I'm starting to agree with the editorial linked from the article [0] that laws against insider trading are pointless. People find ways to do it anyway, but because the laws exist, the general public thinks it's rare. It might be better for everyone to know what shark tank they're jumping into.
Impractical, maybe, but not pointless. As someone else mentioned, insider trading creates perverse incentives for acting on undisclosed information, however, also some of those insiders have a possibility to directly influence those events, which make the perverse incentives even more perverse. Imagine a greedy CEO intentionally causing massive screwups and shorting his company's stocks, for example. At least afterwards it's much easier to prove insider trading than breach of fiduciary trust (also, the former is criminal, and the latter is civil.)
This is the primary concern of insider trading, and why insider trading laws don't exist for commodities markets (which are much less susceptible to willful manipulation).
Really? I have been under the assumption for many years the the commodities markets are thoroughly rigged. See for example (among many others) the Goldman aluminum warehousing case [0-1].
It's not true the "people do it anyway". It is true that some people do it anyway. Big, big difference.
Also, it makes no sense to base judgement of the law on the impossibly high standard of 100% compliance. Indeed, any law that does achieve a compliance level that approaches 100% will almost certainly be accompanied by an enforcement regime so terrifyingly intrusive that it's hard to imagine a threat to civil society that could be greater.
What does make sense is widespread use of the kind of statistical analysis that makes patterns of insider trading very hard to conceal, along with enforcement that includes far-reaching chains of disgorgement in cases where convictions do stick.
Basically, if you're you're foolish enough to do business with a fund that is producing returns that are inexplicable absent reliance on insider trading, you could find yourself loosing large sums to the government if and when the fund's operators are taken down.
I'm with you. At this point the extremely open-ended, poorly written and understood laws exist to serve the uber-ambitious career-building prosecutors seeking the limelight.
Insider trading laws also practically do not apply to members of congress -- prior to 2013 congress was exempt to insider trading restrictions and they have since scaled back reporting requirements. As a class, congress magically out performs the market every year, yet I don't know of any instances a sitting member of congress being charged with any insider trading charges.
Maybe not: http://www.yale.edu/leitner/resources/papers/Eggmueller_2011... ("The average investor in Congress underperformed the market by 2-3% annually during this period, a finding that contrasts with earlier research showing uncanny timing in Congressional trades during the 1990s. Members in-
vested disproportionately in local companies and campaign contributors, and these political" investments outperformed the rest of their portfolios (local investments beat the market by 4% annually). Our findings suggest that informational advantages enjoyed by Congressmen as investors arise primarily from their relationships with local companies, and that widespread concerns about
corrupt and self-serving investing behavior in Congress have been misplaced.")
I find myself agreeing too, but tentatively. What exactly is the argument for insider trading laws in the first place? In the absence of such laws would managers have the wrong incentives?
The money insiders make would otherwise go to other parties/counterparties when the news became public. Insiders charge a rent on everyone else. So do non-insiders doing above-board sales research, but they are subject to competition, keeping the rent/tax down.
In addition to the rent, there is also a benefit provided in accurately pricing securities, but there is no law of economics saying this benefit will exactly cancel out the rent or anything of the sort.
There are fundamental things (like limited number of sufficiently high-level insiders) restricting competition in conventional insider trading to minimize the rent charged from insider "research".
Non-insiders doing above-board research also don't have perverse incentives; they can't profit from selling intelligence on their own screwups (accidental or otherwise)
Is it a transfer of income, or a genuine loss of resources? It seems like the losses to everyone else are offset one to one by the gains to the insider traders.
Yes, a transfer. What I meant by other parties/counterparties is that a sale that went to an insider might instead go to the next highest bidder, and the gains once the good earnings news was released would go to him or her. Or the absence of the insider might mean the bid never goes high enough and the seller stays with the shares, to later make the gain. Zero sum, but basically all the normal market participants are avoiding a "presence of an insider" tax when insider trading can be curtailed.
Insider trading was first outlawed in the United States by the Securities and Exchange Act of 1934. The major motivation for the ban was to increase the public's confidence that they could invest in financial securities without being taken to the cleaners by insiders who had a major informational advantage. [0]
Economic theory does lend some support for the idea that markets will perform better when the public is confident enough to participate in them broadly, and broad participation should drive valuations higher. (The latter is a dubious benefit.) But there is likewise plenty of theoretical justification for the harm done to markets by insider-trading laws. Markets are basically mechanisms for aggregating and analyzing information, and insider trading laws restrict the supply of basic facts. Mispricing ensues.
There are other justifications for banning insider trading, albeit all rationalizations post facto, as far as the legal history goes. Allowing a manager to trade her company's shares (particularly to short them) can put her incentives out of step with those of the company's other shareholders. But the managerial misbehavior that could provoke is already illegal under various other regimes. And the principal-agent problem is no argument at all for setting up a system like we have, one which bans trading by knowledgeable people who are in no position to influence corporate decisions.
But the economics are almost beside the point. The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce. It's a farce not only because the incentives will always drive some people to break insider trading laws, but because ordinary people do not have ready access to all of the legally "public" facts anyway; many of them are locked up in obscure or expensive databases. And if Joe Schmoe did have all the public facts, he would still lack the other big piece of the informational puzzle, which is the ability to interpret the facts properly. That more than anything requires real expertise.
