THE NEXT INQUISITION?
The US Securities & Exchange Commission (SEC) has reportedly spent a little over a decade working on the legal definition of a new variety of unacceptable financial activity: “Outsider Trading”. While the meaning of insider trading is crystal clear, there is still a certain amount of confusion concerning how exactly outsider trading differs from industrial espionage or (data) theft. Industrial espionage & data theft describe slightly different approaches to actually stealing valuable confidential information from the victim to provide an unfair advantage to the perpetrator (or his buyers). So where does outsider trading fit in? It seems that the SEC defines it as the act of exhibiting erratic but profitable patterns in choosing investment destinations. In effect, jumping successfully from venture to venture could now be considered a crime, even if there is no evidence of actually having partaken in an illegal transaction involving misappropriated information.
The operating principle of this law is that there is a ceiling on what a human being can infer from publicly disclosed information & so, if someone exhibits the ability to do more than what can ordinarily be done with the legally-available data, the only explanation is that he or she is committing a crime. But is that really the case? Medical science theorizes that human beings don’t even use their full brain capacity unless they put their minds to it (pun intended); does the majority opinion of the value & applications of a piece of information truly cover everything it can contribute to? If that were the case, people like Albert Einstein, John Nash & Alexandre Dumas wouldn’t be geniuses, but criminals who stole & cobbled together the ideas that made them famous. If Sherlock Holmes had been a real person who had gone into finance instead of criminal investigation, he’d probably be in jail for recognizing the full significance of the relevant public record in each transaction, unlike his colleagues & competitors.
There is no doubt that efficient law enforcement requires the investigation of anomalies, because at least some of them will be indications of the beginning of the commission of a crime. But that is investigation procedure; an anomaly in & of itself does not constitute a crime. Declaring the anomaly a crime only seems like an attempt either to reduce the responsibilities of the investigative authorities (by providing justification for an indictment before the collection of sufficient credible evidence) or to turn an investigation into a witch hunt (by labelling the exceptional as suspected felons).
Taking notice of a spike in activity in any financial sector is the duty of the SEC; but declaring the spike itself a crime, will only create a destructive pattern of discouraging financial professionals from exhibiting any intellectual gifts they might possess. The negative consequences of outlawing increased competence has already been seen in historical blunders like the Spanish Inquisition. The US in particular & the world in general, can’t afford to encourage policies that deter the more accomplished from offering their services freely & legally.
THE DEBATE
The question of whether there should be legislation to regulate the phenomenon of outsider trading has been discussed by experts from practically every relevant professional field. The following illustrations are meant to simplify the question for people who are not necessarily experienced lawyers or legislators.
The “Mary Poppins” Interpretation
Disney’s Mary Poppins (1964) is a very popular movie that has enchanted generation after generation even decades after its official release. In it, the bank at which George Banks works is apparently a British multinational corporation, which invests in development projects all over the world. There is a scene where Mr. Dawes Sr. snatches the money that Michael Banks had intended to spend on bread crumbs to feed the birds in the square. The little boy reacts angrily & within seconds his pleading protests of “Give me back my money!” are resounding through the whole bank. A couple of old ladies, busy transacting business a few feet away, are the first to overhear the altercation & instantly assume that the bank has gone bankrupt & is about to pocket the assets of its account-holders; they hurriedly demand that the teller empty their accounts & return their money to them immediately. Other account-holders hear the ladies & a general panic or “run on the bank” ensues.
While the result is that the bank loses a certain amount of credibility (& credit) which leads to Mr. Dawes Sr. very insultingly terminating George Banks’ services, the scenario does pose an interesting question in light of the outsider trading debate: Did the account holders at the bank commit outsider trading? After all, the exchange between Michael & Mr. Dawes Sr. was not technically for the consumption of the account-holders & had come about because George, Michael’s father, was an employee at the bank.
