Donald Rumsfeld once famously spoke of ‘known knowns, known unknowns and unknown unknowns’. That clip is at the bottom, a famous moment of international political hilarity. Until this week, the financial world had a few of its own ‘known knowns’ that traders had to officially ‘unknow’, until they were known in an official sense.
Welcome to the world of material non-public information and insider trading. The concept of insider trading was initially designed to level the investing playing field. No longer would the rich, the powerful, well-connected ‘insiders’ have better information about publicly traded companies than the typical retail investor. By insisting that trades could only legally be made based on public information that was accessible by all, any misuse of information asymmetry would become punishable by law.
That imbalance of power (information is power, remember?) was facilitated by a lack of technology. In the pre-mobile days of Gordon Gecko, information from the inside of a corporation was hard to come by and harder to verify than it is now. Unless, of course, you were an insider or had one in your back pocket. You had to have a leak, and the means to confirm that leak, before making a trade on the back of it. Imagine that in a world without mobile phones. Unless you had a watertight source of information, you had to receive information in some other form (fax/landline, perhaps) and then locate someone who could corroborate that for you. That meant getting them on a landline, which (remember this?) wasn’t always guaranteed. Not everyone was right by a phone all the time.
Because information was far harder to share, you could reasonably infer intent or recklessness if that sort of valuable information was shared and then traded upon at a profit before anyone else had a chance to do likewise. The phrase ‘insider trading’, in those days, made sense.
The SEC, in the Netflix case, found itself in a ridiculous situation, the opposite of what the insider trading regulations were designed for. When Netflix CEO Reed Hastings posted on his public Facebook stream that Netflix’s monthly online viewing surpassed 1 billion hours, it became public knowledge. However, because it wasn’t released through official investor information channels, this information was classed as ‘material non-public information‘, and not legally tradable. The law which was meant to prevent Joe Punter from an imbalance of information was being applied to protect the class of investor who used to be on the other end of the see-saw. The institutional investor, who would once have had access to more information is suddenly at a disadvantage.
What’s more, all class of Joe Punter, technically, should not have been trading on this new information. It was unofficial – material, but non-public. Not. Tradable. Effectively, Joe Trader was being asked to ignore, or ‘unknow’, this information until the institutional trader could catch up via a traditional release on a traditional channel. It was, for a short time, an unknowable known. The desire for level playing fields aside, this is crazy. It is not ill-gotten information, it is relevant, accurate, and, above all, PUBLIC.
Mobile, instant communications have turned companies inside out. An ‘insider’ is just as likely to be an outsourced consultant, working remotely, as they are a wonk sitting in the centre of HQ. Hell, it could even be a CEO who has pinged his Facebook followers with a relevant update. We all share content dozens of times a day and companies, inadvertently, wear their insides on the outside, courtesy of their employees.
The ruling from the Securities Exchange Commission tries to bring things back to the centre. It says that it’s okay for corporations to share material information via social media now, and for that information to be considered tradable.
The line being jumped on by most people is:
‘Most social media are perfectly suitable methods for communicating with investors, but not if the access is restricted or if investors don’t know that’s where they need to turn to get the latest news.’
The most important lines come in the final paragraph of the SEC release on April 2, most of which is pure caveat:
“[D]isclosure of material, nonpublic information on the personal social media site of an individual corporate officer — without advance notice to investors that the site may be used for this purpose — is unlikely to qualify as an acceptable method of disclosure under the securities laws. Personal social media sites of individuals employed by a public company would not ordinarily be assumed to be channels through which the company would disclose material corporate information.”
What the SEC is saying is that it’s okay for a company to release info via nominated accounts, but only those which are flagged to investors. But if there’s a disclosure from an employee’s twitter account, not flagged to investors in advance, and you trade on the back of that, it’s still insider trading, even if the name of the crime doesn’t really fit.
It’s not going the whole way to opening up social media as an insider information free-for-all, but it is redressing the balance again. Only this time, it’s not in favour of the masses, because the masses already have the upper hand. It’s almost like the SEC read the last line of this Forbes article entitled ‘It’s time for the SEC to join the digital age’ and implemented every word.
There’s further to go, of course, and it will be interesting to see what the SEC does next. Will they wait for another loose, stock-surging tweet or make a pre-emptive move to define in greater detail how companies should regulate information disseminated by their people? Will it lead to even greater restrictions on social media use in publicly-traded companies? What of the non-nominated channels in the interim, the coder who hints at a shipping date on Twitter and just happens to be followed by Joseph Weisenthal from Business Insider who blabs it to the entire financial world? It’s like chaos theory. If a geek tweets in China, what happens when it causes a financial tornado in Texas?
And, wrapping up, hats off to Netflix. Not alone are they disrupting the TV & movie industry distribution model, they’re doing the same for distribution of financial information.