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L: So, Doug, several people have asked us to talk about the scandal that
deposed the head of the IMF; what’s your take on it?
Doug: To all appearances, it couldn’t have happened to a nicer guy,
but I’ve got insider trading on my mind – let’s talk about
DSK next week.
L: Ah. Raj Rajaratnam’s
troubles got you
riled up?
Doug: It’s a disgrace. Rajaratnam is
– or was – a productive member of society who, even if he did
break the law, may very well have done nothing morally wrong –
L: Good grief, Doug, you want the SEC to invite us over for tea and a
chat? I know better than to expect you to ever beat around the bush, but
…
Doug: The SEC is concerned with the enforcement of a set of stupid,
counterproductive, expensive, completely unnecessary, and destructive laws.
It does so by having its bureaucracy create a myriad of even more stupid, counterproductive,
expensive, completely unnecessary, and destructive regulations.
L: But you’d say that about all government law.
Doug: I would, actually, although I know that confuses some people because there
is an overlap between government law and what might be called natural law.
But this one is topical at the moment, and worth debunking here and now, even
though by this time next week people will have totally forgotten that the guy
has been locked away for years… along with about 2.2 million others now
in American prisons – most of whom absolutely shouldn’t be there.
L: Okay, okay, but for the record – there must be a few snoops who
read these things – we abide by all securities and all U.S. law at Casey
Research. In fact, the ethics policy I had to sign and that is strictly
applied to all of us here at Casey Research exceeds SEC standards, because we
not only don’t want to run afoul the law, our reputation is our
business and we don’t want to give anyone any reason to doubt our
integrity.
This reminds me of your old stunt, asking the Feds
in your audiences to stand up and identify themselves, because you knew who
they were. Amazing that you got a few to fall for that.
So… where to begin?
Doug: With a definition, as always. The SEC’s definition of insider
trading is constantly evolving and growing, though the definition itself
– forget about its application – is imprecise and arbitrary. But,
more or less, it says that any officer, director, holder of more than 10% of
a public company’s stock, or anyone they talk to about material
information regarding the company, is an insider.
Like most of the SEC’s rules, the ones on
insider trading are arbitrary. They’re similar to the tax laws, in that
you often can’t know whether you’re breaking them or not.
You’d almost have to live with a specialized attorney to keep from
getting in trouble. They can’t be enforced in anything but a sporadic
way – basically to cause fear, in the hope that fear will keep the
plebes in line. But worse, they are unnecessary and destructive.
L: One thing at a time, then. Unnecessary?
Doug: Yes. There’s nothing wrong with insider trading, per se. For
example, there’s nothing wrong with a manager, who knows his company
will report a good quarter, buying shares in his company in advance. This
causes no one any harm. Let me repeat that: the fact that an insider knows
– or thinks he knows – good news is coming and buys shares does
not hurt anyone. Actually, it spreads out the buying pressure and may help
everyone buy at better prices. Moreover, if someone needs to sell urgently on
a given day, maybe for tax reasons, or maybe because their kid needs an
operation, then the fact that someone is in there buying with gusto does him
a lot of good.
L: But people say it isn’t fair.
Doug: There’s no such thing as fair. “Fair” is
necessarily an arbitrary and contentious word, usually employed by busybodies
and losers. You think it’s fair to the antelope when the lion eats it?
Was it fair to the dinosaurs when Mother Nature wiped them out? Or how about
this: is giving everyone an equal share of something fair, if some worked for
it harder than others? The guy who knows something and buys has not taken
anything from unwilling hands – just uninformed hands – and
people have to make decisions with varying amounts of uncertainty all the
time. You can’t regulate uncertainty or the uneven spread of
information out of existence any more than you can regulate the capacity to
intuit the significance of information into every human skull. Not only is it
impossible to do, it’s ethically wrong to try. If you’re no good
at this game, don’t play it. Life’s not fair. Get over it.
L: I’ve long seen fairness as a false ideal, created by people whom
I suspect were simply jealous of those who had more than they did. It’s
the have-nots, or want-mores, trying to use power over others to compel them
to share what they would not share willingly, instead of working hard to
become haves themselves, honestly.
This has caused nothing but harm to all people
– especially poor people, actually – because calls for
“fairness” often wind up with the ends justifying the means.
Assuaging the plight of poverty-stricken people seems like a noble enough
reason, perhaps enough to justify a little bit of force, a mild
redistribution, especially from those who don’t really need all they
have… But this is not justice; it’s brute force with a benevolent
mask. And once a governing system has been given such power, it can use it
for less noble goals – and in time, it always does. So-called social
justice is just the opposite of what it claims to be. Taking from people what
they will not give willingly is theft, and by any other name, it smells just
as bad.
Justice is hard enough to achieve, though it can be
done, with effort. Fairness is just jealousy dolled up.