In my opinion, the public-confidence angle is the strongest component of the case for outlawing insider trading, but I think it's a rather weak case in the end. The perverse truth is that if insider trading laws inspire the public to think they can play the markets on equal footing with sophisticated investors, then insider trading laws have succeeded in installing a false confidence; they have hoodwinked the public.
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0. This has remained a main justification (at least rhetorically) for maintaining and strengthening insider trader laws over the past eight decades. For example, an act amending the rules in 1984 has this preamble: "Insider trading threatens ... markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules."
However, even though Joe Schmoe cannot process all of the facts, he can have at least some confidence that the (considerably large) network of sophisticated professional investors competing with eachother have done the research, have made their plays, and as a result the intelligence has already been priced into the stock.
Unlike the case where a very small group of investors privy to truly secret information can collude to keep the secret information out of the stock price, to their eventual gain.
Which side of this do you intend to argue? Insider trading laws actually slow down the transfer of information from the insiders to the rest of the market. The situation is a prisoners' dilemma, in which the first insider to sell (or take whatever action) will be rewarded most, but all insiders benefit from delaying that (and arguably the rest of us suffer from that delay). So these laws actually help the insiders punish defectors, which keeps secret information secret.
The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce.
Well that promise certainly is a farce. Any insider action that the law can prevent (which let's face it is only a fraction of the possible insider actions) is going to "reduce" (not really) the insiders' edge over the sophisticated professionals more than it reduces the sophisticated professionals' edge over Mr. Schmoe. Of course, an edge is just information that hasn't yet reached all market participants.
Right. I would say that the basic reason for insider trading laws is the idea that insider trades create an incentive in the market to keep secrets secret, because you're making money off of that secret. Aside from the possibility that this has to ruin companies and the difficulty with prosecuting it as negligence, it still might make sense to support insider trading laws in the name of corporate transparency.
I'm curious, given that I've heard lots of of amatur groups and even monkeys do better than the pros is all that like fake propaganda to throw us off that the pros really are better because of their inside knowledge or is it that only some of the pros have this knowledge so in aggregate it appears the pros don't benefit from it or something else? Or am I conflating something I shouldn't?
Amateurs tend to be much worse at limiting risk, so while they can win bigger, their drawdown/losses tend to be much higher than the professionals, too.
If you want to see how good a trader someone is, look at how much they lose in a bad market rather than how much they make in a good market.
If you look at something like a mutual fund, they will say something like X% performance over X years. BUT what they also do is remove poorly performing positions from their portfolio.
As they are not part of the portfolio they can avoid reporting on the performance, so you don't necessarily get to see the full picture of how their decisions affect their investors.
The random selection (group of monkey) works well during the periods of economic upheaval, when smallcap and microcap do well, and doesn't do as much during the economic downturn.
Random selection tends to bias towards smallcap/microcap, as the sheer quantity of those companies is higher.
The size of the pie is basically fixed. Companies are worth only a certain amount (under big assumptions, the net present value of future dividends). The more insider traders make, the less everyone else makes.
In the end, the laws against insider are simply extensions of the condition that any firm demands from employees and contractors - ie, don't take our take stuff, don't take our delivery van for a joy and don't trade our stock based on secrets we give or leave lying around, ie, The information belongs to the company or its agents and given out to be used for particular purpose.
If there weren't laws against people taking their employer's or contractee's stuff, employers would be hire hit squads to prevent it from happening. Despite vision of libertarian utopias, that wouldn't be an improvement.
I wonder if it would be possible to create a parallel stock market where insider trading is permitted? People could then choose to trade shares (the same shares?) on the normal stock market, or the new free-for-all stock market.
People would just look at how the prices move on the 'free for all' market and then trade the real stock market using that information, thus insider trading on the real stock market would ensue.
You can't have it both ways, you either allow people to trade on private information (thus indirectly making the information public by moving the stock price) or you don't.
Perhaps we should invert the law and make it criminal for publicly traded companies to keep material information secret. Having an unexpectedly good or bad quarter? Give us updates every week.
Why weekly? Why not daily? Or hourly? I'll tell you why...
In big business, quarterly is often as close to "frequent" as one can get. Contracts take weeks if not months to negotiate, net 60 or 90 payment terms, hold backs, terms on goods in transit, etc. For some complex businesses, teams work on nothing but figuring out quarterly filings.
But businesses work on an accrual basis: once the contract is closed, and you can reasonably assume that some influx of capital is real, you put it in the accounting system.
And then: if I am a shareholder, and I own part of the company, why can't I have access to the internal not-yet-audited general ledger status? It's my company, right? It should be feasible to give me access to a secure site where I can get the information...
I believe the real reasons, rather than technical infeasibility, are mainly two:
- Extreme "corporate governance": If shareholders can react on every minute transaction that you do, and they effectively micromanage the company, there is still more incentive for short-term thinking (a problem that a lot of listed companies are already very familiar with).
- Strategy: If competitors can buy one of your shares, they would get access to all your information. You can still do the same, though: on public companies, information is either public, or private. But who is going to start? Who is going to rush to be open to the competitor?
I am not sure if what the Huangs did is considered Insider trading. Majestic Research (Bought by ITG Research) provides anonymized credit card data to Hedge Funds to make investing decisions.
Using Starbucks, Dunkin’ Donuts to Track Economy
As economists look for clues on the direction of consumer spending, they may want to look into how much Americans are willing to spend on their coffee.
Consumers have been more willing to spend since the lows of the recession, but recent declines in retail sales and confidence have sparked worries over whether spending can continue to grow in the second half of the year.
