More Insider Trading: Caveat Emptor?

Stephen Bainbridge responds (here) to my last post, wherein I suggest that insider trading has a negative impact on investor confidence.  In what I view as classic Bainbridge fashion, he writes:

If you're an investor who thinks that the playing field is level today, with draconian insider trading penalties and massive enforcement efforts, you are too stupid to be allowed to go out in public let alone put money in the stock market. Look, any investor with the common sense God gave gravel knows that insider trading is rampant.

Whatever your view of insider trading, that's good stuff.  I'm not sure whether I laughed out loud more vigorously at those lines or an earlier Bainbridge rant about modern law faculty hiring:

Maybe 20 years ago law schools valued things like high grades, law review membership, and prestigious clerkships. Not any more, however. As far as I can tell, what is valued these days are:

• Ability to network with people you knew in graduate school that got hired last year
• Having a PhD
• Having multiple publications, even if they demonstrate the author's utter lack of doctrinal knowledge or inability to do basic legal research
• Knowing what Rawls (or Dworkin) would think of X
• Being able to run linear regressions
• Being able to run regressions about what Rawls would think about X

I probably laughed harder at the latter because I had previously sent a paper proposal to Bainbridge to get his feedback and the paper was entitled "How Would Rawls Teach Citizens United."  And lest there be any doubt, when I say this stuff makes me laugh out loud I mean it as a compliment.  Anyone that can more or less suggest you are an idiot and still get you to chuckle in the process is worth reading regularly.

But I digress.  On the insider trading point, I remain unconvinced that "a fool and his money are soon parted" makes for good regulatory policy.  There is a meaningful body of precedent for the SEC pursuing boiler room operators for bilking retirees out of their social security checks by promising annual returns of 1,000% and the like.  Obviously, no "reasonable" investor would believe such hype.  But is saying "good riddance" really the best we can do?

Bainbridge also  notes that the stock market has continued to thrive in the face of repeated insider trading scandals and that "[i]f any investors believe that the SEC’s enforcement actions drove insider trading out of the markets, they are beyond mere legal help."  For me this raises the question of how much we actually know about investor behavior and beliefs.  I wouldn't be surprised at all if a meaningful number of retail investors responded to the scandals by breathing a sigh of relief knowing the regulators were on the job.  That may be stupid, but I think we need more evidence before we decide it is good policy to disabuse these types of investors of their beliefs.  Bainbridge's point about the efficacy of other markets that don't prize the prosecution of insider trading as much as we do is muted somewhat for me by the question: As compared to what?

What I'd like to see more of in this area is the type of work done by Andrew Torrance in the area of intellectual property, specifically as regards traditional notions of the tragedy of the commmons.  Maybe we'll get some more of this as a result of Dodd-Frank's encouragement of the SEC to do more investor testing.

Ultimately, this is all just convincing me that my next paper needs to be on insider trading.  And who knows, after delving into the relevant materials more deeply I may find that a number of my questions have already been answered in a way I would find counterintuitive.  If that turns out to be the case, I won't hesitate to change my tune.

SJP