Free Martha Stewart!

by Harry Browne

June 4, 2003          

On Wednesday, the Securities & Exchange Commission filed suit against Martha Stewart for allegedly using inside information to sell her stock in ImClone before it fell in price. And the Justice Department indicted her for activities stemming from the alleged insider trading. If found guilty, she could face 30 years in prison.

Being against insider trading is like being against sin or being for apple pie. No decent, God-fearing, patriotic American wants to see insiders take advantage of honest investors.

Unfortunately, apple isn't one of my favorite pies, and I'm not even sure I'm against sin. So I can't seem to get myself worked up about insider trading.

Railing against insider trading is consistent with the great American philosophy: "If you don't get what you want, sue somebody." Whatever happens, don't take responsibility for your own life. Investors shouldn't have to think for themselves, and they shouldn't have to feel responsible for their investment losses. There are evil people out there who took advantage of them.

The Old Level Playing Field

The insider scandals have raised again the concept of the "level playing field." We're all supposed to compete on the level playing field of life in which, I suppose, no one has the advantage of being able to run downhill. I guess this means that all financiers will have to go to the same school of business, and all doctors will have to go to the same medical school to avoid giving anyone an unfair advantage over his competitor.

The level-playing field idea is reflected in the assumption that you have a right to have the stock exchanges operate in a particular way as though you had a right to tell General Motors what kind of cars to produce.

The only right you should have and the only right you need is the right not to buy something if you're not sure it's safe and will achieve the promised result. If you try to enlarge that right into a power to demand that others run their business affairs to suit you, the government will have to enforce it for you (unless you have your own private Mafia).

And you know what happens when someone shows up at your door saying, "I'm from the government, and I'm here to help you."

What happens is that the help you wanted is buried under a stack of new regulations and compulsions designed to enhance the fortunes of those with the most political influence who will never be you or I.

Zero Sum Games

Although you'd never know it from watching the TV news or listening to the politicians, insider trading is a victimless crime. If you ever owned ImClone stock, you'd be hard-pressed to explain how Martha Stewart's actions cost you money.

Investors are not necessarily competing with one another, as though the investment markets were a "zero sum game." If they were, they'd have died out years ago replaced by casinos that offered free drinks as you gamble.

Mutual Profits

When two people exchange money and stock shares, the transaction isn't much different from two people exchanging money and doughnuts a mutually profitable exchange. No economist in his right mind would call the two people "competitors" or attempt to identify which was the "winner" and which the "loser."

If you buy a stock at $30 and sell it to me at $42, and I later sell it to someone else at $51, which of us is the winner and which is the loser?

The answer is self-evident. We each have made a profit, and we each unintentionally helped the other as each of us pursued his own goals. It's just like any other free market transaction.

But what if I had "inside" information? By competing on a tilted playing field, did I hurt you?

Let's suppose I bought the stock from you at $42 because I had some very special information about something that would occur a week later. The expected event occurred on schedule, the price jumped to $51, I sold, and took my profit.

The fairness buff sees this example and concludes that I made my profit at your expense. But that assumes, even if it's not recognized, that you sold only because I wanted to buy.

In fact, you sold for your own reasons. If you hadn't sold to me, you'd have sold to someone else. And if my presence in the market had any effect on you, it must be that you got a higher price for your stock than you would have if I hadn't been bidding for it.

No, says the fairness buff, you don't understand; I should have made my information public before I bought the stock.

But if I had to make my information public, I wouldn't buy the stock at all since revealing the information would have caused the price to rise before I'm allowed to buy. And if I can't buy the stock without revealing the information, I won't bother to reveal the information. So you still would have sold your stock at $42.

My trading hasn't cost you anything. So how would a level playing field make you any better off? (Even if you sold at a loss, the principle would be the same. You'd have the same result as though I had stayed out of the market.)

Wait a minute we're forgetting someone. What about Mr. Latecomer the poor guy who bought the stock from me at $51, at the very top?

I didn't make the stock rise to $51. Nor did I create the event that caused the price to rise. I merely profited from the rise. The stock would have gone up in any case and Mr. Latecomer would have to pay $51 in any case.


The essence of the insider-trading argument is the idea that no one should have access to help that everyone doesn't have.

But everyone's situation is different. Some people have better computers, subscribe to more newsletters, get phone calls in the middle of the night warning them of market crashes, have a better feel for the market, get better executions from their brokers, receive free advice from their mailmen, and in many other ways enjoy unfair advantages. Where do we draw the line?

