Have you heard about this guy Raj Rajaratnam? He’s a billionaire hedge fund manager who seems to have gotten into trouble because he was engaging in “insider trading”. I was talking with someone about this yesterday and they asked “what is insider trading?” Instead of explaining it to her I pointed her to Wikipedia. But because you’re special I’m going to explain it to you.
In the word of Wall Street, information is everything. Whether you’re doing all the research, checking over the latest earnings reports, or even talking to employees of a potential stock purchase to get the “feel” for the company. The only thing more important than information is how fast you get that information. If I live in the east coast and hear that Goldman Sachs has had a great quarter, I can buy the stock and maybe make a few bucks. But because the earnings call was at 9:00 in the morning, my buddy on the west coast slept in and missed it. By the time he got out of bed, the stock had already appreciated as much as it was going to based on the news. Was this insider trading? No.
Earnings statements, PR releases, and news coverage are all public information. It is released in a timely manner, and for the most part released to everyone at the same time. But, let’s say The Sheconomist’s cousin is an intern with the Goldman Sachs finance division and he calls me up and tells me to buy Goldman because earnings are going to be through the roof. He says I’ll make tons of money, and I will, since he told me this two days before Goldman releases their earnings. This is against the law, this is insider trading.
The Goldman earnings information is not public information until Goldman releases it. Goldman executives, spouses of employees, and even hobos the overhear a conversation cannot by law act on this information until it is public. Doing so is insider trading.
But why is it against the law? More power to ya for being in a position to know about information before its released right? Wrong. Simply put, it’s not fair. The markets rely on some levels of efficiency to make sure stocks are fairly priced over the long term. If people are acting on different bits of secret information, the markets would become too unstable to be decent investments. SEC regulations like insider trading exist in the same way speed limits do on the interstate, we all get around better and safer with them.
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. |
| Related Websites |
Great explanation, and standard practice for all public companies. Free markets require symmetry to run, which is what the law helps to regulate. Asymmetry is what gave us CDOs in the first place.
Vicki´s last blog ..Russian President Medvedev, it’s like you’re trying to fail on purpose by cutting down on beer