Enter the coffee indicator. A “tell-tale sign of how consumers feel about employment, income and the future is where they buy their coffee and whether they step up for the more expensive concoction,” wrote Majestic Research economist Steve Blitz in a recent research note.
Majestic Research tracks anonymous credit-card data, and can see how much consumers spend by category and store. Blitz broke out the average dollar transactions at Starbucks and Dunkin’ Donuts. The data show that during the worst of the recession consumers spent less at the two coffee outlets, but as the employment picture started to improve people were willing to spend more per transaction.
AFP/Getty Images Starbucks may hold a key to consumer spending.
The trend reversed at the beginning of April when transaction size turned down. To be sure, much of that change is likely seasonal. Transaction size at Starbucks, especially, takes a big spike around the holidays as shoppers buy coffee baskets and mugs for those caffeine addicts on their lists. In the last two years, it has bounced back a bit through the late winter, turning down in April and then moving back up in the late summer/early fall.
So far, this year’s transactions at Starbucks and Dunkin’ Donuts is following the pattern. If that bounce back materializes in the late summer, it could indicate that consumers are still willing to open their wallets. But if the average transaction size levels off or continues to decline, it could indicate a more thrifty consumer will dominate the second half of this year.
Wouldn't that just mean that the stock price would jump hourly to the corrected price instead of jumping quarterly. Those with insider information would have to work harder but they'd just extract the value from the system in smaller increments?
It's possible that releasing hourly negates the effect of the information withholding; but I don't think it's necessarily a foregone conclusion. Instead of trading on longer term signals you're trading on "did company X sell as much this morning as expected" - which I'll grant you is a ludicrous thing to base that companies worth on. Perhaps it means people who have less effect on long-term signals get to take part in insider trading though - if you know there's a new advert or offer coming out you can predict a revenue shift.
I also don't like anti discrimination laws. I think they should be killed, but with an exception allowing the EEOC, anti-trust or similar to order particular sets of companies to stop discrimination for a period of time if necessary.
This reminds me of a quote by Eric Schmidt : "One day we had a conversation where we figured we could just try and predict the stock market..." Eric Schmidt continues, "and then we decided it was illegal. So we stopped doing that."
They probably have thousands of employees who can access this information, I think it would be foolish to think that absolutely none of them does it for personal purposes.
The purpose of the law is precisely to make Eric Schmidt say what he did. In general, the law can't hope to prevent undesirable conduct, but only create social norms that prevent undesirable conduct at scale. Laws against murder won't stop jealous lovers from killing spouses, but do stop people from turning murder into a business. They won't stop casual drug use, but do stop Wal-Mart from getting into the meth business. Etc.
I once had an interesting discussion with a tech-savvy criminal attorney about whether security researchers could trade public equities using early indicators of compromise or private knowledge of 0-day (gained from outside the company, not under NDA). She thought about it a bit and said "The insider trading laws are so broad that if the US Attorney didn't like it they would make it illegal, and if you had talked to anybody about it they would go down for conspiracy."
My interactions with the criminal legal system as an expert witness since then have only reinforced my belief in Harry Silverglate's axiom that pretty much every US adult is merely an un-indicted Federal felon living their lives at the mercy of the thousands of AUSAs who could plunge them into a living hell.
They were talking about using information from the stream of search queries issuing from each company, as I remember the story. So they'd get advance knowledge of layoffs, diseases among key personnel, that kind of thing.
Interesting, as the article notes - if Capital One had terms and conditions that said, "we can use sales data for unrelated purposes", they would be able to trade on that information themselves. I wonder who else has information that they're willing to use/sell to third parties... Facebook? Google? I wonder how predictive e.g. the ratios of likes of McDonald's/Starbucks/Chipotle pages are. Or clicks on display ads for Puma/Adidas shoes.
> Surely lots of Wall Street firms -- Chipotle is followed by 31 analysts -- and asset managers are doing tons of research to try to estimate Chipotle's sales. They're visiting branches and calling investor relations and talking to pork suppliers and surveying consumers and generally getting paid a lot of money to build a robust estimate of how many burritos Chipotle is selling. One more piece of data -- one credit card company's charges at Chipotle -- would be helpful, but come on, not that helpful.
Could we get this data any other way? How about putting cameras in front of a few flagship Chipotle stores and using CV to track the number of people going in/out? That's legal, AFAIK.
I used to joke you could set up webcams watching the freight rail lines out of ports, count the train cars and types with computer vision software, and sell the data to hedge funds.
How about a company like Mint (Inuit). They've got data on poeple's debit cards from all the banks. They've also got categorical trend data (are people eating out more this month?).
That's quite open to abuse, then... Set up two companies, one collects the data, the other trades. Sell the data "on the market", but set a ridiculously high price. The trading company would still buy it, because it knows that the data is worth that much. Eventually, the "public" might catch up to that, but then you simply set the price high enough to eliminate any potential profits of that information.
> Eventually, the "public" might catch up to that, but then you simply set the price high enough to eliminate any potential profits of that information.
How do you set the price high enough without making it unprofitable for the sibling-company as well?
>> if Capital One had terms and conditions that said, "we can use sales data for unrelated purposes", they would be able to trade on that information themselves.
And then the employees wouldn't be guilty of insider trading. They would only be in violation of some agreement between them and their employer. Right?
> Could we get this data any other way? How about putting cameras in front of a few flagship Chipotle stores and using CV to track the number of people going in/out? That's legal, AFAIK.
