For Boosting The Economy, SAC's Steven Cohen May Lose His Business

In the New York Post, Fox Business Channel's Charlie Gasparino writes that "After years of investigations, neither SAC nor its founder, stock-trading impresario Steve Cohen, has been charged with any crime." Despite the latter, it's increasingly possible that Cohen will lose his business. As Gasparino goes on to write, investors have begun to remove their money from SAC "out of fear that SAC or Cohen himself could face criminal insider-trading charges."

Shame on the Justice Department, and shame on the so-called financial journalists who've lionized these federal witch hunts. Lost on both is that beyond being difficult to define, "insider trading" is economically beneficial. To put it plainly, Cohen may lose his business for at worst doing something that brings great benefit to the economy.

The above is what a largely clueless financial commentariat and Justice Department can't see. Often lacking the most basic of economic knowledge, and clearly influenced by useless books and films of the Den of Thieves and Wall Street variety, they believe it's unfair for sophisticated investors to seek an information edge. Looking at commerce through a very blurry populist lens, they can't see that the economy and markets would and will be much less fair assuming the feds can ever abolish that which is once again very hard to define.

Though financial journalists and federal bureaucrats write and act as though it's not true (most wear their Keynesianism on their sleeve), we live in a world of limited capital. Because we do, when information is slow to reach the markets capital is naturally destroyed. Far from criminals, the investors who aggressively search for return-enhancing information deter capital destruction, and for doing so, stimulate economic growth.

That's the case whether they sell shares short based on what they deem useful information, or go long. Assuming their short sales prove remunerative, they surely make money. Importantly, the market and the economy attain something far more precious: quality price signals. A falling share price tells investors of all sizes where investment is no longer needed. Assuming insiders go long on the way to positive returns, their profits similarly tell investors where capital is desired.

Importantly, quality or ‘inside' information is in the eye of the beholder. What you never hear about are Justice Department and media investigations of market transactions based on non-public information that lead to losses. Put plainly, a media and prosecutorial class ever skeptical of success only pursue the successes. This is notable because it's frequently the case that insider transactions based on allegedly ‘privileged' information aren't a sure thing. By definition.

If the above is doubted, we need only consider the proliferation of high-priced information services (often they charge hedge-fund style clients well into the six figures annually for access to information not yet in the pages of the Wall Street Journal) over the years. If access to ‘inside' information were a one-way bet, these information services wouldn't be selling it; rather they would be raising billions in order to multiply those billions as hedge funds.

Importantly, even when information-armed traders find that their transactions lose money, the economy and markets still benefit. Once again, we live in a world of limited capital. When traders offer up capital based on a hunch about how markets will react to information not yet public, the end result provides precious, capital conserving information to the marketplace more broadly. If a stock soars, investors and entrepreneurs know where investment and talent is desired, and if it falls, they know where not to commit financial and human capital.

Naysayers, and let's face it, they comprise presumably all of the Justice Department and surely the vast majority of the financial commentariat, would argue that it's not fair for those with an information edge to capture the big profits based on knowledge not broadly held. Implicit in the latter is that hard work shouldn't be rewarded, but more important, such naïve sermonizing ignores basic economics. The simple truth is that it's very hard to know how markets will react to new information (see the above commentary about high-priced information services), bets on non-public information are by definition money losers a lot of the time, so when sophisticated investors armed with information transact on it, it's only natural that their profits and losses would be large relative to the average investor. That's the case because they're taking the big risks. That they can potentially achieve extraordinarily high returns means they can also suffer extraordinarily large losses.

Happily for the small investor, the risky investing just described makes markets a great deal less risky for those not so well endowed with ‘insider' knowledge. Indeed, it's the big investors who risk their own capital on new information, and who in doing so, bring essential price discovery to the marketplace.

Beyond that, assuming alleged insiders of the Cohen variety find out through feverish digging that a company is in trouble, their short sales that bring the trouble to light potentially save the small investor from making a money-losing purchase. Assuming the opposite, as in someone like Cohen sleuths that a company's share price is set to rise, their buying brings essential information to shares such that the small owner more quickly owns a stock that is fully priced. On its own this is important, and it's even more important assuming the small investor intends to sell the shares to pay a child's tuition, add on to a house, buy a car, or anything else.

As Gasparino has made plain, DOJ officials have been investigating Cohen for years, but have so far come up short. Of course the latter is not the point. Assuming Cohen has been aggressively trading based on ‘insider' knowledge, far from a signal of guilt, his having done so would be a huge compliment for Cohen bringing information into a marketplace that relies on it, and in doing so, making the markets less risky for investors lacking his level of sophistication.

To put it very plainly, Steven Cohen's presumed actions have by definition boosted an economy ever-reliant on precious information that logically informs capital allocations. It's scandalous that Cohen may lose his business over what hasn't been proven, but the much bigger scandal is that there are laws against "insider trading" at all. Justice officials and financial journalists who wring their hands over this economically beneficial act simply need to grow up.