Re: Insider trading and market efficiency (was: Martha Stewart...)

From: I William Wiser (will@wiserlife.com)
Date: Sun Jun 15 2003 - 14:38:47 MDT

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    I wrote this a few weeks ago and decided not to post it
    but since there is a debate in the investing thread I'll throw
    my questions in.

    First, are insider trading laws about what is widely known
    or what is widely available to be known? If most anyone
    could get the information is that good enough?

    I know the common wisdom is that one can not outdo the
    market without insider information but it does not make
    sense to me. Scientist figure out things other people
    do not know with information that is widely available to
    everyone. It seems like one could also figure out which
    companies are over or under valued by the market given
    sufficient diligence.

    Of course, prices reflect some insider information. And I
    can imagine that sufficient diligence might automatically net
    you inside information.

    But not everyone's reasoning powers, business savvy, etc.
    is the same. I would think one might deal with insider
    trading laws by simply announcing publicly what one
    intends to do and why. Most people can not follow or
    will disagree with good arguments they are unfamiliar with.
    At that point it's public info but you can still take advantage
    of it.

    I suspect something is wrong with these arguments but
    I'm not sure what. Why is the stock market so much
    more reasonable and efficient than science, politics, and
    all of the other human endeavors in which I know people
    are often ignorant? Is it simply that there are enough
    smart, reasonable people working the market so that
    any advantage is quickly and widely distributed. That
    would still leave the possibility of market genius but would
    make it difficult. Or is it that most people smart enough in
    the right way to make money in the market can make more
    money inventing things or starting companies?

    Perhaps dumb money quickly gets gobbled up. A small
    number of people with a lot of money affect the market
    more than many small investors. The money will repeatedly
    be transferred to savvy investors so that they end up competing
    against each other. That makes sense to me but goes against
    the idea that one can't out do the market. If we say one can
    not out perform the market that suggests the people who make
    a lot in the market are all just lucky. Not sure I buy that.
    Could be but it's a funny work view. With such a view I
    would expect people rich from stocks and people rich from
    lotto or Las Vegas to have similar financial ability. People
    rich from stocks seem to do better or is that just part of
    the Wall Street advertising. Or is it just that all of the rich
    people who do well in stocks break the rules (or got lucky).

    Ah well, interesting stuff but I'm not to money yet.

    ----- Original Message -----
    From: "gts" <gts_2000@yahoo.com>
    To: <extropians@extropy.org>
    Sent: Thursday, June 05, 2003 8:05 PM
    Subject: Insider trading and market efficiency (was: Martha Stewart...)

    > Harvey Newstrom wrote:
    >
    > > Consider it this way: Selling stock to someone else is a sales
    > > transaction of property. You are offering to sell a known commodity
    > > that is described by public disclosure statements. If you know those
    > > statements are false due to insider information, and you sell the
    > > product to a buyer who believes those public disclosures are true, you
    > > have cheated the buyer.
    >
    > Yes I know that argument. I spent more than a decade as a licensed general
    > securities broker, and like you I also have an education in business,
    > including business law. I know all the regulations and the theories behind
    > them. I was bound by those regulations for many years. Fortunately I am no
    > longer in the investment business, so I can speak freely. :)
    >
    > Just to be clear, we are not talking about fraudulent public disclosures
    by
    > the company, which are and should be a crime.
    >
    > We are talking about private investors profiting from new information
    about
    > a company obtained before that new information is widely publicized. For
    > example you might obtain knowledge that the next earnings report from XYZ
    > Corp is going to be higher than expected. Should you profit from that
    > knowledge by buying stock in XYZ? The law says no. It is legal to act on a
    > *guess* but not on a *fact*. The only exception is when everyone already
    has
    > access to that fact, in which case there is no excess profit to be gained
    > from your knowledge of the fact as it is already discounted in the stock
    > price.
    >
    > I believe the market should be seen as a competition between investors to
    > acquire and act on the most profitable information, such that "cheating
    the
    > buyer" has the same meaning as "out-competing the buyer." After all, you
    are
    > attempting to "cheat the buyer" any time you sell a stock because you
    think
    > it's going to drop in price. You are hoping someone less savvy than you
    will
    > buy it from you and take a bath in it instead of you. This element of
    > "criminal intent" is present regardless of how you arrived at your
    negative
    > forecast of the stock price.
    >
    > In theory the market should be a game in which superior knowledge about
    > companies buys the investor a superior return over the market averages. It
    > should be a game in which the investor who knows the most, makes the most.
    > This is after all the way most US investors *think* the market works.
    > Investors and their brokers and analysts all operate on the (false)
    > assumption that good knowledge gained from public sources will buy one an
    > excess return in the market. This belief is what drives the market. But it
    > is not the way the US markets work *in reality*. The US markets are so
    > efficient and regulated that knowledge buys one absolutely nothing unless
    it
    > is so-called "inside" knowledge, in which case Uncle Sam says it's a
    crime.
    > And that problem is exactly what I'm railing against. It is in effect a
    > crime in the US to have more knowledge about a company than the investor
    on
    > the other end of the transaction. You can *pretend* to yourself that you
    > have access to more and better knowledge than the other guy, and this is
    > exactly what Wall Street *wants* you to think, but if you actually *do*
    have
    > access to such superior knowledge then you're looking at a prison
    sentence.
    >
    > As I mentioned, this is not the case in every country. Taiwan has a
    vibrant
    > stockmarket but they have no insider trading laws (last time I checked
    > anyway, which was admittedly quite some years ago). In Taiwan, the game
    > works the way it should work: investors who know the most, make the most.
    In
    > Taiwan it pays to do your homework. Smart, knowledgeable investors make
    more
    > money than dumb, ignorant investors. That is the way it ought to be.
    >
    > But studies show that in the US, knowledge obtained through conventional
    > public means buys one absolutely nothing. One might just as well throw
    darts
    > at the newspaper to pick stocks. This is a primary reason that I got out
    of
    > the business ten years ago: after spending more than 12 years in the game,
    > and after doing some in-depth statistical research, I realized to my great
    > disappointment that *public knowledge is worthless*. So-called inside
    > information has value, but the rules make its use a crime.
    >
    > The business section of the newspaper is an interesting story about the
    > drama of American business but otherwise it's just a waste of trees.
    >
    >
    > -gts
    >
    >
    >



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