Insider What?

The Wyly brothers have been recently charged by the SEC with insider trading. The SEC claims that Sam and Charles Wyly tried to stash away $550 million by using clever and complex offshore accounts while using insider trading. The brothers were on various boards (Michael’s, Sterling Software, Computer Associates, & Sterling Commerce) which let them trade using non-public information. This most likely case similar to Michael Milken back in the 1980’s when he worked at Drexel Burnham. From the SEC’s standpoint they want the brothers to admit they committed wrongdoing and to pay hefty fines and penalties. However did the Wyly brothers really commit a crime? I have a feeling that the brothers will make some large payout and most likely avoid any hard time. When you have a billion dollars you can hire superb law firms to be at your beckon call 24/7.

Legislation from insider trading came from the Securities Act of 1933. The basic idea was that corporate insiders had more knowledge than the average person and it was unfair that the corporate insiders were making lots of money off their “insider knowledge” of the company. What strikes me is how few insider trading cases there actually are. The SEC usually goes after the big money in hopes to undercover a great scandal that can not only make the organization look better but also help their funding (think fines and penalties). There really is no fundamental reason why insider trading should be illegal. The premise that the “corporate insider” makes oodles of money.

Michael Milken paid out $1.1 billion in lawsuits when he was convicted of insider trading (around $200 million in fines alone). I am quite sure the SEC could find some great new programs to finance with this money. Even though Michael Milken is a criminal in the eyes of the SEC what about all the companies that were able to be started or able to avoid bankruptcy because of his genius?

Now back to the Wyly brothers. The SEC believes that the Wyly brothers have done something wrong through their overzealous regulatory eyes. Insider trading makes the market less transparent and less efficient. Since people who really know the truth (insiders) are unable to convey what they know by buying and selling, the market has less information for other investors to use. If someone knew that the earnings of a company were not going to be good they could short the stock sending the market a signal of the truth. By waiting until the actual earnings come out there would be more surprises. Allowing insider trading would also decrease corporate fraud because people within the company could sell their options to signal that they did not have faith in the company. If there really was a scandal the market would be made aware and the SEC could take action much faster since they wouldn't have to spend years and resources trying making a case since the market would do it for them. The average person could also benefit because if they had valuable information they could sell it to some hedge fund or institutional investor. Companies could still voluntarily have rules against employees selling information, but the more information the market has the better. Insider trading already exists in other realms. For instance, if a geologist is offering to buy a house under Farmer Ted’s land and if the geologist knows there oil under the land the geologist does not have to disclose this. Only if the geologist was working for Farmer Ted would he have to disclose this information. Clearly, there is a situation of asymmetric information where one party knows more than the other but this is considered a clean and honest business transaction.

Sam Wyly started and created businesses from nothing and built them up reselling them for even more. His first business UCC started with only $1,000 and in eight years had $125 million in sales. He also cofounded Sterling Software and sold it for $4 billion. These businesses not only made him wealthly, but they also gave people jobs, wages, healthcare, and made other people better off as a result. Although the SEC may believe the Wyly brothers are bad and "greedy" men, I would contend that they have done wonders for the economy and have improved the lives of hundreds of thousands if not more. While the SEC may disagree with this we must remember the words of Milton Friedman who said ,“You want more insider trading, not less”.