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Saturday, October 24, 2009

Galleon Insider Trading Fnords

I was watching the Communism Channel, and the comedians were all excited about the Galleon insider trading scandal.

Galleon was a hedge fund. Allegedly, traders at Galleon knew insiders at various corporations. These insiders gave traders at Galleon information. These traders then used this information to profit.

This bit was interesting. The only reason the Galleon insider trading was exposed was that someone turned them in. The story was that one trader was caught, and as part of a plea bargain deal turned in everyone else.

One important evil fnord is "Investigators at the SEC aren't incompetent!" After the Bernard Madoff ponzi scam was exposed, the SEC investigators looked like unqualified fools. Now, this story is hyped as a success for SEC investigators.

The SEC has a monopoly when it comes to policing investment fraud. If the SEC does a lousy job, as with Bernard Madoff, then that's just too bad. If you invested with Barnard Madoff and lost your money, then you don't have a valid complaint against SEC insiders for doing a lousy job. Sometimes, the SEC does catch investment fraud, but that doesn't legitimize the SEC enforcement monopoly.

If you keep money in your checking account, you're guaranteed to be ripped off by inflation. This forces everyone to be an investor in the stock market. Gold is a better investment than the stock market, but State regulations impose extra taxes and costs on gold/silver investors.

"Insider trading" is a crime that's completely created by the State. Insider trading is a crime that cannot occur in a really free market.

Suppose I'm the 100% owner of a business. In that case, it isn't immoral if I chose to disclose details of my business, or only give the information to certain people.

For example, suppose I say "I'm on pace to get 10% more AdBrite revenue in October than in September!" There's nothing wrong with me saying that, whether it's true or it turns out to be wrong or it turns out to be a lie. I'm the 100% owner of my blog. If I'm wrong about how successful it is, the only person injured is me.

If an executive at Google tells a friend "Google made 10% more search ad revenue than expected in October!", then technically he's committing a crime, if that friend uses that information to buy Google stock.

Limited liability incorporation does not occur in a really free market. Limited liability incorporation is a State-granted perk. Without limited liability incorporation, there is no stock market.

Suppose there was a really free market. Suppose you decide to offer to sell me 1% of your business. If I own 1% and you own 99%, then what prevents you from mismanaging the 1% I own? Suppose the business is successful. Instead of paying me a dividend, you could decide to hire your idiot brother-in-law. As a 1% owner, there's I could do about it. I own 1%, but I really own nothing.

Without limited liability incorporation, I'd still be responsible for the losses if your business loses money. I'd be an idiot to buy only 1% ownership in your business. I could get ripped off if it's successful. I could be stuck if it fails.

In a really free market, you'd be an idiot to buy a minority ownership interest in someone else's business.

In the present, the State allows/encourages people to buy a minority ownership interest in a publicly traded corporation. I might own a couple hundred shares, but insiders still control the corporation and its day-to-day operations.

For example, I own my blog. I have 100% control over what content is presented here. I get 100% of the profits. If I double my traffic and double my advertising revenue, then all the gain belongs to me. If I alienate my readers and lose my traffic, then I'm the only one who suffers the loss.

If I buy 100 shares of Coca-Cola, I don't get the right to inspect their factories to make sure they're efficient; I don't get the right to watch the CEO and make sure he's doing a good job. As a minority owner of Coca-Cola, I don't have any say in how the business is run. I only get whatever dividends are leftover after the CEO pays himself and his friends huge salaries and bonuses. I do earn a dividend, but my total return will almost definitely underperform true inflation over time.

The State allows/encourages people to buy a minority ownership interest in a corporation. In order to prevent investors from getting ripped off, the State passes laws regulating what corporate insiders may do. That isn't a contractural relationship between the shareholders and the executives; it's a State regulation. The behavior of corporate executives is heavily regulated. This makes a corporate executive essentially a State employee.

In order to make sure that small shareholders feel comfortable with their investment, a stock market was created where they can buy and sell their shares. The stock market also benefits executives. Executives pay themselves with stock/option grants, and then sell these shares on the stock market.

However, the stock market naturally leads to abusive behavior by executives. The executives control the corporation, but they don't really own it. Via the Principal-Agent problem, executives are tempted into misconduct whenever they control resources they don't own. When you control wealth that you don't own, the temptation is to line your pockets at the expense of the true owners.

The executives control the corporation. They will naturally get access to information about the corporation before everyone else. The temptation is for them to use this information for their own personal benefit. Insider trading laws were then passed. Laws were passed limiting how and when executives can buy or sell shares of their own corporation. Laws were passed regulating how executives disclose information to shareholders. Paradoxically, laws regulating/restricting disclosure encourage insider trading!

There are laws restricting when insiders can buy and sell. This leads to another form of insider trading. Insiders tell their friends about secret information. This is what happened in the Galleon case.

Insider trading hurts all non-insiders. The insiders get to buy before everyone else when there's favorable news. The insiders get to sell before everyone else when there's unfavorable news. The person who sold too cheaply or bought too expensively is disadvantaged.

Even though insider trading hurts non-insiders, "insider trading" is entirely a State-manufactured crime. Without State restriction of the market, there would be no opportunities for insiders to profit at the expense of everyone else.

"Insider trading" laws turn innocent-seeming activities into crimes. It's impossible to spy on everyone all the time, making this law impossible to enforce fairly.

The stock market is one big scam. There's an easy way to protect yourself from stock market theft and theft via inflation. Buy gold and silver and take physical delivery! Unfortuantely, keeping a couple hundred ounces of gold hidden in your home is risky.

The SEC is a "captured regulator" that acts for the interests of insiders ahead of the average small investor. As a small investor, it doesn't pay for me to lobby the SEC and Congress for favors. It does pay for corporate insiders to lobby the SEC and Congress for favors.

The most egregious abuses are caught and punished. This provides the illusion that everyone else is behaving honestly. When some corporate insiders are caught and punished for abuse, this creates the illusion that everyone else is honest. Some dishonest people got caught. Therefore, everyone who's dishonest gets caught.

This is an important evil fnord. Instead of saying "A fundamentally corrupt system is flawed!", statists say "We need more regulations!" The problem is the specific individuals who attempted insider trading. The problem is not a fundamentally corrupt system that allows insiders to profit at the expense of everyone else.

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