"Truths," Tips, and Insider Markets

In the stock market volatility around Donald Trump’s tariff tango, concerns have arisen over possible trading by politicians or others privy to his plans. One trader, who purchased a ton of S&P call options ten minutes before Trump’s tariff pause announcement, made an estimated $21 million in a few hours. Someone was buying Apple four days ago, and any who maybe “knew” that Trump would create a tariff exemption for smartphones are already up 25% without even needing to use options. Trump’s “Truth” post on the morning of April 8 that it was “TIME TO BUY,” signed with his stock symbol DJT, looks in hindsight like a tip to all, but first to his followers.

I noted in a previous Substack¹ my view that the closest thing we’ve had to kleptocracy in America has been insider trading by members of Congress. One of the best at it, having generated 700% returns since 2014, is Nancy “Jesse Livermore, Jr.” Pelosi, but this is a bipartisan practice. Trump’s newfound superpower to move markets creates opportunities for in-the-know politicians and cronies to profit “like we’ve never seen before,” as he’d put it. Sens. Schiff, Warren, and Booker have called on the SEC and state attorneys general to investigate trading around the tariff news, but there’s no sign at least that the SEC will do anything.

It seems likely instead that stock market shenanigans will continue under Trump and that SEC and DOJ enforcement will be rare, with the administration’s allies being essentially immune. If Democratic members of Congress see GOP colleagues profiting from information, they will be encouraged to drop any restraint and trade on whatever they know. Emboldened members may well expand the circle of information to family members or close friends, as often occurs in these cases.

Inconsistent enforcement would give ammunition to those who believe that insider trading should be legalized. Selective prosecution, as of celebrities like Martha Stewart (who avoided a loss of just $45,000 using a tip), has sparked such calls before; and the law could be weaponized by a president to blackmail tippees or punish critics. There is also a first amendment argument against these laws, as I discussed in a New York Times opinion I published in connection with my novel about an inside trader.²

Another issue is that “insider trading” is not specified in any statute and instead relies on general 10b-5 anti-fraud and case law. The SEC has used the “Misappropriation” theory to define it, i.e., a necessary condition that the tipper had a fiduciary duty to the company/source of information. This is not always clear though. Because the tippee may not be sure about the tipper’s fiduciary status, the SEC has also created a “willful blindness” standard, whatever that is. And what if the tipper is the President of the United States? To whom does he owe a fiduciary duty?

One recent case that illustrates the law’s malleability involved an employee who knew his company was being acquired, bought call options in another similar company, and was convicted of insider trading. Really?

Or, say five investors meet with a CEO and he gives them confidential information: it seems clear that they can’t trade on it. But what if there were 20 investors in the room? 100? 1000? You get the problem.

Trading Insider Markets

I’ve seen Eastern European stock markets where insider trading laws went totally unenforced, and while we are quite a bit away from that here, the class of people who can get away with it may be growing. What does that mean for average investors?

Markets are like ecosystems: they adapt to conditions. I always assumed when investing in Russia that some traders had inside information, and I acted accordingly. If a stock began to run up for no obvious reason and brokers called looking for shares, the odds were high that good news was coming. You could buy some yourself, if you wanted to speculate, but you’d at least hold onto what you had, until the truth came out.

The reverse was also true, and catching a falling knife – buying a falling stock – was especially unwise in Russia. I’ve heard of emerging market investors whose main strategy was to buy stock breakouts and sell breakdowns. This can work in emerging markets, which move dumbly on inside info, but not in developed ones. In the latter, insider trading is less common, but chart manipulation – now done automatically by algorithmic and high-frequency traders – is much more so. Trade a breakout or breakdown of a NASDAQ stock at your peril.

Another lesson I learned in Russia and have followed elsewhere is that an outsider should never trade right before earnings releases. In the rare case when I may have had inside information, I couldn’t use it as an investor arguably subject to U.S. laws even when overseas. In all other cases, when I possessed no information, I had to assume that the person on the other side of a trade did – and was free to use it.

Insider markets aren’t all the same. In Russia, there were so many stocks and so many participants thinking they had information that much of what “insiders” were trading on was misconstrued or outright false. In that kind of market, even a schmuck like me could do well. In emerging markets where the dispersal of inside information is more tightly controlled and to a smaller group, it’s hard for an outsider to win. Turkey comes to mind, and possibly mainland China.

If the U.S. does become more of an insider market, it would be the Russian type, vast enough to leave opportunities for the average investor, especially one who buys and holds, avoiding noise via “Truths” or otherwise. What would occur, however, is that the market ecosystem would price in the aggregate cost of fraud, and the valuation multiple on U.S. stocks would be lowered. This may already be happening.

1.

2. Rick Green, Esquire (Simon & Schuster 1995)