Insider Trading?

[Blake Hampton]

I’m thinking up questions to ask the management of some companies I’m currently looking at. My issue is I don’t quite understand the specifics of insider trading.
 

For example, is it illegal to buy a stock after learning of a company’s customers with that information not being publicly disclosed? At what point exactly does it become insider trading?

[Gregmal]

Focus on understanding the material non public part. Inside information by itself doesn’t really mean much. 

[Saluki]

For my law review I thought about writing about why, in a supposedly efficient market for stocks, CEO salaries vary so much from country to country.  If the US pays CEOs much more than CEOs in Europe, and most executives in international companies speak English, why don't they come here? Or why aren't they paid more there. The two plausible answers I came up with are that corporate governance here which allows things like poison pills, keep you from removing bad managers and that's why they can pay themselves so much with impunity.  The other option is that insider trading laws (and monitoring for such activity) is so lax in Europe that you can make up for that difference with your side hustle. 

 

The law about insider trading https://www.investopedia.com/terms/r/rule10b5.asp changes so what I learned when I was a securities/ M&A lawyer is probably not the law now.  However, if you are not an insider, the standards are different, and how you come about the information is important.  If your brother in law works at the accounting department of Google and told you what their quarterly numbers are, that's bad.  But if you ferret out information on your own that other people don't have,  but could have if they went to the effort, that's okay.  For example, hedge funds used to pay satellite companies for photos of the parking lots at retailers so they can count the number of cars in the lot.  If you know the average sales amount per customer and you count the cars, you can get a good estimate of earnings.  It's not public information, but if someone went to the same trouble, they can get it, so it's not "insider trading". 

 

So when @Gregmal talks to locals or goes to planning meetings to find out what's getting permits for which businesses and along what part of 30A, that's okay.  It's not on any website, but it's information that you COULD get if you wanted to put the same effort in. If he had access to the same information because he worked at the company, then he couldn't trade on it until it became publicly known. 

[gfp]

Well said Saluki.  And incidentally, the best part of those panhandle planning meetings is that, not only are they all videotaped and archived online, but they actually make and  publish a computer-generated transcript of the meeting - and the whole of all of the transcripts is searchable by text phrase!  So you can search for anytime someone says something that a computer might think sounds like St. Joe or Topgolf or Watersound or whatever and instantly be taken to all of the video clips where the words were said.  They really make it easy down there.  

 

Not like that goddam texas railroad commission website.  I hate that thing...

[Spekulatius]

3 hours ago, blakehampton said:

I’m thinking up questions to ask the management of some companies I’m currently looking at. My issue is I don’t quite understand the specifics of insider trading.
 

For example, is it illegal to buy a stock after learning of a company’s customers with that information not being publicly disclosed? At what point exactly does it become insider trading?

Insider trading is if you trade as an insider on material non-public information that you received through your employment. Disclosing this information to others that may trade on this is also insider trading.

[ValueArb]

There used to be a useful insider trade for Wall Street banks that had taxi data for rides to the Fed.

 

Quote

We introduce taxi ridership between the Federal Reserve (Fed) Bank of New York and large financial institutions headquartered in New York City as a novel proxy for Fed–bank face-to-face interactions. We document a negative relation between past Fed–bank interactions and future stock market returns, particularly on days around the Fed’s public announcements. We also find significantly elevated Fed–bank interactions immediately following the lifting of the Federal Open Market Committee blackout. Our findings suggest that the Fed increases its information gathering via face-to-face interactions when it possesses negative private information about the condition of the economy.

The paper is “When Bankers Go to Hail: Insights into Fed–Bank Interactions from Taxi Data,” by Daniel Bradley, David Andrew Finer, Matthew Gustafson and Jared Williams, and I guess that makes sense: When the Fed is more worried about the economy, it meets with bankers more often, and measuring those meetings gives you some signal about the economy.

 

[ValueArb]

Also a decent summary of "mis-appropriation theory" in insider trading.

 

Quote

US insider trading law is weird. Most people have some rough intuition like “if you know about a merger that hasn’t been announced yet, it is illegal to trade the stock of the target,” and in many countries that is roughly the law. (Not legal advice, in any countries.) In the US, though, the law does not match closely with that intuition. In the US, if you know about a merger that hasn’t been announced yet, it’s probably illegal to trade on the stock of the target, but there needs to be some extra factor: You have to have gotten the information from an insider in exchange for a personal benefit, or you need to have violated some duty of confidentiality to the person you got the information from, or the merger needs to be a tender offer. (Not legal advice, anywhere.) There is not just a rule that says “if you know about a merger that hasn’t been announced yet, it is illegal to trade the stock of the target.” Instead there is a hodgepodge of other rules that almost, but not quite, add up to that general rule.

 

I think this is broadly good — a rule saying “you can never trade on any information that isn’t public” would discourage analysts from finding out new facts — but that’s not the point. The point is that US insider trading law is complicated, a collection of specific rules rather than a general prohibition, and it changes over time.

In particular, for a long time, it was roughly true that:

• If you worked for the target of a merger, and you knew about the merger in advance, you couldn’t trade your company’s stock: You were an insider, and that would be insider trading.3 As an insider of the company, you had a fiduciary duty to the shareholders not to take advantage of them by trading on inside information.
• If you worked at the acquirer, and you knew about the merger in advance, you could trade the target’s stock. You weren’t an insider of the target, just of the acquirer; you had no fiduciary duty to the target’s shareholders so you could go ahead and trade.

Not legal advice, in the past, or now. But at least some courts took this view. And then in 1997, the US Supreme Court expanded the lawin a case called US v. O’Hagan, endorsing a “misappropriation” theory that made it illegal for anyone to trade on nonpublic information that they misappropriated from anyone, including acquirer insiders trading target stock.

