“Galaxy-level stupidity.” That’s how a securities lawyer of my acquaintance characterized the alleged insider trading operation of Rep. Chris Collins, a Republican from New York’s 27th District. If the indictment is accurate, the fact that Collins allegedly phoned illegal tips from the White House lawn is not even the most surprising or interesting thing about this case. What would be truly wondrous is his thinking he could get away with it.
If you are on a pharmaceutical company board and you tell your son to sell the firm’s stock because its new drug just failed in trials, there is basically a 100 percent chance that regulators are going to connect the dots. And if your son tells his fiancee and his future father-in-law, and said father-in-law then tells his brother and sister — well, the chances that someone close to you will be indicted are also good.
In this case, it was Collins, his son and the father of his son’s fiancee who were charged with wire fraud, securities fraud and conspiracy to commit securities fraud. All three pleaded not guilty, and Collins vowed not only to keep his seat but also to continue campaigning for reelection in November.
Okay, what Collins is alleged to have done wasn’t too bright. But was it wrong?
At some level, yes, it’s wrong because it’s illegal and you shouldn’t break the law. Except people break the law all the time when they think no one is being harmed, as when they speed on a deserted stretch of road or put money into the office pool during March Madness.
Who was hurt by what Collins allegedly did? The answer might seem obvious: anyone who bought the stock that Collins’s son, Cameron, and others sold. But it’s not as if Cameron Collins went door to door persuading pensioners to buy his ticking-bomb shares. According to the indictment, he used a broker to sell the stock. The broker presumably sold that stock to people who already had an interest in buying it.
Yes, Cameron Collins allegedly knew that the interest was misguided. It would have been selfless of him to hang on to the stock and bear the losses himself. But if he hadn’t sold, those interested buyers would have bought shares from someone else. And here’s the kicker: Since share prices tend to decrease as the supply of shares increases, the buyers might have actually paid a higher price if Cameron Collins’s weren’t on the market, and thereby would have lost more money.
But maybe insider trading is bad for the market? Actually, insider trading probably makes markets more efficient. During the interval between the discovery of material nonpublic information and the publicizing of that information, the shares are being systematically mispriced through general ignorance. If insiders were trading, the shift in the supply of the stock would tend to push the price closer to a more realistic value.
Critics contend that insider trading can reduce confidence in the market, making investors — particularly the ordinary mom-and-pop kind — reluctant to invest in publicly traded securities. The problem is, there isn’t much evidence that’s true. Investor confidence levels were just fine during periods in which insider trading seemed to be particularly rampant — too confident, possibly, since more than once those markets proceeded blithely onward into speculative bubbles.
As that suggests, confidence in the markets is not exactly an unalloyed good. Insider trading scandals don’t appear to discourage ordinary investors from dabbling in stock trading, but something ought to, because amateurs who can’t read a balance sheet have no business buying individual stocks. If insider trading made them less likely to do so, that would be a point in its favor.
Which leads us back to where we started: It’s surprisingly hard to pin down an actual harm from insider trading. And yet we have a stubborn intuition that it ought to be illegal because it just doesn’t seem fair. That’s a reasonable response: Insiders such as the sons of congressmen and board members should have to take the same losses as anyone else on speculative investments.
There is no evident problem with confidence in the markets today, but there is an obvious problem with confidence in our institutions. That’s the harm of insider trading — and all sorts of other self-dealing, self-interested practices by networks of folks with cultural, economic or political power. Occupational licensing, building restrictions that make it impossible for disadvantaged families to gain access to better schools, professional networks and degree requirements that help “people like us” climb the ladder into the best jobs — all of these look, from the outside, like more insider trading. They’re also often defended by people who regard the allegations against Chris Collins with horror.
By all means, condemn Collins; if he did what the government says, he deserves it. But take an honest look at the ways the institutions you belong to manage to hoard the best benefits for people like you. And ask if we don’t have a much bigger problem than insider trading. Possibly even one of galactic proportions.
Update, 10 a.m. Aug. 14: Reader Joe Sill argues that the accused inside traders in this case created new buyers by either filling trades in an illiquid market or pushing the stock price down and triggering new sell orders from people whose instructions were, say, “Buy at 50 cents a share, but not 52 cents.” It’s hard to know the counterfactual; once the company had the results of its drug trial, Innate Immunotherapeutics announced that it would have important information to share in a few days, which shut down trading in Australia but not the American over-the-counter market. During the period between the company’s notification of the Australian exchange to halt trading in its stock and the disclosure of the drug trial results, activity in the stock exploded from both buyers who presumably assumed the news would be good and sellers who decided to get out. The selling activity had pushed the price down by the day before the news became public, which could mean that if Cameron Collins and the others did what prosecutors say, they either took a bit from a lot of willing sellers, and more from those who decided not to sell at the somewhat lower price, or they created new buyers. My assumption is that the loss was mostly borne by sellers, and I originally included a few sentences on this in the column, but they didn’t appear in the final, edited version. My primary point is that the intuition most people have — that the buyers bear the losses — is surprisingly hard to prove. But if that assumption is wrong, the new buyers would bear at least some of the losses.
However, we still must note that even under that assumption, these are people who were willing to buy at the price they purchased the stock for, even though they knew that there was a good chance the company’s drug would fail in trials. Several readers have analogized this to someone who sells you a used car, or to other face-to-face transactions. But the situations aren’t quite parallel; the allegations against Cameron Collins don’t say he made misrepresentations about the stock or otherwise induced people to buy it. And the people who bought were — or should have been — well aware that there was a serious risk that the stock might lose most of its value. That’s what it means when a biotech firm says, “The clinical trial results are ready for our blockbuster drug candidate.”
Which is not to in any way to suggest that what Chris Collins and the others are accused of doing was all right; insider trading is both illegal, and wrong, for the reasons I laid out in the column. But had the stock buyers purchased their shares from someone else, they would have lost the same amount of money. To the extent that the alleged insider moves did depress the price, they may well have saved some people money on worthless stock they would have purchased anyway, which is why this is so complicated.
But more than one reader found it unfair that anyone had bought stock when insiders knew it would become near-worthless, regardless of whether insiders traded on the information. And one thing this suggests is that we might try to do what Australia did in this case: halt trading in stocks in situations such as this, where there is important material information known to the company but not yet available to the public. Insiders would have a harder time profiting from that sort of information — or, as may have happened in this case, avoiding losses.