Here’s how you know a company is about to miss earnings: The stock falls slowly after the quarter ends and continues trickling until the announcement that, lo, the company didn’t live up to analysts’ estimates. Someone knew it was coming and traded on the tip. Someone always knows.
It’s called insider trading, and Preet Bharara, the U.S. attorney for the Southern District of New York, has convicted 80 people of it. On Friday the Second Circuit Court of Appeals denied Mr. Bharara’s petition to rehear U.S. v. Newman, which overturned the convictions of two hedge-fund managers by suggesting that the pair didn’t have direct insider knowledge, but instead received information passed along by others.
If you think that is a fuzzy legal distinction, you’re right. There is no actual law against insider trading, only securities fraud. Last month Rep. Jim Himes (D., Conn.)—whose constituents happen to include a flock of hedge-fund managers—introduced bipartisan legislation to ban “material, nonpublic” insider trading, the latest of many such attempts. Here’s a better idea: Open up the information vault and make everyone an insider.
First, a little history. On your first day on Wall Street, you learn that it is illegal to trade on “material, nonpublic information.” Until 2000 analysts and investors could use “mosaic” analysis. You couldn’t ask a company what it was going to earn in the first quarter, but you could ask about product trends or pricing, and companies would provide “guidance.” As, say, widget sales slipped, companies would call analysts and change the guidance. If you were any good, you could cobble together a picture of what the quarter might look like. There was an art to it, and there weren’t many surprises.
In 2000 the Securities and Exchange Commission enacted Regulation Fair Disclosure, known as Reg FD, on the tenuous premise that small investors were being hurt by big boys getting information first. Reg FD required companies to disclose information to all investors at the same time. Then came the unintended consequences, and “fair disclosure” morphed into Regulation No Disclosure. Companies clammed up even further after the 2002 Sarbanes-Oxley law, which required CEOs to sign off on all released information.
Now public companies only release information once a quarter, but someone always knows. A crooked insider, an accountant or the brother-in-law of a salesman who missed a quota. Reg FD has been a boon for insider trading.