I genuinely think this is a grey area, and it's far from "insider" trading. Is it moral, I don't think so. Should Capital One sanction these employees, probably. But I think this is far from ilegal.
Huang and Huang had access to a db which is not open to everyone, granted, but they had to extrapolate the stock direction based on data from a subset (customers who buy Chipotle with a CC), of a subset (with a Capital One card)... and then compare that to analyst expectations, etc. but then, would it be insider trading if I stood outside a Chipotle polling customers who exited on the dollar amount spent? That is also proprietary information, and one I can use to trade stocks on. I'd like to know if they did any trades where the return went south. I know of sector investment funds which pretty much do this all day long, forecasting all sorts of industries, and it's not ilegal.
Well, in the article the make clear that there is case law that this is illegal and considered "misappropriation" insider trading.[1]
Even if we decide it isn't insider trading, Capital One is on the hook for what it's employees do. Chipotle or whoever could sue CapOne for breach of contract, and CapOne could sue these guys for that. So even if we decide as a society it's not criminal, another group of guys doing the same thing somewhere else might not get to keep all that sweet dough they made purely on civil grounds. I don't know. It's interesting.
> Well, in the article the make clear that there is case law that this is illegal and considered "misappropriation" insider trading.
I'm not sure that is the exact same thing. These guys had to do some research.
Consider, for example, a large pork supplier. If they see orders from Chipotle trend up by (say) 30% over a quarter, are they free to buy call options on CMG? What if you're a feed supplier to this pork supplier, and you know that Chipotle is their biggest customer, and see that this pork supplier's demand for feed has gone up by 30%; can you then buy call options?
This is a gray area, and I'm not sure the line is really that clear cut.
>This is a gray area, and I'm not sure the line is really that clear cut.
Your examples are not novel issues, certainly there would be case law on point. I can not cite the case law, but I would tend to believe your examples fall within the classification of insider trading (i.e. trading based on a companies non-public information). I know for example as an attorney if I am working on a merger and I buy/sell stock or inform someone else who buys/sells the stock that would be insider trading.
Generally, think of the Martha Stewart allegations, she was informed by a friend/corporate officer that the FDA was rejecting the companies cancer drug. Based on that non-public information her brother sold the stock and then the FDA decision became public and the stock dropped. It is a stretch from your hypothetical, but the non-public information paradigm would seemingly still apply.
I don't think that example is insider trading. Insider trading is trading on material nonpublic information that was obtained in violation of a duty of confidence (and for a benefit). Do Chipotle's suppliers have a duty of confidence regarding their order sizes? I suspect either it's explicit in the contract, or they don't.
Is that ("that was obtained in violation of a duty of confidence") true? I don't think it is. I'm pretty sure you can't trade on information you overhear in a bar, for example.
The SEC might argue that bar patrons have such a duty of confidence - they have previously done so for roommates, and golfing partners. Or they might charge the person you overheard with violating the Reg FD selective disclosure rules. Or they might let you both away with it (IANAL). But yes, it absolutely is part of the law; http://www.law.cornell.edu/cfr/text/17/240.10b5-2 is the detailed version.
>Even if we decide it isn't insider trading, Capital One is on the hook for what it's employees do.
Under the legal theory of Respondeat Superior, Capital One would generally be liable for acts of its employees. However, liability will generally not extend to the employer when employees are acting outside the scope of their employment. Certainly if the employees were breaking the law it can be presumed they were acting outside the scope of employment, but even if it is found the employees were not breaking the law it would appear they were acting outside the scope of their employment. In short Capital One would have affirmative legal defenses.
I recently worked at Capital One (left recently), they were not following protocols and probably had gained access to information they should not have had.
That being said, I highly doubt Capital One is "on the hook" because they were breaking company rules and would have been terminated. Further, I am pretty sure the employees were breaking several laws as well as Capital One's policy (at least according to the contracts I signed and seminars I had to sit through), Capital One would not be directly responsible if they attempted to prevent such behavior (which they do).
In this case, Capital One could only be on the hook if they benefited or distributed individuals data, they actually did neither. They had only general sales data and only the two employees illegally made money.
Thanks for the link, it sent me down a path of learning more about breach of fiduciary duty. You are correct, this is a very complex and interesting case.
I heard of people at a renowned analyst company who would trade on their findings before release. Supposedly that was all clear as they only used public data.