Analysts already do this with satellite data for parking lot occupancy rates for businesses.
On the other hand "making all financial transactions public and instantly accessible" is one of the best arguments I've heard for pushing people towards bitcoin/blockchain style accounting systems.
It would do all sorts of weird things to the theory of the firm forcing internal transactions to maintain information asymmetry.
What if the information they sold/use was anonymized and they gave you more rewards for card use for this information, would you be more inclined to use their card?
Kind of highlights the true value of data that users are giving away with every single, in this case, transaction.
I am not quite sure how one would go about an alternate method for assessing the actual value of user data, but it has always seemed rather obvious to me that it is hugely downplayed by all the self-interested parties and their defenders.
Would it, in this case maybe be the change in market cap pre and post sales figures? But even that, as pointed out, has some increases baked in based on alternative research to estimate performance. I guess you would need to find a very specific company that really does not lend itself to outside, tangential research and that keeps its performance measures and metrics under wraps really well between announcements. Anyone have any idea of an industry or company that fits such a profile?
Does anyone else realize we are really in and moving deeply into an era that is going to add significant opportunities for corruption and economic capture.
The problem with ascribing dollar values to data (a.k.a. facts) is that you can make up a million untestable hypotheses about how data could theoretically have worth. To give an extreme but illustrative example: let's say that by typing this comment to you, I raise the temperature in my router by a millionth of a degree, which alters the wind pattern in my room, which causes butterfly to flap its wings, which... you get the point.. causes a hurricane in some remote part of the world. Does this make the "expected value" of my comment negative billions of dollars?
You can back this argument out to less extreme versions and see that it's very difficult to economically value a fact. E.g. what if the traders named in this article had 100X the capital on the line for the same trade. Is the data now 100X more valuable because of the added economic value they derived from it? What if their trade netted them more than the change in market cap?
These guys should start their own credit card transaction aggregator (ala Mint), and gather user data that is expressly made available for market research. Make the analysis for privacy tradeoff more explicit and distribute profits.
Damn...waiving transaction fees is probably valuable enough to merchants, they would freely contract the right for the processor to utilize the information for those purposes.
However, that information would still be non-public and likely run afoul of insider trading. That said nothing prohibits companies from making this information public in real-time and maybe it makes sense for the SEC to require publicly traded companies to make this information public in real-time.
I imagine this might fall under the mosaic theory (that non-insiders are able to undertake original research to correlate a wide variety of individually non-material data to form an opinion about a security). As far as I know, such actions (by non-insiders) do not fall afoul of insider trading prohibitions. Otherwise, how would stock analysis work?
Whether a card processor's handling of financial transaction flow would be viewed as non-insider is something that I don't know. I can make reasonable arguments either way.
Well, the problem with all of this is that you're assuming the market opportunity for trading on this sort of information is large.
Exploiting a pricing failure eventually corrects it: buying up undervalued options eventually raises the price to where they're no longer undervalued. An important question is how much you can buy up before they're priced correctly and how much you can make off doing so.
It's possible that these two gentlemen were already exploiting the price difference to with an order of magnitude of its potential. Being able to reliably make ten million or so a year is pretty cool, but not enough to run a sizable business off of -- it might not even be worth it for the 'big boys' to exploit. If you could pull in hundreds of millions or billions of dollars a year, then you're talking -- but you'll be splitting it N ways, with everyone else who decides to exploit the same trick.
> A credit card processor that charges 0% fee on transactions would have a huge advantage when pitching retailers.
So why, you may ask, do we have such high fees for credit card transactions? And believe me: they ARE high. No more than a hiccup when debit card fees were restricted to roughly $0.15/transaction but CREDIT card fees (which use the same systems) continue to be a substantial fraction (a few percentage points) of every purchase.
It's because no one is pitching retailers. The cards are sold to the consumer (who pays nothing). The retailer pays, but the contracts they are offered do not give them space to do much other than refuse to take a type of credit card (and give up a bug chunk of their business) or to accept them and pay the fees.
Huge barriers of entry. In order to make a card product that is really competitive to Visa & Mastercard, it's a chicken and egg problem - you need on board both a lot of merchants (to make the product useful to customers), a lot of customers (to make the extra effort viable to merchants), and a lot of money (measured in billions, not millions) to get it started - even major tech companies like Ebay/Paypal and Stripe are too small to afford this kind of effort on their own.
If you make the product really attractive to merchants, then you will have a problem getting customers. You will have to compete with the existing credit card products. Banks make a lot of money on those existing products and are highly motivated to ensure that the product you propose never, ever gets off the ground. History shows that they are both willing and able to (a) use this money to "buy" customers over with bonuses that you won't be able to match because you aren't charging the merchants so much; and (b) aggressively try to keep you out of all the infrastructure - there are many 'moats' that they control, including the large settlement systems, technical infrastructure installed at merchants (forget about using the same POS terminals to read your cards and Visa/MC, even if it's technically easy), etc.
There have been and are many attempts to make new alternative card products, but they aren't realistic to succeed. EU considers a wish for such a card system every couple years, but it turns out to be unfeasible even given the combined financial resources of the interested governments. Right now Russia has a strong motivation to support and subsidize such a system, but again, they don't want it that much to warrant the huge expenses for the relatively low expectations of success.
As a retailer you can negotiate like crazy with credit card processors. One of my cofounders worked at a processor and using his knowledge bank managaged to get us absolutely insane rates vs the "walk up" rate.
