Insider Trading?

Running around the news has been the recent spikes in InTrade odds of the health care “reform” bill passing. See the chart below.

Now comes news that it is likely DC political insider trading driving the price spike. From Intrade CEO, John Delaney: is a reasonably active market but atypically a lot of the trade is coming from the DC area when normally we might see trade coming from all the major urban areas.

Of course, no one will be up in arms about this insider trading. Indeed, it has clearly made the InTrade market much more efficient. Is it clear that we should highly regulate insider trading in other markets? Don Bourdreaux, in pique contrarian fashion, has said no, firms can decide the rules and specifications governing insider trading perfectly fine.

As University of Michigan law professor Adam Pritchard emphasizes, the challenge is to distinguish information that should be treated as proprietary from information that does not warrant such treatment. While this challenge is theoretically easy—protect only that information whose revelation to the public through insider trading would likely reduce overall economic efficiency—practically it is devilishly difficult.

Fortunately, neither elected officials nor government bureaucrats need to bother themselves with solving this challenge.

Discovering what types of inside information are proprietary and which are not proprietary—and, hence, which types of information are appropriate to protect and which not to protect from insider trading—can be left to corporations themselves.

The economic case against insider trading is fairly strong (much like the case in favor of organ markets)…indeed, firms are very efficient at weeding out large-scale theft, corruption, bribes, sabotage, etc. And yet, the public overwhelmingly wishes to ban the practice of insider trading. Well, the answer is a little bit more complex than it may seem.

There are plenty of areas in which we either allow, or simply ignore the fact that (sometimes large-scale) outcome manipulation happens. Old school horse-racing is an obvious culprit. Sumo wrestling is a more contemporary target. Sure, the people who have financial stakes in these contests wish to expose this maleficence, but the outside public that simply watches the games could mostly care less. Of course, this is because sports largely doesn’t matter, aside from being a status game. Who wins the Super Bowl obviously doesn’t affect the world in any earth-shattering ways.

Of course, in the corporate world, what people think of when they think of insider trading is a scheme in which the company usually goes out with a bang. The counterfactual that you have to ask yourself is, if insider trading was not illegal, would another insider at Enron have been placing bets on the other side of the market? It is clear that these types of schemes can not last forever, unless you happen to be the government. However, it is only the stories that end in tragedy that appeal to the public’s selection bias. A case where a smaller firm is about to be bought out by a larger firm, and a few people cash in on insider bets is likely not even going to reach the general publics periphery.

What “we” are trying to do is assuage our collective sense of “fairness”. Unfortunately for modern humans, this sense evolved during a period in which “complex” coordination consisted of 6-9 people — and there were severe and obvious checks and balances (just look at Og’s pile of food!). Of course there have been studies done in which people work most efficiently in small groups — of 6-9 people…and, of course, the public at large has an innate mistrust of large organizations. But, there are surely much more efficient ways around the insider trading issue than the blunt, often ineffective regulation we currently employ. Perhaps a specific futures market having to deal with insider information, with a much more acute price mechanism (which means a smaller price movement would mean much more)?

I don’t really have an answer to the last issue…but I do believe that are capable of moving beyond our heuristic biases.

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