this case, Raj Rajartnam -- a billionaire who was convicted of fourteen counts of insider trading because he stupidly discussed what he was doing, and acknowledged that he knew he was doing something illegal.  This May 11, 2011 New York Times article has the juicy details (as juicy as insider trading gets).

I generally agree with those who argue that insider trading should not be illegal, because it hurts no one.  I also agree that it is a bit unseemly to being taking advantage of knowledge that others do not have.  If Rajartnam was some desperate little guy who was trying to make enough money to get ahead in life (as some of those who get caught are), I might be a bit more sympathetic.  But Rajartnam is a billionaire.  His illegal activities made him about $60 million, from what I have read.  To you or me, that's big money, but not to a billionaire.

Why would you risk going to prison for less than 6% of your net worth--especially when you have so much money that you could live extravagantly on the annual interest on the annual interest of your net worth?  (I'm serious: a billion dollars invested in corporate bonds gives about $50-$60 million a year; the interest on $50 million a year is $500,000 to $600,000 a year.)  This is crazy.

UPDATE: The theory of why insider trading hurts no one is this:

1. Mr. R knows that company X is about to go up, and he buys stock in X because he knows that.  Mr. Q sells his stock in X, unaware of the information that the stock is about to go up.  He has already decided to sell his stock at a certain price, and thus he is out nothing by making that sale.

2. Mr. R knows that company X is about to go down, and sells stock in X because he knows that.  Mr. Q buys his stock in X, unaware that the stock is headed down.  Mr. Q has already decided to buy that stock at whatever price he pays for it.  He is out nothing by making that purchase.

I agree that there is something unethical of Mr. R using that insider information.  It certainly creates a real lack of trust in the transparency of our institutions.  (Although if you have much trust in this you are a fool.)  As I understand it, the U.S. is the only developed nation with an insider trading ban.

I have read that the very first person actually convicted of insider trading was not a Gordon Gecko, He-Man Master of the Universe Wall Street type, but a guy working in a print shop in the 1950s who noticed the prospectus he was printing--and went out and bought shares in the stock that would be affected.


James B. Shearer said...

I don't understand why people think insider trading hurts no one. It is like counterfeiting, the harm is diffuse but it exists. Some person (or combination of people) is losing the money the inside trader makes.

James B. Shearer said...

The theory of why insider trading hurts no one is this:

Sure, but this theory seems clearly wrong. Suppose X buys 1000 shares of A because he has inside information. Without inside information X would not have traded A. This increases the demand for shares of A. Markets balance supply and demand by adjusting the price. So the price of A will go up a little and the number of other buyers and sellers will adjust to supply the 1000 shares. Perhaps the increase in share price will induce Y to sell 500 shares he would otherwise have held onto and will discourage Z from buying 500 shares he would otherwise have purchased. Y and Z lose (by missing out on the rise in shares of A) what X gains.

The profits an inside trader makes don't appear out of thin air, the economy as a whole is no better off (in contrast to profits from say an invention), they are at the expense of the other market participants. Like a poker game in which one player knows the cards are marked.

Rich Rostrom said...

Your argument assumes that the ignorant outsider agent(s) would have bought or sold regardless of the actions of the agent with insider information.

This may be true in the case of a broadly traded security and relatively small trade by the insider.

But in other cases, the market for the security may be thin, and the action of the insider may induce the outsider to trade.

Besides which, the argument really amounts to a restatement of the old excuse that an injury which is spread thin enough ceases to be an injury. If I embezzle a few thousand $ from a billion $ corporation, the effect is negligible, so the crime is victimless.

Likewise, this claim about the victimlessness of insider trading is based on the idea that the insider's trades are dispersed across such a large volume of trades that no other party has significant traceable losses. I don't buy it in either case.

I'll further suggest that passive misrepresentation is fraud. Anyone who buys or sells securities does so on the basis of the public information about them. One who sells securities, knowing that the public information is wrong, is engaged in passive misrepresentation.

Which deserves to be treated as fraud.