It probably saves us thousands to tens of thousands of dollars each year and we don't even have a huge amount of revenue.
I like that idea way more than selling [aggregated, anonymized] consumer purchasing habit reports to advertisers, which is what I figure tons of payment processing companies are doing now (I have no source on this, but it seems obvious),
I believe LevelUp does this. They don't allow retailers to use any credit card as things still need to go through the LevelUp system via QR code, but as far as I know they don't charge for processing.
I see a lot of comments about how they could have figured out this data by just counting customers outside some Chipotle restaurants. This misses a key point: using their massive database, they were able to sift through thousands and thousands of businesses and actually figure out that Chipotle was one to watch. Without that data, they wouldn't know where to put their customer watcher.
If they were a little savvier, they could have used their data from CapitalOne to decide which businesses to research and then create shill research, much like the FBI's "parallel construction" of evidence. I wonder whether that would have put them in the clear; when the SEC came knocking, they could have pulled out their research, saying "Look, we figured this out fair and square."
Wonder how closely footfall at high-street traders equates to their revenue - pretty close I'd imagine?
I'm thinking whether a firm running city centre CCTV could do this with some computer vision systems. Mobile phone operators and ISPs that serve businesses must have similarly closely correlated signals to hand too.
>"Wonder how closely footfall at high-street traders equates to their revenue - pretty close I'd imagine?"
To put it another way: I was thinking that the number of people who go in to shops in the high-street might correlate well with the revenue for those same shops.
Many hedgefunds follow the method of "Parellel Construction"; one such method is: many buys and sells before the stock moves. So, the defense is: we have been selling and buying for 2 weeks before the major change.
I genuinely think this is a grey area, and it's far from "insider" trading. Is it moral, I don't think so. Should Capital One sanction these employees, probably. But I think this is far from ilegal.
Huang and Huang had access to a db which is not open to everyone, granted, but they had to extrapolate the stock direction based on data from a subset (customers who buy Chipotle with a CC), of a subset (with a Capital One card)... and then compare that to analyst expectations, etc. but then, would it be insider trading if I stood outside a Chipotle polling customers who exited on the dollar amount spent? That is also proprietary information, and one I can use to trade stocks on. I'd like to know if they did any trades where the return went south. I know of sector investment funds which pretty much do this all day long, forecasting all sorts of industries, and it's not ilegal.
Well, in the article the make clear that there is case law that this is illegal and considered "misappropriation" insider trading.[1]
Even if we decide it isn't insider trading, Capital One is on the hook for what it's employees do. Chipotle or whoever could sue CapOne for breach of contract, and CapOne could sue these guys for that. So even if we decide as a society it's not criminal, another group of guys doing the same thing somewhere else might not get to keep all that sweet dough they made purely on civil grounds. I don't know. It's interesting.
> Well, in the article the make clear that there is case law that this is illegal and considered "misappropriation" insider trading.
I'm not sure that is the exact same thing. These guys had to do some research.
Consider, for example, a large pork supplier. If they see orders from Chipotle trend up by (say) 30% over a quarter, are they free to buy call options on CMG? What if you're a feed supplier to this pork supplier, and you know that Chipotle is their biggest customer, and see that this pork supplier's demand for feed has gone up by 30%; can you then buy call options?
This is a gray area, and I'm not sure the line is really that clear cut.
>This is a gray area, and I'm not sure the line is really that clear cut.
Your examples are not novel issues, certainly there would be case law on point. I can not cite the case law, but I would tend to believe your examples fall within the classification of insider trading (i.e. trading based on a companies non-public information). I know for example as an attorney if I am working on a merger and I buy/sell stock or inform someone else who buys/sells the stock that would be insider trading.
Generally, think of the Martha Stewart allegations, she was informed by a friend/corporate officer that the FDA was rejecting the companies cancer drug. Based on that non-public information her brother sold the stock and then the FDA decision became public and the stock dropped. It is a stretch from your hypothetical, but the non-public information paradigm would seemingly still apply.
I don't think that example is insider trading. Insider trading is trading on material nonpublic information that was obtained in violation of a duty of confidence (and for a benefit). Do Chipotle's suppliers have a duty of confidence regarding their order sizes? I suspect either it's explicit in the contract, or they don't.
Is that ("that was obtained in violation of a duty of confidence") true? I don't think it is. I'm pretty sure you can't trade on information you overhear in a bar, for example.
The SEC might argue that bar patrons have such a duty of confidence - they have previously done so for roommates, and golfing partners. Or they might charge the person you overheard with violating the Reg FD selective disclosure rules. Or they might let you both away with it (IANAL). But yes, it absolutely is part of the law; http://www.law.cornell.edu/cfr/text/17/240.10b5-2 is the detailed version.
>Even if we decide it isn't insider trading, Capital One is on the hook for what it's employees do.
Under the legal theory of Respondeat Superior, Capital One would generally be liable for acts of its employees. However, liability will generally not extend to the employer when employees are acting outside the scope of their employment. Certainly if the employees were breaking the law it can be presumed they were acting outside the scope of employment, but even if it is found the employees were not breaking the law it would appear they were acting outside the scope of their employment. In short Capital One would have affirmative legal defenses.
I recently worked at Capital One (left recently), they were not following protocols and probably had gained access to information they should not have had.
