April 28, 2011
Insider Trading: Government Abuse and Government Waste
The Wall Street Journal has a very interesting story on what it’s like to be under investigation for insider trading. It focuses on Craig Drimal, who recently pleaded guilty in the Galleon case. Among other things, the government improperly recorded phone calls in which Drimal and his wife discussed intimate personal details completely unrelated to the investigation. Judge Richard Sullivan refused to suppress all of the recordings because of this violation, but called the government’s action “nothing short of disgraceful.” I agree.
This leads to a broader point—the misallocation of government resources by financial regulators. One doesn’t have to accept Henry Manne’s views on insider trading to believe that there are many financial practices much more damaging to investors and the economy. Yet, the SEC continues to aggressively pursue even the puniest insider trading case while Bernard Madoff takes billions from investors and the economy almost collapses because of the mismanagement of financial risk. The SEC keeps asking for more money, but until they get it, wouldn’t it make sense to allocate what it has to where the real economic damage is being done—the investigation of real financial fraud? And why should Congress give them more money if they're not capable of prioritizing what they have?
April 28, 2011 | Permalink
To understand the SEC's priorities, you need only scroll through a few months or years of litigation releases at sec.gov. As you do so, hold in mind the underlying fact that approximately 95% of securities transactions in this country are carried out by the major investment banks. Compare 95% with the percentage of enforcement actions that involve major investment banks or major public companies... 3%? 5%?
Instead, these enforcement actions are almost all against SMALL targets: small investment banks and broker-dealers hoping to someday become competitors to Goldman Sachs, or small, entrepreneurial companies that raise money through small investment banks. Many enforcement terms have sprung up over the years to express this incredible bias. The small companies are "pink-sheet" companies, "unlisted," "microcaps." The small investment banks are "bucket shops" or "boiler rooms" engaged in "pump-and-dumps" and reverse-mergers (boy do the major investment banks hate reverse-mergers!). In many cases, exactly the same investment banking practices that are perfectly legitimate when performed by the major investment banks are criminalized when performed by small investment banks.
Stripping away the good intentions and looking only at the actual conduct of the enforcement division of the SEC under both Democratic and Republican leadership, overwhelmingly and undeniably the primary activity of the division has been to act as thugs with baseball bats on behalf of the major investment banks, quashing new small investment banks, brokers, money managers, and any public companies that dare to reach the public without paying protection money (fees) to the major investment banks.
Underfunding the SEC should be the least of anyone's concerns. If anything, it will improve competition, quality and pricing in the capital markets and publicly-traded financial markets in general. Ironically, it would facilitate capital formation and increase market efficiency.
Posted by: James | Apr 28, 2011 8:10:53 PM
James, a couple of studies claim to show SEC bias in favor of big firms. The latest I've seen is a paper by Stavros Gadinis. Controlling for the type of violation and the level of harm to investors, he finds that: (1) the SEC is more likely to bring actions against big firms as enforcement actions; and (2)big firm employees receive lower sanctions.
Posted by: Steve Bradford | Apr 29, 2011 3:03:01 PM
The SEC pursuing inside traders is of a piece with law enforcement going after college athletes who accept a bribe to stay under the Vegas point spread. It creates the impression of a clean game, so that the professional gamblers can lure in the suckers. No amount of insider trading prosecutions will even the odds for the widow in North Dakota, who will always be the last to hear. She'll be better off turning over her money to a professional, or staying out of the market.
Posted by: Arthur O. Armstrong | May 1, 2011 9:37:51 AM