Felix Salmon has raised an interesting question: could The New York Times sell early access to market-moving scoops to hedge funds?
After The New York Times published the results of its investigation of the Wal-Mart bribery case, something like $12 billion came off its market cap.
Clearly, early access to the story would have been very valuable to traders. So, in this age of cash-strapped news organizations, shouldn’t The New York Times be able to monetize the value of scoops by selling early access to hedge funds?
In a sense, there’s something very economically inefficient about scoops like this one. The NYT story came out in the middle of the weekend, when markets were closed; when they opened on Monday morning, both Walmart and Walmex had billions of dollars shaved off their market capitalizations, but no one was given the opportunity to short those stocks at their prior level. After many months of diligent and valuable work on this story, one would think that a genuinely capitalist economy wouldn’t just leave money on the table like that.
It’s very clear that The New York Times isn’t in the front-running business. In fact, I suspect that the potential market-moving effect of the story played a role in the timing of the publication. By publishing it over the weekend, the editors assured that information would be fully disseminated into the market before anyone could trade Wal-Mart’s stock . No one received even a momentary edge from asymmetric information.
But let’s say a particularly enterprising publisher took over at the paper and decided to launch a NYT: Frontrunner subscription service.
Would it work? Would it be legal?
Commenters on Felix’s post, particularly Daniel Davies, have argued that the Times and its subscribers would be engaging in illegal insider trading. I don’t think that’s correct.
Let’s take that New York Times story. It’s very clear that reporters at the Times had access to material non-public information about Wal-Mart. Some of this appears to have been acquired from Wal-Mart insiders in breach of their duties of confidentiality owed to their employer.
On the surface, this sounds like the makings of an insider-trading case. You have many of the key elements: (a) non-public information, (b) materiality, and (c) an intentional breach of a duty confidentiality.
There is, however, one element missing: the personal benefit for the insiders providing the information.
In a 1983 case known as Dirks v. SEC, the Supreme Court held that a corporate insider who discloses material nonpublic information to someone who trades on the stock of the insider’s company cannot be held liable unless the tipper benefited or expected to benefit from making the tip. What’s more, the trader also couldn’t be held liable unless the tipper benefited—even if the trader made a profit by trading on the insider information.
The facts of the Dirks case make its applicability to the Wal-Mart case even clearer. Raymond Dirks was a Wall Street stock analyst specializing in the insurance sector. On a spring day in 1973, Dirks got a tip that an insurance and mutual fund company called Equity Funding of America was fraudulently overstating its assets. The tip came from Ronald Secrist, a former officer of Equity Funding, who urged Dirks to investigate.
Dirks flew out to Equity Funding’s Los Angeles headquarters and met with several officers and employees. Senior management denied any wrong-doing—as senior management tends to do. But certain employees corroborated Secrist’s charges.
Throughout the investigation, Dirks discussed the information he was obtaining with a number of clients and investors. Some sold Equity Funding stocks, including five investment advisers who liquidated holdings of more than $16 million. During Dirk’s two-week investigation, the price of Equity Funding stock fell from $26 per share to less than $15 per share.
Dirk’s also contacted the L.A. bureau chief of the Wall Street Journal and shared his information with the paper. The bureau chief thought the allegations were too far-fetched. He was also worried about being sued if the allegations turned out to be false.
The rapid decline in price, with no publicly announced news, led the New York Stock Exchange to halt trading on March 27. Shortly thereafter, California insurance authorities impounded Equity Funding's records and uncovered evidence of fraud. The Wall Street Journal then ran a front page story about the fraud, based mostly on information Dirks had given the paper.
The Securities and Exchange Commission rewarded Dirks’ work uncovering this massive fraud by charging him with insider trading. Although he didn’t trade the stock himself, he passed along the insider “tip” about the fraud. The idea was that train of tipper-tippee liability stretched from Secrist and other tipper employees, to Dirks who was both a tippee and a tipper, to his clients who traded on the information.
Dirks lost in the administrative trial and then again on appeal. His case lasted almost a decade—until his vindication by the Supreme Court.
The Supreme Court ruled that Secrist and the other employees who spoke to Dirks lacked a corrupt motive in disclosing the information about the fraud. They expected no personal benefit. Their real motivation was just to expose the fraud at the company. The court was in part swayed by the public good that came of the disclosure—the end of the fraud at Equity Funding.
The liability of Dirks for insider trading depended on the liability of Secrist and the other employees. But since they lacked the personal benefit element of insider trading, Dirks could not be held liable either. It didn’t matter that Dirks benefited from receiving and spreading the information, or that his clients made money. Neither Dirks nor his clients were “insiders” under the law. The communication of the information by Dirks and the trading by Dirks’ clients was completely licit. The entire case collapsed because of the lack of a corrupt motive behind the initial disclosures.
In the Wal-Mart bribery story, we have no reason to believe the Wal-Mart sources of The New York Times sought to personally benefit from leaking the tale to the paper. The New York Times is quite assiduous at avoiding such conflicts of interest when it can and disclosing them when it cannot. Sources who stand to benefit from a story typically have their conflict of interest clearly identified.
In other words, the Wal-Mart employees who spoke to The New York Times cannot be found to be illicit tipsters under insider trading law. This means that neither The New York Times nor the subscribers to the Frontrunner service would be held liable if the Times had sold the story before publication.
The same analysis would have applied to Fortune Magazine if they had sold Bethany McLean’s Enron expose to hedge funds prior to publication. The fact that the Times or Fortune would have been seeking out the information to profit from selling it to traders is legally irrelevant. So long as the sources aren’t seeking to personally profit, everything that happens to the information later is permissible.
It’s helpful to remember that insider trading law in the U.S. is built off of a brief and quite vague antifraud rule. A good rule of thumb is the cases where material information is disclosed or used to trade without any sort of deceit or fraud usually are not going to be considered insider trading violations. So a newspaper that gathers information in the ordinary way is free to disclose it selectively—and subscribers are free to trade on the information.
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