Market cheating is back!
And, worse, it's being defended.
If the allegations are true, Galleon Group founder Raj Rajaratnam can be put on the "greed is good" Mt. Rushmore, along with 80s icons Michael Milken, Ivan Boesky, and Gordon Gekko.
It's tempting to put these latest insider trading charges in a "there Wall Street goes again" box, but at least the bailouts kept our financial system functioning. Insider trading, on the other hand, has absolutely no silver lining.
The stock market is a zero-sum game. In each trade, there is a winner and a loser. When big investors cheat, it's small investors like us who are put at an unfair disadvantage. After all, the companies that Galleon Group is alleged to have gotten insider tips on include such heavily traded stocks as IBM (NYSE: IBM), Intel (Nasdaq: INTC), Akamai (Nasdaq: AKAM), and Google (Nasdaq: GOOG).
For faith in the fairness of the market to be possible, insider trading must be punished. At least, that's what I've always thought. Believe it or not, though, some economists actually see the good in insider trading. In fact, they want to abolish our current rules and allow insider trading.
The big guy vs. the little guy
Before I tell you about this latest outrage, let's remember that the big guy (Wall Street) is always trying to get an upper hand on the little guy (us individual investors).
Recall that until nine years ago, companies were allowed to release material nonpublic information to large investors without releasing it publicly. The large investors would frequently act on the information, and you'd see a large stock price movement with no idea why.
You may be thinking, "What's the difference between that and insider trading?" The answer is: not much. That's why The Motley Fool, among others, fought hard for the SEC to banish the practice. And it did so by issuing Regulation FD (Fair Disclosure) in October of 2000.
The big guy vs. the almost-as-big guy
Wall Street still likes the concept of special access, though. Even among its own clients. Goldman Sachs' (NYSE: GS) "trading huddles" hit the news a few months ago. The gist: Each week, Goldman analysts would gather and trade hot stock tips. They'd share this information selectively with their top clients, but wouldn't disseminate the information to the thousands of clients who got their research reports. Not surprisingly, many of those not-quite-top clients were less than amused.
The Goldman explanation for how some of these stock tips occasionally differed from their research reports: These were short-term ideas that weren't necessary contrary to the longer-term research report forecasts. Keep this in mind. I'll be coming back to it.
Why I don't listen to economists
Knowing that we must stay vigilant to ensure fair markets for every size investor, I was shocked when I read a recent Wall Street Journal opinion piece by George Mason University economics professor Donald J. Boudreaux called "Learning to Love Insider Trading."
I kept waiting for the "just kidding," but it never came.
Basically, Boudreaux argues that the market would be better off if there were no regulations against illegal insider trading. Sure, companies could restrict their employees in any way they saw fit, but the government wouldn't. He argues that insider trading is actually a good thing -- a mechanism that would get more information in the market and increase efficiency.
It gets better.
He gets some backup from Harvard University economist Jeffrey Miron, who says: "In a world with no ban, small investors might fear to trade individual stocks and would face a greater incentive to diversify; that is also a good thing."
Our game plan
Wow. And in a world with no seat belts, drivers would face a greater incentive to drive safely. Let's get rid of those, too.
I'd love to live in the fantasy world some of these economists call home, but I don't. I care about the practical challenges of ensuring a fair stock market for all. To keep faith in the system, we must have deterrents like the insider trading laws.
Fortunately, one misguided article by an economist aside, I don't think we're in any danger of a repeal of those laws.
Instead, we can focus on how to beat the cheats. Recall the distinction by Goldman Sachs between short-term and long-term stock ideas. Our ability to be patient and make long-term calls is our advantage.
Insider traders are usually trying to profit from short-term swings. Witness Rajaratnam's Galleon Group. They actually lost all the money they made on their other insider trades (and then some) on one trade in shares of AMD (NYSE: AMD). They made a big bet on a rumor, but the unpredictable Mr. Market moved against them.
We long-term investors can shrug off short-term losses and wait for Mr. Market to correct himself, but short-term traders with flimsy investment theses don't have that luxury.
Though we will encounter a Galleon Group from time to time, we're fortunate that as individual investors in the U.S., we can spend most of our time trying to win the zero-sum market game instead of worrying that it's tilted against us.
At the Fool, we're doing just that. In fact, we're investing our own money. In our Million Dollar Portfolio, we invest the Fool's own money exclusively through our newsletter recommendations. Of course, we tell our members first, so they can buy before us. To do otherwise would be so Wall Street. If you want to see what we're buying these days, the service will soon be opening up again to new members for the first time in over a year. Just enter your email address in the box below for more information.
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