Stats 101 - A sample of the total customers is sufficient to calculate the monthly average. As long as the sample size is sufficient (capital one credit cards) and the sampling method is not too biased (or in this case stedaily biased month-to-month). So yes this information appears highly valuable for forecasts as it gives customer amount and sales amount ahead of reporting.
sure, i'm not debating that this isn't stats, but it's a skewed subset, skewed towards those who can afford to have a credit card. then, stats is far away from knowing confidential information. I don't know...
At the end of the day I am not so sure the value of the information matters, even though in their case it turns out the data subset accurately reflected the larger picture (e.g. Capital One data was consistent with not just other credit card transactions, but cash as well).
Nevertheless, one may still be committing insider trading by trading based on non-public information even if the bet was wrong. Though is such a circumstance they may not have come up on the radar.
It's not very clearly insider trading, because the traders had no fiduciary duty to Chipotle. It's arguably insider trading because their relationship to Chipotle is colored by the relationship payment processors have to Chipotle. And that argument will probably prevail.
The point of Levine's post is that for the markets to work, there have to be traders trading at an advantage. The point of insider trading laws isn't to level the playing field --- that's exactly what you don't want. It's to eliminate a class of agency problems.
We can (probably should) want to deter credit card companies from trading on data mining payment data without believing that insider trading laws are the right vehicle to do that with. Privacy regulations and mandatory confidentiality agreements could set up an effective civil deterrent, rather than sporadic and incoherent SEC and criminal investigations.
Violation of fiduciary duty is only a requirement in order to meet the "Manipulative and Deceptive Practices" part of SEC Rule 10b-5.
However there are other ways that requirement can be met for instance SEC v. Dorozhko found that a hacker using stolen information to trade was guilty of insider trading. Obviously he had no fiduciary duty however he was found to be deceptive.
If the SEC prosecute this case I imagine they'd try to extend the argument presented in Dorozhko.
Yes, that's what I was alluding to in my first paragraph. (I did read the article; I am sort of religious now about reading Matt Levine, who is awesome.)
But don't insider trading rules apply even to people with no real agency power? A secretary who overhears that a drug trial failed is not in a position to affect how the company reacts to that information, and probably does not have enough capital to move the stock. But she would still be violating insider trading laws if she sold all her stock before the press release was issued.
I can see why professional traders and speculators might not want to level the playing field, but I don't see why long-term investors would feel that way. When I invest in stocks, I intend to hold for a long time. I'm betting on the business success of that company or group of companies, not on inequalities in the availability of information about them.
It's not in the interests of long-term investors to keep advantaged traders out of the market. The alternative to the participation of informed investors is mispricing. Fundamentals investors want prices to reflect actual value, too.
I feel like this begs the question of information inequality, though. If all traders were equally informed, then mispricing would be avoided as well. And without the complexity of trying to infer information from the trades of others.
Isn't this what insider trading laws try to do? The law obviously can't keep insiders from learning information first, so the law prohibits insiders from acting as investors until the info is public. At worst this creates a lag between information and price, but that wouldn't matter much to long-term investors.
Not that insider trading laws can create total information awareness for every investor. But at least it gives every investor a more equal opportunity to find and use information.
> I feel like this begs the question of information inequality, though. If all traders were equally informed, then mispricing would be avoided as well. And without the complexity of trying to infer information from the trades of others.
If all traders were equally informed (perhaps by a law that any information you wanted to trade on had to be public), there would be no way for people to profit by digging up new information. We (society) like it that analysts have a financial incentive to figure out the truth about how well a company is doing - whether that be by coming up with a better model of how one industry affects another (which will ultimately lead to better allocation of resources), or doing the legwork to realise that a particular company is a massive fraud (which leads in a more direct/obvious way to better allocation of resources).
But we don't want them to just bribe insiders - that causes agent-principal problems, gives certain market participants unfair advantages, and all the rest of it. Hence the law, where figuring out these things through research is encouraged, but getting them from insiders is illegal.
The laws keep insiders from doing that, but it does not prevent other people from amassing non-public data through research, investigation, or financial modeling. Instead, the law protects the products of those activities as trade secrets, thus enshrining into law the idea that some traders do in fact get to be advantaged with non-public information.
I'm having a hard time thinking of non-public data that would be legal to trade on. The examples in the article and this thread all seem like public information. Anyone can observe a sales floor, or a parking lot, or a store entrance. Anyone can observe the IR radiation coming off oil tanks. Anyone can observe tweets.