Confidence Versus Competence
The United States Agency for International Development (USAID) has been the leading foreign entity to partake in Pakistani development projects since decades. If it were a commercial enterprise, it would have cornered the market on Pakistani development projects. Until now, it had carte blanche on the nature & scale of the projects it chose to spearhead. But times have changed & USAID might have to take another look at its operating principles. While it was promoting women empowerment in Abbottabad District, Khyber Pakhtunkhwa (mostly by telling the ladies that being poor is not such a bad thing if you have high self esteem), the Korea International Cooperation Agency (KOICA) has announced its involvement in the fledgeling pastoral farming sector of Chakwal District, Punjab Province; in a pleasant surprise, KOICA has stipulated that the capital of 10 goats per person will be offered to candidates who will then be obligated to prove that they are not only knowledgeable about goat-rearing but also genuine farmers (& not career criminals in need of an alibi for when they pursue their actual profession).
The brutal truth is that, if done right, profitable goat farms are more likely to prove financially beneficial to all stakeholders than a crowd of still-penniless-but-now-confident ladies. It also means that Korean brands in the farm goods & services sector are likely to become better known in Pakistan (& the Subcontinent in general) over the coming years. Most importantly, considering that the Chief Minister of Khyber Pakhtunkhwa has taken a wise step in officially assuring the general public that KP is open & safe for business (a fact that is confirmed by the efforts of the top KP bureaucrats to encourage transparency in all official transactions), it means that KOICA could conceivably expand its program to places like Peshawar where practically every household in the surrounding villages keeps a goat or a cow. If these circumstances lead a currency speculator in Wall Street to increase the share of Korean Won at the expense of US Dollars in his portfolio, would that qualify as erratic (& consequently suspicious) investing behavior? Could such an act be declared outsider trading?
RELEVANT CONCEPTS
Outsider trading has not been mainstreamed into contemporary financial jargon at the moment. Therefore, the best way to understand what it might be referring to is to acquaint oneself with well-known concepts that cover the worries that are prompting the SEC to invent (for lack of a better word) a new financial crime in the first place:
Hacking
Hacking is the identification & exploitation of flaws in computer systems or computer networks. The purpose may be profit, protest, challenge, enjoyment or security evaluation. Hackers are conventionally divided into 10 groups:
- White Hats (who test computer security by hacking it)
- Black Hats (who violate computer security out of malice or for personal gain)
- Grey Hats (who hack computers either to market their skills or to alert the public to a defective program or system)
- Blue Hats (who bug-test systems as a credible outside party)
- Elite Hackers (who receive this title because they are the best & brightest)
- Script Kiddies (who break into computers using automated tools written by third parties only)
- Neophytes (who have very little computer hacking knowledge)
- Hacktivists (who utilise technology to publicize a message)
- Nation States (who carry out espionage & cyberwarfare)
- Organized Criminal Gangs (who commit cyber crimes for profit)
Data Theft
The term “theft” is actually misleading in this instance because data theft is rarely about depriving the legitimate owner of information as much as it is about illegally making a copy of the target information. The most popular methods are
- Thumbsucking (the use of a USB device to download data from individual computers or large networks)
- Podslurping (the use of a data storage device to download data by plugging it directly into the target computer)
- Bluesnarfing (the unauthorized access to information from a wireless device through a Bluetooth or wi-fi connection)
- Sneakernet (a tongue-in-cheek play on Ethernet & sneakers, it is the transfer of electronic information through the physical transportation of the hardware that holds the data)
Industrial Espionage
The purpose of industrial espionage is:
- The illegal acquisition of intellectual property
- The sequestration of proprietary or operational information
- The theft of trade secrets
CONCLUSION
The aforementioned illustrations clearly indicate that the fear the SEC is suffering from, which prompts it to declare a step that merely constitutes cause for an investigation, as an illegal act, is an exercise in futility, because it poses so many legal conundrums, that such a law would do more harm than good. It would be far more constructive to invest as much money as it can afford in hiring the best & brightest financial investigators to actually track illegality through the clues that mankind has used quite successfully since civilization began. In conclusion, the current framework of rules should prove more than sufficient as long as SEC investigators actually know what they are doing.
Satisficing Profits 