(Interviewed by Louis James, Editor, International Speculator)
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.
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