Anyone with the time and means to do so, anyway. Anyone could do these things; but most don't. For the people who do, what is protected is their investment in gathering and analyzing the data. The law does not grant Person A access to the data set of Person B--true--but the question is whether Person B could do their own work to gather the same data set.
Whereas information that is only available, in any form, to Person A would be considered non-public, and not legal to trade on.
If I read it correctly your third paragraph describes how things should work. I'm saying that misappropriating 3rd party information has already been established by case law to be insider trading.
No. US v O'Hagan did not establish misappropriation as "insider trading". It established it as fraud, and as an SEC §10(b), which covers a broad range of securities fraud that is not describable as insider trading.
The syllabus for the case itself seems to be at pains to distinguish misappropriation from insider trading.
The importance of the distinction is that the Capital One case is something the spirit and letter of the law wants to deter, while satellite imagery of commercial activity isn't, despite it too being an example of market actors leveraging their own access and assets to gain an advantage in the market.
If this is just a terminology debate, O'Hagan-style misappropriation theory cases are called "insider trading" cases by nearly everyone, including the SEC[1], the Justice Department[2] and the SDNY (a judge recently issued an opinion discussing "insider-trading cases prosecuted under a misappropriation theory"). They are usually contrasted with "classical theory" insider trading cases.
The use non-public information is what the article talks about - there are plenty of other non-public data sets that traders use to gain an advantage (e.g. using helicopters with infared sensors over oil fields).
The difference in this case seems to be they broke customer confidentiality rules to obtain the data, so use of that data for profit is now illegal.
"This is clearly insider trading. It's non public info." is broken logic. You are allowed to trade on non-public information; in fact, for the markets to work effectively, you want people to do exactly that.
You got downvoted because you appear to have either missed the words in breach of a fiduciary duty or other relationship of trust and confidence in your own quote, or responded under the misconception that I'm arguing that the Capital One guys should be allowed to do what they did.
Well the SEC agrees, so I'll go ahead and trust them and my years of training.
Trading on any insider non-public info is actionable by the SEC. Keep your eye on this one, should be fun for those involved. I sure as hell wouldn't risk it.
And Google, Microsoft, Yelp, Facebook, etc employees can buy and sell stock and have non public info as they work at the companies. The question here is, is it material? Inside companies you see and hear about many things... which of them material, well, that's the grey I'm referring too in part.
Employees always (in my experience) are explicitly restricted from trading company stock based on non-public info. There are also [usually] specific windows in which employees cannot trade in the company's stock.
Additionally, I have worked for companies which prohibited transactions in any derivatives or options and barred shorting the stock.
Certainly, I too was restricted at my company: no shorting (of any stocks!) and no buy/selling of stocks x-days before earnings announcements. A part from that, you could trade without any other contractual restrictions. The determination of material information wasn't not decided by the company... and I guess it's something that is is only brought up in case of an investigation.
At the very least it is misuse of Company resources. They can probably sue these goons for every single dollar they made and then some, especially if they are found guilty, which they probably will be.
Even at that, you have, what is essentially insider information on the raw sales data of a company that way since you are essentially seeing the same information that the company itself sees, but just a rather linear proportion of it.If you have the Capital One portion of Chipotle sales, and you know the electronic transaction market share of Capital One cards, and you know the proportion of cash to electronic transactions; I would not be surprised one bit if you could essentially predict the sales figures down to within 1% margin.
I think (and I'm not terribly informed here) that the difference would be that Capital One has a business relationship with Chipotle, albeit somewhat indirect. Polling customers while otherwise being unrelated to the company is different from mediating payments to the company and using that data.
According to the article, the big problem here was that the data being used here belonged to Capital One, and these researchers were running their own thing on the side using that data.
Huang and Huang had access to a db which is not open to everyone, granted, but they had to extrapolate the stock direction based on data from a subset (customers who buy Chipotle with a CC), of a subset (with a Capital One card)... and then compare that to analyst expectations, etc. but then, would it be insider trading if I stood outside a Chipotle polling customers who exited on the dollar amount spent? That is also proprietary information, and one I can use to trade stocks on. I'd like to know if they did any trades where the return went south. I know of sector investment funds which pretty much do this all day long, forecasting all sorts of industries, and it's not ilegal.
I'd like to know what others think.