Maybe Mark Cuban will be consoled for his Mavs' loss in the NBA finals by his new media venture. As discussed in Business Week,
Cuban's planning an online publication that will engage in
investigative business journalism. The tricky part is that Cuban
evidently plans to trade on the information the journal finds, before
publication. Presumably this means that he will sell "short" the stocks
the journal investigates, and then buy them after the revelations
puncture the price.
Is there anything illegal here? Not on the face of it. Unlike Foster Winans,
a journalist anti-hero of a past famous insider trading scandal,
nobody's planning to trade on misappropriated information, which the Supreme Court's O'Hagan case made the trigger for insider trading liability. Here the person who paid to get the information plans to do the trading.
Nor should we be concerned about the journalists' writing being
tainted by the trading. Some readers might feel cheated if they learned
the writer had an ulterior motive (although they actually should be
comforted, as discussed below). But no problem here as long as Cuban
tells his readers he'll be trading on the stories.
There might be a legal problem if the reporters pay corporate
insiders for the information. The profiting insiders might be breaching
their duty to their employers under the Dirks case,
and the trading publisher might be knowingly participating in their
breach. But in order to reach this conclusion we would have to
recognize the company's property right in information concerning its
own fraud -- a rather dubious proposition.
The only remaining "problem" here is that these journalists have an
advantage over the ignorant traders they're selling to. Is this unfair?
Only if you buy into the argument the Supreme Court has never accepted
-- that everybody's entitled to trade securities with equal
information. There's no social benefit from requiring equality of
information, and a significant social cost in reducing incentives to
produce the information that makes markets efficient.
Since Cuban, like other publishers, can just sell ads and
subscriptions, does he really need to be able to trade? After all, the Wall Street Journal
is collecting kudos and credibility from its backdating expose, all of
which eventually adds up to advertising and sales. Cuban plans to use
his media companies to profit from the frauds he exposes, for example
by making another Smartest Guys in the Room.
But as a mere publisher Cuban first has to get readers. And
it isn't going to be easy for a startup to blow open startling frauds
that everybody wants to keep well hidden. As a trader, Cuban
doesn't need to build readership or hit homeruns with big, splashy
exposes. All he needs is information the market doesn't have. If the
information is good, the market will react to the truth and the trades
will be profitable. That's the beauty of insider trading -- the market
provides a built-in high-quality incentive device. The trader's work is
judged not by some dumb boss or lazy bureaucrat, but by the "wise
crowd" of the stock market.
The idea of business journalists staking real money in the stock
market on their stories refreshingly improves on mainstream business
journalists' usual incentives. As I discuss in my article, The Public Face of Scholarship, and in my weekly analysis of the NYT's Gretchen Morgenson,
you tend to see a political agenda about giving "shareholders" (e.g.,
labor activists) more power, promoted by harping on option backdating
or other scandal of the day. This frivolous entertainment usually says
very little that's new or useful about what's really going on inside
the companies -- that would take too much energy and expertise. A
short-selling business journalist, by contrast, makes money only if the
market judges that the story is not only true, but has real
significance for the value of the company.
Critics might still insist that there's something sleazy about
profiting from bad news. Think about those dreadful short selling
vultures betting against paragons of capitalism. Trading on negative
information gives the traders negative incentives.
The supposed problems of short-selling problems are overblown.
Insiders might sabotage the company, but this is less a worry for an
outsider like Cuban's journalists. Outsiders have an incentive to lie
and buy back at the lie-distorted price, but there are remedies for
lying to the market.
Even if there are dangers from trading on negative information,
there are also significant benefits, and therefore costs of regulating
the trading. There is credible theory
that the incentives to disclose negative information are weaker than
those to disclose positive information. Evidence indicates that
short-sellers contribute to market efficiency. The law already restricts short-selling,
adding to traders' general risk of staking significant money on what
the market will do in the short term. More regulation would further
deter this beneficial activity.
Let's not forget that it was one of those nasty traders, Jim Chanos, who shorted Enron back in November 2000.
No one complained more loudly about the Enron shorts than Jeff
Skilling. Sometimes corporate insiders don't want the markets to have
all of the facts and sometimes, as in Enron, nobody, from executives to
outsider directors to auditors, does much to find out the truth.
When everybody is lining up to bolster a company, the market's only
friend may be the short-seller. Usually employees -- who may have the
best information -- have a strong incentive to just lie low. Job protection for whistleblowers under laws like Sarbanes-Oxley
doesn't accomplish much other than making it harder to fire incompetent
employees. If you were an employee with information, would you bet your
job on protection from OSHA, the agency charged with enforcing the SOX
whistleblowing provisions? "Qui tam" laws
give whistleblowers only a small fraction of the value of their
information. Hence whistleblowers are likely to be of the modest sort,
like Sherron Watkins, who kept the facts about Enron buttoned up in the
There is a particular advantage in combining short-selling with
journalism. The seller's or his boss's investment in the journal and
its reputation in a sense "bonds" the accuracy of the disclosure. A
short-selling journalist's short-term profits from lies may be more
than offset by the long-term hit to his reputation.
So instead of thinking about regulating this sort of trading, we should consider de-regulating it. We could start with a law clarifying that those who trade on information about fraud are not liable.
The law might, for example, clarify that an employee who sells
information about fraud to one who trades on the information is not
misappropriating the information for purposes of the insider trading
Once we've cleared up what to do about Cuban's idea, there are
analogous situations that may deserve similar attention. For example,
there have been stories recently about trading on advance knowledge of
lawsuits, also known as "dumping and suing" debated here. There are other stories about dumping and boycotting, where a prospective boycotter shorts the shares of the company he plans to boycott.
As Bruce Kobayashi and I explain in Outsider Trading as an Incentive Device,
while these situations might seem unsavory, they actually reveal the
advantages of markets in providing incentives for the discovery of
information. If the trader commits bad acts in order to profit, we can
punish those acts. Regulating trading risks punishing legitimate
conduct and weakens one of capitalism's most potent incentive devices.
So we should wish Cuban's new venture well as one of many possible
ways that free markets can help cleanse themselves of fraud. Government
has had its chance: Sarbanes-Oxley has produced a nightmare of
paperwork for thousands of innocent firms. There must be a better way.
Larry E. Ribstein is Corman Professor of Law at the University of
Illinois College of Law. Ribstein's weblog focusing on business law is www.ideoblog.org and his webpage is www.ribstein.org.