The Coin of the Realm

How Inside Traders Are Rigging America

By Robert Reich

A few years ago, hedge fund Level Global Investors made $54 million selling Dell Computer stock based on insider information from a Dell employee. 

When charged with illegal insider trading, Global Investors’ co-founder Anthony Chiasson claimed he didn’t know where the tip came from.

Chiasson argued that few traders on Wall Street ever know where the inside tips they use come from because confidential information is, in his words, the “coin of the realm in securities markets.”

Last week the United States Court of Appeals for the Second Circuit, which oversees federal prosecutions of Wall Street,agreed. 

It overturned Chiasson’s conviction, citing lack of evidence Chaisson received the tip directly, or knew insiders were leaking confidential information in exchange for some personal benefit.

The Securities and Exchange Act of 1934 banned insider trading but left it up to the Securities and Exchange Commission and the courts to define it. Which they have – in recent decades so broadly that confidential information is indeed the coin of the realm.

If a CEO tells his golf buddy that his company is being taken over, and his buddy makes a killing on that information, no problem. If his buddy leaks the information to a hedge-fund manager like Chiasson, and doesn’t tell Chiasson where it comes from, Chiasson can also use the information to make a bundle.

Major players on Wall Street have been making tons of money not because they’re particularly clever but because they happen to be in the realm where a lot of coins come their way.

Last year, the top twenty-five hedge fund managers took home, on average, almost one billion dollars each. Even run-of-the-mill portfolio managers at large hedge funds averaged $2.2 million each.

Another person likely to be exonerated by the court’s ruling is Michael Steinberg, of the hedge fund SAC Capital Advisors, headed by Stephen A. Cohen.

In recent years several of Cohen’s lieutenants have been convicted of illegal insider trading. Last year Cohen himself had to pay a stiff penalty and close down SAC because of the charges, after making many billions. 

SAC managed so much money that it handed over large commissions to bankers on Wall Street. Those banks possessed lots of inside information of potential value to SAC Capital. This generated possibilities for lucrative deals.

According to a Bloomberg Businessweek story from 2003, SAC’s commissions “grease the super-powerful information machine that Cohen has built up” and “wins Cohen the clout that often makes him privy to trading and analyst information ahead of rivals.”

One analyst was quoted as saying “I call Stevie personally when I have any insight or news tidbit on a company. I know he’ll put the info to use and actually trade off it.” SAC’s credo, according to one of its former traders, was always to “get the information before anyone else.”

Insider trading has also become commonplace in corporate suites, which is one reason CEO pay has skyrocketed.

CEOs and other top executives, whose compensation includes piles of company stock, routinely use their own inside knowledge of when their companies will buy back large numbers of shares of stock from the public – thereby pumping up share prices — in order to time their own personal stock transactions.

That didn’t used to be legal. Until 1981, the Securities and Exchange Commission required companies to publicly disclose the amount and timing of their buybacks. But Ronald Reagan’s SEC removed these restrictions.

Then George W. Bush’s SEC allowed top executives, even though technically company “insiders” with knowledge of the timing of their company’s stock buybacks, to quietly cash in their stock options without public disclosure.

But now it’s normal practice. According to research by ProfessorWilliam Lazonick of the University of Massachusetts, between 2003 and 2012 the chief executives of the ten companies that repurchased the most stock (totaling $859 billion) received 58 percent of their total pay in stock options or stock awards.

In other words, many CEOs are making vast fortunes not because they’re good at managing their corporations but because they’re good at using insider information. It’s the coin of their realm, too.

None of this would be a problem if the only goal were economic efficiency. The faster financial markets adjust to all available information, confidential or not, the more efficient they become.

But profiting off inside information that’s not available to average investors strikes many as unfair. The “coin of the realm” on Wall Street and in corporate boardrooms is contributing to the savage inequalities of American life.

If Congress and the Securities and Exchange Commission wanted to reverse this and remove one of the largest privileges of the realm, they could. But they won’t, because those who utilize those coins also have a great deal of political power.