That being said, I highly doubt Capital One is "on the hook" because they were breaking company rules and would have been terminated. Further, I am pretty sure the employees were breaking several laws as well as Capital One's policy (at least according to the contracts I signed and seminars I had to sit through), Capital One would not be directly responsible if they attempted to prevent such behavior (which they do).
In this case, Capital One could only be on the hook if they benefited or distributed individuals data, they actually did neither. They had only general sales data and only the two employees illegally made money.
Thanks for the link, it sent me down a path of learning more about breach of fiduciary duty. You are correct, this is a very complex and interesting case.
I heard of people at a renowned analyst company who would trade on their findings before release. Supposedly that was all clear as they only used public data.
Stats 101 - A sample of the total customers is sufficient to calculate the monthly average. As long as the sample size is sufficient (capital one credit cards) and the sampling method is not too biased (or in this case stedaily biased month-to-month). So yes this information appears highly valuable for forecasts as it gives customer amount and sales amount ahead of reporting.
sure, i'm not debating that this isn't stats, but it's a skewed subset, skewed towards those who can afford to have a credit card. then, stats is far away from knowing confidential information. I don't know...
At the end of the day I am not so sure the value of the information matters, even though in their case it turns out the data subset accurately reflected the larger picture (e.g. Capital One data was consistent with not just other credit card transactions, but cash as well).
Nevertheless, one may still be committing insider trading by trading based on non-public information even if the bet was wrong. Though is such a circumstance they may not have come up on the radar.
It's not very clearly insider trading, because the traders had no fiduciary duty to Chipotle. It's arguably insider trading because their relationship to Chipotle is colored by the relationship payment processors have to Chipotle. And that argument will probably prevail.
The point of Levine's post is that for the markets to work, there have to be traders trading at an advantage. The point of insider trading laws isn't to level the playing field --- that's exactly what you don't want. It's to eliminate a class of agency problems.
We can (probably should) want to deter credit card companies from trading on data mining payment data without believing that insider trading laws are the right vehicle to do that with. Privacy regulations and mandatory confidentiality agreements could set up an effective civil deterrent, rather than sporadic and incoherent SEC and criminal investigations.
Violation of fiduciary duty is only a requirement in order to meet the "Manipulative and Deceptive Practices" part of SEC Rule 10b-5.
However there are other ways that requirement can be met for instance SEC v. Dorozhko found that a hacker using stolen information to trade was guilty of insider trading. Obviously he had no fiduciary duty however he was found to be deceptive.
If the SEC prosecute this case I imagine they'd try to extend the argument presented in Dorozhko.
Yes, that's what I was alluding to in my first paragraph. (I did read the article; I am sort of religious now about reading Matt Levine, who is awesome.)
But don't insider trading rules apply even to people with no real agency power? A secretary who overhears that a drug trial failed is not in a position to affect how the company reacts to that information, and probably does not have enough capital to move the stock. But she would still be violating insider trading laws if she sold all her stock before the press release was issued.
I can see why professional traders and speculators might not want to level the playing field, but I don't see why long-term investors would feel that way. When I invest in stocks, I intend to hold for a long time. I'm betting on the business success of that company or group of companies, not on inequalities in the availability of information about them.
It's not in the interests of long-term investors to keep advantaged traders out of the market. The alternative to the participation of informed investors is mispricing. Fundamentals investors want prices to reflect actual value, too.
I feel like this begs the question of information inequality, though. If all traders were equally informed, then mispricing would be avoided as well. And without the complexity of trying to infer information from the trades of others.
Isn't this what insider trading laws try to do? The law obviously can't keep insiders from learning information first, so the law prohibits insiders from acting as investors until the info is public. At worst this creates a lag between information and price, but that wouldn't matter much to long-term investors.
Not that insider trading laws can create total information awareness for every investor. But at least it gives every investor a more equal opportunity to find and use information.
> I feel like this begs the question of information inequality, though. If all traders were equally informed, then mispricing would be avoided as well. And without the complexity of trying to infer information from the trades of others.
If all traders were equally informed (perhaps by a law that any information you wanted to trade on had to be public), there would be no way for people to profit by digging up new information. We (society) like it that analysts have a financial incentive to figure out the truth about how well a company is doing - whether that be by coming up with a better model of how one industry affects another (which will ultimately lead to better allocation of resources), or doing the legwork to realise that a particular company is a massive fraud (which leads in a more direct/obvious way to better allocation of resources).
But we don't want them to just bribe insiders - that causes agent-principal problems, gives certain market participants unfair advantages, and all the rest of it. Hence the law, where figuring out these things through research is encouraged, but getting them from insiders is illegal.
The laws keep insiders from doing that, but it does not prevent other people from amassing non-public data through research, investigation, or financial modeling. Instead, the law protects the products of those activities as trade secrets, thus enshrining into law the idea that some traders do in fact get to be advantaged with non-public information.
I'm having a hard time thinking of non-public data that would be legal to trade on. The examples in the article and this thread all seem like public information. Anyone can observe a sales floor, or a parking lot, or a store entrance. Anyone can observe the IR radiation coming off oil tanks. Anyone can observe tweets.
Anyone with the time and means to do so, anyway. Anyone could do these things; but most don't. For the people who do, what is protected is their investment in gathering and analyzing the data. The law does not grant Person A access to the data set of Person B--true--but the question is whether Person B could do their own work to gather the same data set.
Whereas information that is only available, in any form, to Person A would be considered non-public, and not legal to trade on.
