Insider trading: an odd federal crime
On March 8, 2017, the U.S. Department of Homeland Security notified Equifax, the credit reporting agency, that software used in its website contained a serious vulnerability. According to the prepared congressional testimony of Richard Smith, then Equifax’s CEO, the company recognized the significance of the warning but failed to apply the necessary patch.
On May 13, exactly as the company had been warned, hackers used the known vulnerability to gain access to Equifax’s vast storehouse of consumer credit information. Equifax didn’t notice the ongoing hack until July 29. After a day of observing the hackers in operation, Equifax took the vulnerable web application offline. (This is all according to Smith’s prepared testimony, which was presumably tailored to make him look good.)
On Friday, Aug. 25, Equifax executives received an email informing them of a “VERY large breach opportunity,” a peculiarly cheery euphemism for the disaster. The following Monday, the chief information officer of an Equifax unit, Jun Ying, searched the web to learn what effect the news of a prior hack had on another company’s share price, according to a civil complaint filed against him by the Securities and Exchange Commission and a parallel criminal indictment. After learning the other company’s share price dipped on the news, Ying allegedly exercised all his vested stock options and sold 6,800 shares of Equifax stock that very day, reaping $950,000.
On Sept. 7, Equifax announced the breach, revealing that the personal identifying information of some 143 million Americans — names, Social Security numbers, birthdates, addresses, and in some cases driver’s license numbers — had been acquired by criminals. Equifax’s stock price took an immediate hit. If Ying had waited until the breach was publicly known, his proceeds would have been $117,000 less, according to the SEC.
(In October and again in March, Equifax disclosed still more victims of the breach. The current total stands at 147.9 million.)
Classic insider trading occurs when an employee of a public corporation, such as Ying, “trades in the securities of his [or her] corporation on the basis of material, non-public information.” Insider trading can take many non-classic forms, too, such as the passing of tips. (Carl Icahn’s alleged recent dumping of the shares of a steel-importing company in advance of the president’s announcement of a steel tariff doesn’t meet the classic definition, since he didn’t obtain the information as a corporate insider.)
Insider trading is a federal crime, but an odd one. No federal statute specifically outlaws the practice. Rather, the SEC Act and regulations prohibit “any manipulative or deceptive device or contrivance” that “operate[s] as a fraud or deceit on any person.” If the laws were written any more precisely, they would become easy to evade by the very sort of trickery they were intended to combat. But their generality means that judges have a lot of leeway in interpreting them.
Then, too, it’s not immediately obvious that anyone is hurt by insider trading. Assuming that Ying sold his shares as alleged, whoever bought them must have liked the price. If they hadn’t bought from Ying that day, they would have bought from someone else.
But that misses the big picture, which is admirably sketched in by Matthew Josephson’s 1934 muckraking classic “The Robber Barons.” The book is anything but an objective history of American capitalism, and its caricatures of various Gilded Age worthies are gleefully malicious. But it’s a rollicking catalog of every sharp practice ever perpetuated on Wall Street, from bear raids to corners, with insider trading a perennial favorite.
For much of American history, investing in the stock market was like asking to join a highstakes craps game, when all the other players
exchange a brief knowing glance before demanding to see your money.
Honesty was a long time coming to the stock market. Federal regulation by the SEC didn’t begin until 1936, and it made a huge difference. Today, 54 percent of Americans have money invested in stocks, according to a Gallup survey. That’s a staggeringly huge source of capital for business. But investment is a form of entrustment. All investments depend on trust.
Insider trading is an assault on trust. Corporate insiders are, or should be, working on behalf of their shareholders. An insider who trades on non-public information rejects that duty, engaging in a form of deception directed toward the very people he or she is supposed to serve. When all the short-term price risk is on one side, a transaction becomes fundamentally unfair, exactly like betting money on the roll of loaded dice. The greatest harm of insider trading is to investment itself. Joel Jacobsen is an author and has recently retired from a 29-year legal career. If there are topics you would like to see covered in future columns, please write him at legal. column.tips@gmail.com