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Insider Trading, Gambling & Weed: Legalize, Not Penalize

|Includes:BlackBerry Ltd. (BBRY), NFLX, OSTK, TSLA

This week we have witnessed an outpouring of media coverage on Steve Cohen's SAC Capital Advisors indictment for insider trading. Certainly there are a lot of opinions on what this means for Mr. Cohen, his investors, SAC employees (past and present) and the hedge fund world at large. What happens to them reminds us of the song "Que Sera, Sera (Whatever Will Be, Will Be)". There certainly are no shortages on opinions on the situation, but we must highlight two in particular. First is the full page ad in the WSJ yesterday as reported by Reuters:

"(Reuters) - Chief Executive Patrick Byrne appeared in an unusual full-page ad in The Wall Street Journal on Saturday "congratulating" Steven A. Cohen on the indictment of his SAC Capital Advisors hedge fund by federal prosecutors on insider trading charges."

We do have an opinion on this. Hogwash company. Byrne's company was a short candidate because it was a terrible operator. Yes , the company may have been the victim of "naked shorting" but the company had no real 'value add' to the Internet boom it was benefiting from and therefore the market punished Overstock shares. The real way to give transparency to investors against anonymous short sellers is to report in real time during the trading day how many shares of a company were sold by longs and how many shares of the same company were sold short. This would be a very informative tool for active traders as to what is happening during a trading day. We call this Dynamic Trading Reporting "DTR" and it can easily be implemented by the exchanges with software enhancements utilizing data already available at brokerage firms. Final thought on Byrne: he wasted his, or's (NASDAQ:OSTK) money on this advert and accomplished nothing in the name of trading transparency.

The more interesting article we feel needs to be highlighted and expanded upon is, "Insider trading enriches and informs us, and could prevent scandals. Legalize it." By Dylan Matthews, Published: July 26. This excerpt really sums up his point:

"Here's the thing though - those profits shouldn't be illegal. As unsympathetic a figure as Cohen is, and as sleazy as insider trading sounds, there really isn't much of a reason to ban it."

We agree and want to go further with this line of reasoning using some examples on companies we have written about in the past here on SA.

We do liken this hypotheses to the state by state hopscotch path legalization of Marijuana and online gambling underway here in the US. The process has been fraught with confusing regulations causing a lot of stops and starts for businesses and investors alike as the de-criminalizing of these activities sweeps across America with likely profound implications for our society. We think the two are similar because there is no uniform federal legislation. Congressman Peter King of New York introduced legislation in June to legalize on-line gambling nationwide and here are some excerpts from the Denver Post article commenting on it:

Republican New York Congressman Peter King proposed federal regulations Thursday that would rescue online gambling from the legal gray zone where it currently languishes.

The federal government cracked down on online poker in 2011. But the same year, the U.S. Justice Department issued a ruling making online gambling legal so long as it's permitted on the state level. ...

"A common federal standard will ensure strong protections for consumers, protect against problem and underage gambling, and make it easier for businesses, players, lawmakers and regulators to navigate and freely participate," he said in a statement. ...

Morgan Stanley predicts that by 2020, online gambling in the U.S. will produce the same amount of revenue as Las Vegas and Atlantic City markets combined: $9.3 billion.

We think the same logic used for this bill applies to the fractured approach to legalization of Marijuana.

Let us get back to our main subject: Insider Trading and why its criminality should go the way of the buggy whip. We think Dylan did a great job teeing up the prospect of a disruptive change that should be implemented by the SEC. And yes, this would be nationwide and possibly international in one fell swoop. This would embrace the further democratization of capital markets. Why, because we no longer live in the dark ages. We have dynamic, robust communication networks. The idea of an earning release is about as arcane as watching a particular television show at a specific time because that's when the only time you can see it. This is an antiquated model that was made crystal clear in a popular SA article "The Perfect Storm - Cable Companies Sail Into The Vortex" which we think is summed up in this paragraph :

"The final straw is young people cutting the cord with Cable. Forbes points out that a recent Nielsen study shows 5 million U.S. homes have "Zero TV." That's up from 2 million in 2007. They go on to point out that "Zero TV" does not mean zero video. Streaming is filling the void and in this capacity Cable is likely to remain the Dump Pipe."

Here is the main point: we have communication tools, as consumers, investors and companies, and these should be used to make transparency and due diligence something that must be required for private as well as professional traders in their daily investing criteria. The old fashioned method of waiting for an earnings report and for "formal public dissemination" of information is passè. In fact, Mr.Cohen's access to better information channels would be a non-issue if companies communicated more effectively on a real time basis. And those companies that don't will be punished by the market because they would be seen as the ones giving selective information, perhaps to selective traders and therefore be shunned as we explain below. The SEC seems to be coming around on this concept and issued a statement with regard to Netflix (NASDAQ:NFLX) CEO Reed Hastings use of social media as reported by the NY Times:

"....Mr. Hastings and Netflix said that his message was both immaterial and readily available to investors, having been picked up by a number of blogs and news media outlets. "We use blogging and social media, including Facebook, to communicate effectively with the public and our members," Mr. Hastings wrote - on his Facebook page, naturally - after disclosing the investigation last year.

Now, the S.E.C. seems to be relaxing its stance.

After an investigation of several months, regulators said that companies could treat social media as legitimate outlets for communication, much like corporate Web sites or the agency's own public filing system called Edgar. The catch is that corporations have to make clear which Twitter feeds or Facebook pages will serve as potential outlets for announcements."

We think the best example of this is Tesla Motors (NASDAQ:TSLA) CEO Elon Musk and his use of social networks to keep his investor base up to date with his company. Musk's openness and transparency coupled by excellent management coupled with solid financial and product performance by TSLA have led to the meteoric rise in his company's share price from Mid $50's in may to Last weeks close just under $130 per share.

We think the free flow of information should be embraced and enhanced. In fact, it should be the diligent who are rewarded, both the investor and the company who works hard to keep current on releasing and watching information flow. This is the beginning of a sea change where arcane rules made for times when investors did not have real time information should be thrown out. Insider trading should be viewed as informed trading, and companies who are vastly transparent will be rewarded as TSLA and NFLX have been recently. And on the other side of the coin, companies such as BlackBerry (NASDAQ:BBRY) who have chosen to be less transparent have been punished. We have written on this in the past and feel that lack of transparency is a short sellers best friend and the flip side is also true.


A swift movement to encourage company transparency at the SEC is already underway and we should accelerate the process by using it to make insider trading a "lame duck" policy in the world of debt and equity investing. Also, the SEC should make DTR a requirement and increase the information both long and short traders have at their disposal.

Disclosure: I am long TSLA, BBRY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.