If I read it correctly your third paragraph describes how things should work. I'm saying that misappropriating 3rd party information has already been established by case law to be insider trading.
No. US v O'Hagan did not establish misappropriation as "insider trading". It established it as fraud, and as an SEC §10(b), which covers a broad range of securities fraud that is not describable as insider trading.
The syllabus for the case itself seems to be at pains to distinguish misappropriation from insider trading.
The importance of the distinction is that the Capital One case is something the spirit and letter of the law wants to deter, while satellite imagery of commercial activity isn't, despite it too being an example of market actors leveraging their own access and assets to gain an advantage in the market.
If this is just a terminology debate, O'Hagan-style misappropriation theory cases are called "insider trading" cases by nearly everyone, including the SEC[1], the Justice Department[2] and the SDNY (a judge recently issued an opinion discussing "insider-trading cases prosecuted under a misappropriation theory"). They are usually contrasted with "classical theory" insider trading cases.
The use non-public information is what the article talks about - there are plenty of other non-public data sets that traders use to gain an advantage (e.g. using helicopters with infared sensors over oil fields).
The difference in this case seems to be they broke customer confidentiality rules to obtain the data, so use of that data for profit is now illegal.
"This is clearly insider trading. It's non public info." is broken logic. You are allowed to trade on non-public information; in fact, for the markets to work effectively, you want people to do exactly that.
You got downvoted because you appear to have either missed the words in breach of a fiduciary duty or other relationship of trust and confidence in your own quote, or responded under the misconception that I'm arguing that the Capital One guys should be allowed to do what they did.
Well the SEC agrees, so I'll go ahead and trust them and my years of training.
Trading on any insider non-public info is actionable by the SEC. Keep your eye on this one, should be fun for those involved. I sure as hell wouldn't risk it.
And Google, Microsoft, Yelp, Facebook, etc employees can buy and sell stock and have non public info as they work at the companies. The question here is, is it material? Inside companies you see and hear about many things... which of them material, well, that's the grey I'm referring too in part.
Employees always (in my experience) are explicitly restricted from trading company stock based on non-public info. There are also [usually] specific windows in which employees cannot trade in the company's stock.
Additionally, I have worked for companies which prohibited transactions in any derivatives or options and barred shorting the stock.
Certainly, I too was restricted at my company: no shorting (of any stocks!) and no buy/selling of stocks x-days before earnings announcements. A part from that, you could trade without any other contractual restrictions. The determination of material information wasn't not decided by the company... and I guess it's something that is is only brought up in case of an investigation.
At the very least it is misuse of Company resources. They can probably sue these goons for every single dollar they made and then some, especially if they are found guilty, which they probably will be.
Even at that, you have, what is essentially insider information on the raw sales data of a company that way since you are essentially seeing the same information that the company itself sees, but just a rather linear proportion of it.If you have the Capital One portion of Chipotle sales, and you know the electronic transaction market share of Capital One cards, and you know the proportion of cash to electronic transactions; I would not be surprised one bit if you could essentially predict the sales figures down to within 1% margin.
I think (and I'm not terribly informed here) that the difference would be that Capital One has a business relationship with Chipotle, albeit somewhat indirect. Polling customers while otherwise being unrelated to the company is different from mediating payments to the company and using that data.
According to the article, the big problem here was that the data being used here belonged to Capital One, and these researchers were running their own thing on the side using that data.
It reminds me of how search engines know about things like shopping cart exploits right away because all of a sudden there are thousands and thousands of queries for a particular shopping cart software package being used on a web page.
Personally I agree with Matt that this is a not the usual kind of thing. Clearly Chipotle could anonymize their sales with dummy purchases but the actual numbers would still be there. Like a search engine, for the data stream (credit card charges) to work you are forced to put enough information in the transaction to identify it.
This is also something I see happening with IoT type technologies, when it becomes possible for someone to collect data on their own at thousands of locations for relatively small numbers of $, like the helicopters trying to estimate oil availability, you'll have data streams that can inform economic activity. Imagine something like a cellphone sized thing with a camera that just counts customers using OCV to note blobs at the counter, in a restaurant and texts a tally once an hour. Seems ridiculous but its quite possible to do, and much more cheaply than just repurposing disposed cell phones (although that works too).
It's almost impossible to anonymize large data datasets like that. Significant aggregation is basically the only way to do it properly, and that significantly reduces the value of the data.
So I wonder how much insider trading occurs via government spooks analyzing surveillance data that we don't know about. I doubt the SEC would be able to make a public lawsuit about this .
Workaday co-CEO Dave Duffield said in some interview that he invests privately in the companies that buys Workaday cloud hr solution. If he can sees how many employees are added to a certain company that buys Workaday cloud product, he can use that an edge.
This is a stretch of insider trading laws, which I assume is why they haven't been charged criminally (the SEC can only pursue civil sanctions). The data was in the possession of their employer, not of the publicly traded companies. They could probably be prosecuted under the CFAA for misusing a protected computer system, but I cannot imagine them being convicted criminally for insider trading here, or even losing at trial if they choose to fight the civil SEC case.
If I pay people to go count the number of customers in line at a representative sample of Chipotle restaurants during lunch every day, compare the results to the previous quarter where I was doing the same thing, and trade on that data, is that illegal? It's nonpublic information. Would my employees be prosecuted for this if they traded on it?
Prosecutors and the SEC attempt to stretch our laws every day. It doesn't mean that they are going to win these cases.
