Tuesday, November 23, 2010

The Most Absurd Article of the Week

It's been awhile since I've done a Misleading Financial Post of the Week (maybe I should replace week with month).  Anyway, I found another one that I want to bring to your attention. 

One of the big financial news stories hitting the airwaves is about a "massive" insider trading probe being conducted by the SEC.  Apparently, many of the big financial firms are involved, including the ubiquitous Goldman Sachs.  In an editorial on the CNBC website, anchor Michelle Caruso-Cabrera attempts to make the case that insider trading should be...



Wait for it...



Legal!!!

Before you fall down laughing from the absurdity, here is a quick summary of her arguments in favor of legalizing insider trading:
  1. Enforcement is asymmetric, meaning that you can't be accused of insider trading if the inside information prevented you from making a trade.
  2. Milton Friedman said so.
  3. It is not unfair to the average investor because most people can't trade on news the instance it becomes public anyway.
The first argument basically boils down to this:  because we can't catch everyone who might have benefited from insider information, we shouldn't even try.  Voltaire said that "the perfect is the enemy of the good", and it is certainly true in this case.

Besides, let's think about this scenario for a moment.  Let's say that you obtain some insider information which is going to cause a company's stock to go down once the information is made public.  In a world where insider trading is legal, if you want to maximize the benefit of that information, you wouldn't refrain from trading.  You would sell the stock short.  For those who don't know, short selling is a way to make money by "betting" that a stock will go down.  However, in the world we live in, this is illegal and enforceable.  Therefore her argument that enforcement is asymmetric holds no water.  You can get busted for insider trading for taking advantage of negative information, as well as positive information.

The second argument is just lazy and dumb. Milton Friedman might have been a Nobel prize winner, but we can't just take his word for it. Instead of telling us that he said so and leaving it at that, Ms. Caruso-Cabrera ought to tell us what Mr. Friedman's arguments were. Instead she uses it as a segue to plug her book, which I won't be buying anytime soon!

The third argument is also wrong because it confuses equal opportunity with equal outcome.  When people are only allowed to trade based upon public information, everybody is on a level playing field.  Everybody has an equal chance to benefit from that information.  Some people choose not to pay attention to it, because they are working or whatever.  However, that is each person's choice.  People are free to choose to stay home and watch Ms. Caruso-Cabrera on CNBC for the latest breaking financial news.  Unlike what she says, this is perfect fair because it guarantees all investors, both big and small, with an equal shot to take advantage of the information.

The main reason why insider trading is illegal and should stay illegal is that it undermines the public's confidence in financial markets.  If insiders have an unfair advantage because they are privy to information that the rest of us don't have, it leads to a situation where the public feels that they can't trust the stock market.  If people don't trust the stock market, they won't invest in stocks.  If they don't invest in stocks, the stock market collapses.  If that happens, then people's retirement savings disappears, companies go under, people lose their jobs.  Most importantly for Ms. Caruso-Cabrera, nobody will watch CNBC, and she'll be out of a job, too!

The bottom line is that insider trading is illegal for a reason, and nothing that Ms. Caruso-Cabrera has said has convinced me otherwise.

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