Sorry… That one really gets me. Back to
insider trading. Buying on good news is one thing – what about on the
sell side? What if someone knows a company is going to be sued, or have a
patent rejected, or some such negative insider info?
Doug: What of it? So, they get out before others do. Some kid gets to the
water fountain before the rest – it happens. And, again, it can spread
out the selling, actually blunting the impact of the bad news.
Look, there’s no problem with insiders buying
or selling based on their knowledge. Even if news is kept airtight until
it’s press-released, some people will get it before others. Only the
people paying close attention at that time will be able to act immediately.
Is that “fair” to everyone else? If the exchanges slapped trading
halts on every share every time a company reported news, everyone would be
trying to buy or sell the moment the halts were lifted, greatly magnifying
the swings, both up and down. This would tend to cause more harm to all
shareholders. The whole idea is simply silly.
The fact is that there are many buyers and sellers,
each with different levels of knowledge, ability, and need, and the more
important differences – in understanding and insight, for example
– are internal and individual. There’s no way to truly level the
playing field. It’s an impossible ideal, and therefore a destructive
goal.
L: What if an insider knows there’s bad news and is telling people
otherwise, urging them to buy, like the proverbial used car salesman who
fills a knocking transmission with sawdust to quiet the sound?
Doug: Well, that’s fraud then. It’s got nothing to do with
being an insider, it’s got to do with lying. A
crook is a crook, and he doesn’t stop being a crook just because there
are rules – rules just change the way he cheats people. There are ways
to deal with this – even laws, if you want to use them. I’m not
defending deceit, fraud, or theft. All I’m saying is that it’s
impossible for everyone to hear of financially relevant news at the same
time, and that it would be counterproductive if it could be made to happen.
Further, if shareholders really want to try
equalizing trading opportunities by demanding certain policies regarding
trading and the handling of material information, they could do that. This
could all be dealt with by contract between the company and its employees. Or
by allowing exchanges to regulate this in different ways, appealing to
investors who care about different things.
Instead, we get the SEC, which should really be
called the Swindlers Encouragement Commission, telling people it’s
making sure everything’s fair, thus luring the lambs to the slaughter.
The investment world is full of sharks, and it always will be – all the
SEC does is lower the average guy’s defenses, which really does
encourage swindlers. Just look at Bernie Madoff, a perfect example. The SEC
has never prevented a fraud, to my knowledge. Rather, by making everyone
think they’re protected, it makes a fraud much easier to perpetrate. Lambs
to the slaughter.
L: Don’t hold back, Doug…
Doug: [Chuckles] It gets worse: adding insult to injury, the SEC costs
business billions of dollars annually – probably scores of billions, if
you take all the secondary and trickle-down costs into account: direct fees,
legal fees, printing, mailing, and other costs of compliance. They have a
direct budget cost of something over a billion dollars per year, but
that’s trivial relative to the indirect costs they impose on the
economy. They ought to be ashamed, diverting a significant fraction of GDP
from productive use into the pockets of parasites, in the name of protecting
business and investors, when they do the opposite. The SEC is like a Pied
Piper who attracts ravening hordes of rats with his flute instead of getting
rid of them – and then charges people tenfold for the
“service.”
This is one agency I would abolish, immediately and
completely. Not a single one of its functions should even be handed off to
other agencies. The SEC serves absolutely no useful purpose whatsoever
– just the opposite. It’s not a question of getting it under
control, or paring it back. It should be eliminated in toto.
L: On some level, I think everyone in the market knows this is true. They
go along with the insider trading charade because Big Brother is watching,
but they know they’ve read things others have not, they know people
others do not, they have relevant experience others do not. To hear the bawdy
tales around the trendy pubs in financial districts, everyone thinks they
know something others don’t. Nobody is trying to be fair – they
are trying to win. Short sellers are perhaps the brassiest of the lot;
their very positions proclaim that they think they know something others do
not. Their counterparties to the short sells know this, and willingly enter
into contract with them, pitting their own knowledge and understanding
against that of the shorts.
It’s all about skating around the edges
without crossing the lines… and for some,
it’s all about crossing the lines without getting caught. I think this
really is a case of the emperor’s new clothes, at least among
investors. But if everyone knows this, why does the myth persist?
Doug: The public and the fat cats – and absolutely the politicians
– all think that a high stock market is, almost by definition, a good
thing. But a high stock market doesn’t necessarily mean an economy is
doing well, or that public companies are doing well – it just means
there’s a perception that this is the case. Or worse, in some cases
– like now, I suspect – it means nothing at all, other than that
people are afraid to hold currency, government bonds, real estate, or other
assets and so-called assets. An artificially high stock market can send dangerous,
false signals to businessmen and investors. It can cause false confidence
– the kind Wile E. Coyote still has when he runs off a cliff. But the
government seems to love a high stock market…
Of course short sellers love to see an overpriced
market too. And speaking of short sellers, I’d go further and say that
they provide a very valuable positive service to other market participants.