What if Chipotle signed an agreement with Visa and their credit card processor saying that their data wouldn't be provided to traders to trade their stock on?
What if Capital One signed an agreement with Visa saying that in exchange for issuing cards, they wouldn't provide the data to stock traders, and would keep it safe?
What if they didn't trade on it, just sold the info to Taco Bell?
Seems like a situations I want to avoid, if I'm Chipotle.
>What if Chipotle signed an agreement with Visa and their credit card processor saying that their data wouldn't be provided to traders to trade their stock on?
If they did, then obviously these two would be in violation. But I have seen no mention of such an agreement.
How is observing lines of Chipotle customers private information? Anyone can do it.
Anyone CANNOT query Capital One's transaction databases, which is the entire problem here. Make the transaction databases public (Bitcoin does) and open the casino to everyone else.
The point is that this wasn't private information, and it was not in a database that was the property of the target businesses. It didn't come from inside the company. Hence no "insider trading".
The implications are bigger than for public companies' insider trading.
Think about the success of the Oatmeal's Exploding Kittens card game on Kickstarter. Aside from the fact that KS's new payment processor Stripe is leeching an astounding amount of money from this campaign (where most pledges have probably been made with cash-like debit cards being charged at the rate of credit cards), there are also implications of aggregation inside that cartel.
How many playing card printing companies out there are eager to handle that order? What if you knew ahead of time who they were going to use, based on that "bank account" info you have to give out when you sign up for a campaign on KS? Private companies leverage this info all the time, and it's much easier for them to get away with it.
This stuff is already being done legally, with certain industries and within certain financial institutions. Just seems like these guys were just caught in an unfortunate legal snag - otherwise they just seem like good traders to me.
The point is not whether somebody does a lot of research or not. The point is whether he/she had data available that is not available to the public. That is simply not fair.
Now, using helicopters to track oil tankers - as described in the article - seems to be a blurry line, but in theory anybody could do that and then use that information, it is available to everybody... In principle at least.
This data was entirely private, so I would agree with being not fair.
That said, I hope these guys do not have to go to jail, but are simply forced to pay their gains (or a portion of those) back, maybe as a fine.
This is probably going on right now in lots of other companies that have access to such data. We only hear about the ones that get caught. Seems like they didn't try too hard to cover their tracks. Just think about all the companies that have access to credit card data and all the people that are connected to those companies who could either be selling the data to others or trading on it themselves. Best thing to do to prevent this unfair advantage is releasing publicly available CC spend data.
> Best thing to do to prevent this unfair advantage is releasing publicly available CC spend data.
Who releases it? Every credit card company? At what frequency?
What if one of the nightly bulk loads into the transaction data warehouse fails with an integrity error, alerts the DWH team, is picked up by a junior person because of a staffing anomaly, who forces it through, and then the next day's data release is off by a couple of million, but the automated trading bots and manual trading desks don't know this, so they trade on this new signal...
I've always felt this would be a really interesting job to have. The ability to look at a CC company's data and be able to generalize market trends. There are so many questions I'd want to ask about socioeconomic status and impact on debt, fraud, specific types of purchases, etc. It'll never happen, but someone should give a big data firm unfettered access to answer some interesting societal and behavioral questions.
> That's amazing! These two like customer-support guys...
> You sometimes see insider-trading cases where someone makes like a thousand-percent return...
Am I the only one bothered by the author's writing? Am I getting old? Conversational is ok, I guess (though, Bloomberg?). But these "like"s? They're not 'like customer-support guys', they are customer-support guys (or else they are analysts).
I think they were primarily a victim of their massive success. If they had only made $500,000 instead of $2.8 million, they might still be going along fine.
How did they get caught? Did the SEC see this account has 1,800% return on investment over 3 years and investigate who owned it? Or did Capital One discover some odd queries on their production database and report them to the SEC?
I think generally it's the large unhedged options position that makes 10x after an earnings surprise that gets noticed. To your point, yes I think in this case pigs got slaughtered.
Couldn't this kind of thing be easily solved by having companies release sales data more frequently? It seems like the only reason this is profitable is because earnings are released quarterly, so there's opportunity for the stocks to become wildly mis-priced over those months.
What would the downside be for releasing earnings data daily, or even weekly or monthly?
Big question. If they setup a hedge fund and bought the data from the card issuer, and did the exact same thing. Would it be legal? Don't they use private satellites to take pictures of mall parking lots and crop fields to estimate holiday sales and crop yields? Hows is this different. Its data that public doesn't have access to.
You're describing a world in which said data is available on the market, which is already a drastically different world than the one we live in. I would be surprised if they can legally sell that data - surely credit cards come with a privacy clause?
Not sure about the US but this is more or less what happens in Japan:
Brokerages are obligated to flag and report suspicious orders or trades to the [equivalent of] SEC.
If necessary, the SEC then asks the brokerage for more information and investigates it.
The definitions of "suspicious" can be somewhat arbitrary, but those >1000% returns would definitely be considered suspicious. Two people at the same workplace getting abnormally high returns would also be considered a red flag.
Yes! That's the question! Was it that they were too successful trading, or was it their employer (or a co-worker) reporting on their side-business to the SEC.
for better or for worse, the establishment of decentralized prediction markets will essentially make insider trading laws moot. Who cares if you can't bet on the original market when you have another unregulated market where you can bet on the veracity of the first?
[0] http://www.wsj.com/articles/SB100014240527023042799045795161...