Feds File Charges Against SAC Capital

Thanks to Dr Gibson for alerting me to this. He’s also got a piece on insider trading that was first published in the Freeman in December of 2010. We’ve been able to reproduce it here at NOL. He writes:

Insider trading is restricted but not entirely forbidden. Just what constitutes the “bad” kind of insider trading? This is generally understood to be trading on information originating within a company that could have a material effect on the share price had it been publicly known. The law applies not only to insiders—employees and directors—but also to any outsiders to whom inside information is disclosed […]

We see that insider-trading regulations are subjective and arbitrary, rivaling antitrust laws in this respect. It is no wonder that Congress never defined insider trading and that the SEC resisted defining it for many years; the courts have had to make up the rules as cases arose. Every so often someone like Martha Stewart is thrown to the lions, drawing cheers from the jealous and spreading fear to successful and therefore high-profile managers.

Dr Gibson’s suggestions for alternatives to government regulation are, by themselves, worth the price of admission.

Update: this piece, also by Dr Gibson, explaining what hedge funds are is well worth your time, too.

The Mystique of Hedge Funds

Hedge funds are controversial these days. Though it’s unlikely that the average citizen or the average congressman could say just what hedge funds do, many are certain they must be reined in by additional regulation because they can—and do—cause widespread damage to our financial system. Almost everyone takes it for granted that regulation of some sort is the solution, ignoring the possibility that at least some of the problems are actually caused by regulation.

What is a hedge fund? The name implies hedging, a strategy that reduces risk. If you bet on several horses in a race, you are hedging your bets—spreading your risk. You can buy gold to hedge against inflation. You can sell interest-rate futures to hedge the risk that rising interest rates would pose to your bond portfolio.

The first hedge fund was created in 1949 by Alfred Jones. He believed he could pick stocks that would outperform and those that would underperform the overall market. But Jones didn’t know where the overall market was going, so he would buy his expected outperformers and sell short the expected underperformers. He thereby insulated his portfolio from general market moves, which would affect about half his holding positively and half negatively.

Most present-day hedge funds don’t do much hedging, but the name persists. Instead, they engage in a bewildering variety of trading methods, including buying on margin (using borrowed funds) and selling short (selling borrowed assets so as to profit from a price drop). They trade stocks, bonds, options, currencies, commodity futures, and sophisticated derivatives thereof. Some try to anticipate global political or economic events, while others seek opportunities in specific industries or companies. Continue reading