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.
Thus many simply want to legalize insider trading, calling it a victimless crime. Nobody’s hurt, the argument goes, the stock was going to go down or up anyway. That argument only goes so far; if an insider is buying, someone without that information is selling. The problem is that no one really knows who that someone is.
That’s why the best solution is to eliminate insiders. Make companies post product sales information more often—every day or even in real time. Spray investors with a fire hose of information. A great model is WisdomTree, a manager of exchange-traded funds. Every day on its investor-relations Web page, the firm posts assets under management and average fees and so anyone who can use a calculator can figure out revenues. Voilà: no insiders.
Right now, third-party researchers scrape Amazon prices and Google search trends trying to divine if sales are headed north or south. What a waste of time. Make companies post daily sales. General Motors knows how many cars it sells each day; why shouldn’t investors know? There is no such thing as too much information. Eliminate the quarterly guessing game as to how many iPhones Apple sold. Some worry that daily updates would give the wrong impression to investors, who would sell the stock after a rough day. So what? It would trade up the next day on better sales.
Even medical trials could be published daily. Throngs of investors will build databases to track trends, and so will patients. How about takeovers? Most merger agreements are made, and then lawyers who charge by the hour take weeks to iron out the details. Announce mergers within 24 hours to minimize leaks.
Companies will balk at providing so much data, as they believe they gain a competitive edge by keeping information close. Get over it. If you can announce it quarterly, you can announce it daily. The data exists on internal dashboards, and public companies should be open to the public.
Eventually, investors would learn to ignore short-term blips and focus on the long term. Insider trading would no longer be illegal because everyone will be an insider. Now that’s investing.