The hazy line between legal market analysis and insider trading
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TEXT OF INTERVIEW
Tess Vigeland: This week marks 20 years since Michael Milken was sentenced to prison for insider trading and stock manipulation. Just to show that the more things change, the more they stay the same, today authorities raided the offices of three hedge funds. Part of a broad investigation into a wide swath of traders, research analysts and consultants. But this is not your father’s insider trading.
Wall Street runs on research. Analysts are paid a lot of money to get the inside skinny on corporate America. But just how far inside they’re getting seems to be the focus of a broad investigation into alleged insider trading.
The details surrounding the investigation are still murky. But we’ve called Stephen Bainbridge, he teaches law at the University of California, Los Angeles. Thanks for joining us.
Stephen Bainbridge: Thank you.
VIGELAND: So we’re tossing around the term “insider trading” here. But if people automatically think “Martha Stewart,” this is different, right? A little more nuanced than your traditional definition?
BAINBRIDGE: Yes, it is. The case that we’re talking about these days involves what are known as “expert networks,” where large institutional investors — hedge funds, mutual funds, pension funds — hire companies like Primary Global Research or Broadband Research to come in and brief their traders on information, data analysis about the firms in which these investors are buying and selling stock.
VIGELAND: Then I guess the question is when legitimate market research crosses the line into insider trading, right? Is there a bright line there or a wavy one?
BAINBRIDGE: It’s a very hazy line between legitimate market analysis and illegal insider trading. The standards by which we decide whether or not something is illegal don’t come from a statute, they don’t come from a rule; they came from 30-odd years of judicial opinions and there’s a great deal of gray area.
VIGELAND: Why keep it gray?
BAINBRIDGE: Well the SEC taken the view that if they defined insider trading, that would be a blueprint for people to do illegal activity. They always wanted to have a lot of ambiguity in the law, so that they’d be able to crack down on new types of abuses.
VIGELAND: That sounds like the TSA saying that they’re not going to define what they’re looking for in airline passengers, you know, because then the terrorists would find a way around that.
BAINBRIDGE: Yeah, I think that’s exactly the right analogy.
VIGELAND: If this is indeed found to be insider trading, can you describe for us what the follow-up effect is for investors? How are they hurt, what does this do to them?
BAINBRIDGE: There is not a lot of evidence that insider trading has any significant negative impact on investors. The real justification for regulating insider trading is not that it harms investors, but that it’s theft of information, right? And we don’t permit that. We don’t permit you to make a profit by stealing information from the company and using it for your own trading.
VIGELAND: So if there isn’t going to necessarily be a huge impact on investors, what about the market analysts themselves? What could this do to that business?
BAINBRIDGE: Well this is, I think, the problem in this case. These networks — these expert networks — are really central to how analysts get access to information these days. And as a result, you’ve got an enormous amount of legitimate market analysis going on that really contributes to the efficiency of the markets, that now people are going to be saying, ‘O.K., I don’t know whether asking this analyst this question is going to result in me spending the next 20 years in prison.” Because the law of what is illegal and what is legal is so vague.
VIGELAND: Stephen Bainbridge is a law professor at UCLA and the author of “The Law and Economics of Insider Trading.” Thanks so much for joining us.
BAINBRIDGE: You bet.
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