Selling Secrets

What about people whose professions put them in a position to get privileged information, and then violate that privilege by making it available to people who profit from it in the investment markets?

That's a different story. That isn't a victimless crime.

Companies that have access to sensitive information such as law firms, accounting firms, and investment banks have rules about such things. They usually require their employees to sign secrecy agreements. They are even in a position to sue former employees who have violated their oaths.

After all, it's bad for business to become known as a company that can't keep a secret. (Look at the CIA.)

And that's the real point. If someone uses a business secret for special gain, the injured party isn't an investor rolling down a tilted playing field. The victim is the company whose employee has violated his contract. And the company is free to press charges for breach of contract.

So why do we need SEC storm troopers to regulate what insiders do?

Insider Losses

One way the government witch-hunters attempt to get the public riled up is to call attention to the obscene profits of the witches who are being hunted. It's assumed that inside information is a license to print money.

Unfortunately, the SEC doesn't publish statistics showing the number of times that "inside information" didn't pay off. They're too busy making pitches for a bigger prosecuting staff.

Although we'll never know, I suspect that more money has been lost with inside information than gained. Many times in my investment career, someone gave me information from a special source none of which ever proved to be worth anything.

My favorite example was the head of the precious metals department at Switzerland's biggest bank, who in 1970 guaranteed to a friend of mine that gold would never go above $40. Asked how he could be so sure, he said, "Because we control the market." (Gold reached $800 in 1980.)

There are newsletters devoted solely to tracking the (legal) transactions of company officials dealing in the stocks of their own companies. If insiders know something we ought to know, those newsletters ought to be racking up outrageous profits for their subscribers. But somehow they seem to be in the same slow-pitch league where we mere mortals play.

Pandora's Box

Most likely, the Martha Stewart matter will lead to new Congressional investigations, at which crusading senators will make Joe McCarthy look like Mother Theresa. Then they'll point with pride to some new laws, to be added to the tens of thousands of regulations that currently weigh down the investment markets.

The net result of all this will be less efficient markets, higher costs in trading and investing, wider bid-ask spreads, higher costs for legal insurance, and the suppression of information that's available now. But none of these costs will come with a tag attached saying, "Necessary because of insider trading prosecutions."

The government can't protect your investments any more than it can win a War on Drugs or a War on Poverty. Government doesn't deliver on any promise, and you should never rely on it to protect you.

Victims & Politicians

The crusaders are always on the lookout for a new class of victims for whose protection new legislation will be urgently needed. Victims have already included blacks, women, homosexuals, tenants, borrowers, employees, handicapped people, politicians, and more.

The newest victim is the investor who is being denied his rights under the 37th Amendment, to wit: "No investment exchange, dealer, or broker shall deny a level playing field to any investor."

After all, a lone investor is helpless. How can one person by himself hope to compete with the insiders of this world?

Actually, that's one reason we have mutual funds pension funds, commodity pools, limited partnerships, money managers, financial broadcasting, and investment newsletters. All these entities offer professional help to investors.

If someone loses money continually in the investment markets, it isn't because there are insiders, arbitrageurs, market-making specialists, floor traders, scalpers, raiders, or other bogeymen. He loses money because he isn't a competent investor. He loses because he risks too much of his money in one type of investment, or because he blindly follows the fads, or because he arrogantly thinks he's smarter than everyone else and can't lose.

No matter what laws are passed, he'll continue to lose money until he learns to be a better investor or he delegates the job to someone more competent.

But to some investors that just doesn't seem fair. In fact, too many investors have the entitlement mentality of welfare recipients . . .

  • "I have a right to a 'level playing field' when I invest."

  • "I have a right to know that insiders don't get to the market ahead of me."

  • "I have a right to be protected from misleading financial statements and overly optimistic earnings estimates."

In truth, you have no more right to these things than you have a right to earn $200,000 a year or a right to be loved or a right to live at the expense of anyone else.

We live in an uncertain world. If you're going to invest or speculate, you face numerous risks. No one can eliminate those risks, either by superior knowledge or by using the force of government.

No one owes you anything.

If you lose money for whatever reason that's your problem. Don't go whining to the government when the risks cause problems.

You can wish that government would eliminate risks, but the truth is that it won't.

If you can't diversify your investments enough to make them safe, keep your money in Treasury bills or some other low-risk place.

But don't expect people in the investment markets to devote their lives to giving you profits.

What the Martha Stewart Case Means to You