Intuitively you might think something like: “Well, before 1997, it was basically legal in the US for people who knew about a merger in advance — not all of them, but at least the acquirer’s employees and bankers and lawyers — to trade in the target’s stock, so there must have been a ton of insider trading in advance of merger news. And then after 1997, it was basically illegal for most of those people to do that, so all that insider trading must have stopped.” There are of course flaws in that logic:

• Before 1997 it was at best ambiguously legal to do this. (O’Hagan himself — who worked at an acquirer’s law firm and bought call options on the target — was arrested and convicted of insider trading, though an appeals court threw out his conviction, before the Supreme Court reinstated it.)
• After 1997 the legality is still somewhat complex, and there is not a clear blanket ban on trading on inside knowledge of a merger.
• Not everyone who might do insider trading follows the nuances of Supreme Court insider trading jurisprudence, so they might not update their behavior immediately.
• Some people wouldn’t have done this even when it was legal, because it seemed shady, and other people will do it even when it’s illegal, because it’s lucrative and they don’t expect to get caught.

Still you could imagine that 1997 would be a step change in the amount of insider trading on mergers. And I suppose it was. Here are a fun paper and related blog post by Fernan Restrepo about “How the Misappropriation Theory Affects the Amount of Insider Trading”:

My paper tests this hypothesis by examining the impact of O’Hagan on a common proxy for insider trading: target run-ups in mergers and acquisitions (“M&A”) – that is, the cumulative abnormal returns for the shares of the target company before the transaction is publicly announced. The intuition behind this proxy is that individuals who hold non-public information about mergers and acquisitions can make significant profits if they buy shares in the target company before the transaction is announced (since mergers typically involve the payment of a large premium over market prices); as a result, a significant increase in the target’s pre-merger price is likely indicative of a high incidence of trading on confidential information about the transaction. ...

The results show that the run-ups in fact decreased significantly in relation to the announcement returns after O’Hagan. Before O’Hagan, the average relative run-up was 7 percentage points lower than the announcement returns; after the decision, the difference became 9 percentage points. In this sense, after O’Hagan, there was less anticipatory trading explaining the overall valuation effect of M&A bids, which is consistent with the notion of less insider trading.

I suppose a thought experiment would be: If the US got rid of its current rules and replaced them with a simpler, “if you know about a merger that hasn’t been announced yet, it is illegal to trade the stock of the target”-style rule, would that change the average run-up? My guess is no: My guess is that the current hodgepodge of rules covers basically every practical situation, so expanding them wouldn’t have much effect.4 But I’m not sure.

 

 

[brobro777]

All I can tell about insider trading in the US (and other countries too, it seems) is that the authorities will go after pikers and make examples out of them so they can give each other high fives and promotions while the whales laff to the bank

 

Martha Stewart as exception? Maybe but more likely in the making an example category

 

 

[ValueArb]

50 minutes ago, brobro777 said:

All I can tell about insider trading in the US (and other countries too, it seems) is that the authorities will go after pikers and make examples out of them so they can give each other high fives and promotions while the whales laff to the bank

 

Martha Stewart as exception? Maybe but more likely in the making an example category

 

Martha Stewart was never convicted of insider trading, she was convicted of lying to a federal agent. If she had just told the agent to talk to her lawyer instead she would have never been convicted of anything and still be a public company CEO.

 

So while we discuss the various ways to commit insider trading and to avoid committing insider trading on this thread, let's always remember, don't talk to the police!

 

 

[Blake Hampton]

6 hours ago, Saluki said:

For my law review I thought about writing about why, in a supposedly efficient market for stocks, CEO salaries vary so much from country to country.  If the US pays CEOs much more than CEOs in Europe, and most executives in international companies speak English, why don't they come here? Or why aren't they paid more there. The two plausible answers I came up with are that corporate governance here which allows things like poison pills, keep you from removing bad managers and that's why they can pay themselves so much with impunity.  The other option is that insider trading laws (and monitoring for such activity) is so lax in Europe that you can make up for that difference with your side hustle. 

 

The law about insider trading https://www.investopedia.com/terms/r/rule10b5.asp changes so what I learned when I was a securities/ M&A lawyer is probably not the law now.  However, if you are not an insider, the standards are different, and how you come about the information is important.  If your brother in law works at the accounting department of Google and told you what their quarterly numbers are, that's bad.  But if you ferret out information on your own that other people don't have,  but could have if they went to the effort, that's okay.  For example, hedge funds used to pay satellite companies for photos of the parking lots at retailers so they can count the number of cars in the lot.  If you know the average sales amount per customer and you count the cars, you can get a good estimate of earnings.  It's not public information, but if someone went to the same trouble, they can get it, so it's not "insider trading". 

 

So when @Gregmal talks to locals or goes to planning meetings to find out what's getting permits for which businesses and along what part of 30A, that's okay.  It's not on any website, but it's information that you COULD get if you wanted to put the same effort in. If he had access to the same information because he worked at the company, then he couldn't trade on it until it became publicly known. 

Those are great examples, thanks

[Gamecock-YT]

Also related to MNPI, if you ever don't want to disclose to people what you are working on at a company just tell them a part of it involves MNPI and you'll scare them away

[schin]

Blue Horseshoe loves Anacott Steel. 

 

Watch the movie, Wall Street and just don't do what Gordon Gekko does... LOL.

[focused1]

my thought on this was always the following…

 

1). Never go anywhere close to anything resembling insider trading or the appearance of it. 
 

2). If you have any role with the company whatsoever and legitimately see dollar signs and opportunity ahead then consult a lawyer on valid exclusions or carve outs under the law. 
 

if you can’t afford # 2 stick to # 1.