To Block Out Insiders Like Steven Cohen Is To Blind the Markets

As the Wall Street Journal reported earlier this month, when George Weinert, CEO of Novatel Wireless, learned of a planned order cancellation from a large Novatel client, he e-mailed the company's managers that the sales loss "would have a major impact on our business." Later that year, and apparently without his company having disclosed the cancellation, Weinert sold $3.3 million of Novatel stock.

To many, Weinert's actions speak to the supposed problem of that which can't be defined, "insider trading." Though it's very difficult to foretell how markets will react to an earnings shortfall, and also whether the sale was related (some CEOs diversify on a quarterly basis), Weinert's print would surely bother the myriad do-gooders in our midst eager to "level the stock market playing field." The do-gooders need to grow up.

Stock markets are at their most basic a price provider. Markets can be wrong, but they always adjust for just that. Prices tell investors where capital is most needed, and for doing so, they're an essential economic stimulant for pushing capital to its highest use.

Assuming Weinert simply wanted to shield some of his wealth from eventual bad news, he still did all investors and the economy a favor. Indeed, if we ignore the existence of disclosure rules that would probably exist without the regulation itself, it's very important that those most on the inside of a company transact based on what they know.

That's the case precisely because company insiders (a CEO being the most "inside") provide the best pricing information of anyone to the broader market. If the sales are disclosed, investors can then price presumed bearishness on the part of insiders, but even if no disclosure, share sales will on the margin weigh on share prices such that the broad market itself is far wiser as a result.

For buyers of a company like Novatel, insider sales mean that investors of all sizes are far better off for purchasing stock that is fully informed in terms of price. For existing owners, they similarly benefit for insider sales pregnant with information perhaps telling them to sell, or unload altogether.

This would also be true if a CEO or top executive were to buy shares based on knowledge of good news. Shareholders with intent to sell would print a trade at full price, and then buyers would benefit earlier from an insider-driven price signal telling them that good news awaits.

Notable here also is that it's very difficult to invest based on even the best information. That is so because the investors who comprise the market don't view all information in the same way. The beauty of insiders transacting based on being close to the company in question is that they're the first to risk their capital on knowledge that hasn't yet reached the markets. For taking that risk, one that could burn them depending on the market's direction, it's only logical that they should benefit the most from a correct trade simply because they're risking the most.

More broadly, and per George Gilder, a modern shame of the stock markets is that thanks to ill-conceived rules written by SEC regulators who for working at the SEC evidently couldn't get jobs on Wall Street, is that when companies go public they essentially become opaque. Right at the time when they're being public strongly suggests that their doings should be most transparent, economy-sapping rules mean they must essentially shut down the information flow.

Interesting here is that while some are not bothered by an act of "insider trading" that courts have struggled to define, they argue that trading by corporate insiders is what should be abolished. It says here in this article that this is a foolish conceit, but for those who are naively bothered by company insiders trading on knowledge of same, they should love people like SAC Capital's wrongly persecuted founder, Steven Cohen.

Indeed, for do-gooders and those who simply think it's unfair that CEOs trade on non-public information, they should celebrate the Cohens of the world who constantly seek an information edge. While Cohen was never found to have done anything wrong, it's people like Cohen and his employees who will do the sleuthing that exposes to the marketplace good and bad news that public companies might not be so quick to disclose either verbally, or through share sales/purchases.

Going back to the Weinert example that began this piece, the mere possibility that Novatel had something to hide makes those in search of "insider" information most necessary. Rather than prosecute, fine and jail those seeking the best knowledge of a company's health, we should elevate their work for bringing truth to stock market prices.

And as evidenced by the tautological reality that it's hard to profitably bet on non-public information in a consistent way, we should embrace the ability of insiders like Cohen to occasionally earn outsized market returns as a reward for their detective work. Just as company insiders do, they're risking their capital on information in ways that could hurt their performance the most, and because they are, they should similarly be rewarded the most if their economy-enhancing work results in a successful trade.

Like it or not, we live in a world of limited capital always seeking its most profitable use. Those with good information ensure the least amount of capital destruction for their maniacal devotion to information making markets themselves most informed.

Not only is it naive to presume that "insider trading" won't happen given the amount of money at stake, it's quite simply juvenile to seek markets that are bereft of information. It hurts the economy, and ultimately makes investing less fair for the little guy precisely because the small investor will needlessly enter a lot of blind allies assuming regulators ever achieve opaque markets that are not only undesirable, but also impossible.

The do-gooders and fence straddlers in the space of insider trading quite simply need to grow up. If these intrepid investors didn't exist our economy would be weaker for their absence, and that's why we'd have to invent them if they didn't already exist.