L: How so?
Doug: To start with, they’re always on the lookout for frauds.
They’re really the policemen of the market, taking down inflated stock
prices of bad companies, and alerting other investors of the danger.
Plus, when they short a stock, no matter how the
trade goes, they have to actually buy it back at some point, to be able to
deliver on the contract. If they are right about a company being grossly
overvalued, their selling provides a warning by driving down the price.
Further, they are there to provide a bid after they’ve been proven
right. By then, almost no one else is buying, and the shorts offer some
liquidity, a bid, to the fools and amateurs who didn’t do their
homework. And if they are wrong, being forced to cover their short position
can push the stock higher, to the benefit of the incorrectly judged company.
L: So, it’s the Wild West?
Doug: First, the Wild West wasn’t nearly as wild as Hollywood has
made it out to be. It had an unregulated economy that worked quite well most
of the time – better than ours does now, I’d say, given the huge
wealth it created for so many people who had the grit to go out there and
take nature on. But that’s a conversation for another day. Second,
“security” is a fiction – it doesn’t exist once you
leave your mother’s womb.
What I’m saying now, to use your metaphor, is
that at least out in the Wild West, people knew that they had to be on their
guard and take extra care. In the so-called Civilized East, that was just as
true – but the need was masked by the veneer of civilization, and
people were conned in droves.
And that’s still true today; every investor
who enters the market needs to understand that on the other side of every
single trade he makes, is another human being. As in all walks of life, not
all human beings are equally honest, or smart, or friendly. Remembering this
would encourage investors to do more homework.
L: So, back to Raj Rajaratnam. He didn’t
do anything wrong?
Doug: I don’t know – I don’t have all the facts of the
case at my disposal. If he did something unethical, shame on him. From what I
know, it would appear the possible real wrongdoers were the executives of the
companies who relayed information to him – if their deal with the
company required them to keep it confidential. Of course, if that was the
case, then Raj may have been guilty of receiving stolen goods. But that is
not what he’s been convicted of. He’s only been convicted of
breaking SEC rules.
But I do know one thing: Raj was a very smart and
productive guy – that’s how he became a billionaire. Now, instead
of creating value and wealth in society, he’s going to be locked up in
a cage for years, and transformed into a burden on society.
In any event, if he committed a tort, it should be
the subject of a civil suit. It’s not something that should
automatically be the subject of a criminal prosecution. If a crime is
involved, let an action be brought by the party who was stolen from –
not by a government agency, acting on its own.
L: Well, if people want to help him, Rajaratnam’s
brother is leading a letter-writing campaign. But the SEC isn’t going away any time soon,
so this is all academic. Are there any real-world investment implications you
want to point out?
Doug: Sure. Remember that government regulation is just another distortion
in the marketplace, like taxes, trade barriers, inflation, and so forth. All
such distortions have consequences, and one of them is to create
opportunities for speculators. I haven’t done it, I confess, but I
think someone who studied the SEC’s predatory behavior could make a
substantial fortune predicting outcomes. It’s full of young hotshot
attorneys looking to make their bones by attacking guys like Raj. Then they
can join a law firm, and charge $1000 an hour to defend clients against the
next crop of hotshot young SEC attorneys, who will do the same thing.
It’s a very corrupt system.
L: You’ve said things like that several times. It occurs to me to
ask what speculators would do in a true free-market economy, where there are
no such distortions?
Doug: We’d all have to find another line of work. In a free-market
economy there would be very few speculators, because there would be very few
distortions in the way the world works.
L: I think I’d become a venture capitalist. It’s the next
best thing – plenty of volatility and speculative upside… but it
is riskier, because you’re betting on specific innovations, not trends
that have to play out sooner or later.
Doug: Perhaps I’d invest in nanotech research, to hasten the day when
they can rejuvenate my body and I can play polo properly again. But for now,
I really want to urge people who agree with us about the SEC to think long
and hard about the issues. They should be crystal clear in their minds, so
they can raise their voices in opposition when others around them mindlessly
parrot the party line on insider trading. Hope may be scant of changing the
system, but that’s no reason to hesitate to debunk erroneous
conventional wisdom. It should be debunked because it’s the right thing
to do, and because falsehoods and lies are everyone’s enemy. The
current corrupt system will go the way of the dodo eventually, on its own.
But the more people there are reminding everyone that one just can’t escape
the “caveat emptor” dictum, the sooner and the easier the
transition will be.
But most of all – the most practical advice I
can give investors now – is not to be taken in themselves
by the SEC con. There are more sharks than ever in the water, and nothing the
SEC does reduces that number. Always, always keep your guard up, and do your
homework. Start with researching the people in any given play. That’s
what we do at Casey Research: People is the first of
our eight Ps of resource speculation.
L: Great – words to the wise. Thanks, Doug.
Doug: My pleasure, as always. Until next week.
L: Next week.
Doug Casey
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