The Information Trading
Markets for information, such as traditional media like Reuters, Bloomberg, and Financial Times as well as the modern ones spread around the internet, are an important element in financial markets. Information related commodities, like newsletters, security analysis, active portfolio management reports, and investment advisory services, therefore represent a strong tool for traders who adapt their trading strategies according to these commodities.
Legal information trading
It is important to take into account that some agents (traders, asset managers, brokers, etc.) in the financial markets have the information other agents do not have. Such information represent a certain advantage and can be sold to other traders who have to observe and assess whether the information is usable for trading purposes or not.
The value of information to an individual trader is defined as the amount of money that equates the traders expected utility with or without the information. In other words, if the profit returns after the utilization of information are favorable or not. Furthermore, selling information is typical for risk-averse traders who prefer to stay away from high-risk investments. Despite competition that is fierce in this particular business, the information sale allows better risk sharing.
Hedge fund — a way to sell information
There is a way to sell information and at the same time create a zone of risk sharing — to create a mutual fund. Investors in a mutual fund do not observe the information directly, instead, they purchase shares in the fund. The fund then uses the information to determine its trading position. By charging each investor a fee, the information owner effectively charges for the response to the information. Like this, the information owner can control the effects of competition among these indirectly informed traders and thus increase his profits.
Until now, we were talking about legal trade and usage of trading information. But there is also more controversial part of this business that considers illegal trade — the insider information trading.
Insider information is defined as a nonpublic material information. Material nonpublic information is information that would affect the market value of a security or a digital asset and has not yet been disseminated to the general public.
Information is considered to be material if its dissemination to the public would affect the market value or trading price of securities or digital assets. It is information which, if disclosed, would likely influence a reasonable investor’s decision to purchase or sell an issuer’s securities.
Information is considered to be nonpublic when it has not been adequately disclosed to the general public. Information ceases to be material, nonpublic information only when it has been widely disseminated to the public or is no longer material.
Knowing about a company’s significant, confidential corporate developments, such as the release of a new product or a merger, could provide an unfair advantage if the information is not publicly disclosed.
For example, Eric, an employee of the development department of an online shopping company overhears a meeting between the CEO and the CFO behind open office doors and these doors were not meant to stay open.
A week before the company merges with bigger online service provider, the CFO confidentially discloses to the CEO that the company is ready to close the deal. This is an example of insider information because the merger has not yet been released publicly. Eric has advised his father to purchase the shares six months ago but now he feels like advising him to buy more shares because the information could cause the spike in price. We shall break this example to give a legal illustration about the handling of the trading information.
Authorities must prove several elements to accuse someone for trading on or tipping confidential corporate information.
- Shares must be bought or sold.
- The action of purchase or sale must have been prompted by the possession of material and nonpublic information.
- A trader or a tipper must know that information he or she is dealing with is valuable and confidential and it will affect the price on the market once it goes public.
- A trader or a tipper must be breaching a fiduciary duty owed to their company, meaning that he or she is breaking the NDA.
Is our example given a case of an insider trading? Let’s analyse it.
First, in case that father buys shares after getting the information before being publicly disclosed it is a clear case of insider trading. However, the law does not penalize a failure to buy or a decision to hold.
Second, was the information the employee overheard both nonpublic and material? Yes. The executives were speaking behind opened doors that were probably not meant to be open, speaking about a matter that could influence the price of the stock on the market. And the authorities can prove materiality if a reasonable investor would consider the information important in a decision to buy or sell.
Third, Eric knew that the information he overheard is valuable and therefore confidential.
Finally, Eric as an employee of the company is under the NDA, thus any communication of insider information would mean a breach of fiduciary duty.
How about if Eric wasn’t an employee could he go and sell or buy, depends on a nature of the information, based on what he has overheard? By law, no. The law treats all secret information that might affect a stock’s price the same way, whether that information is good or bad and whether it originates from the company itself, a business publication or a Wall Street research department. Trading and other professionals have been sentenced after they traded on or tipped others about privileged information belonging to their employers.
As an employee, one is sure to know some confidential inside information, so can he or she legally sell his or her stock? Securities regulators in some countries have offered a possibility to trade on the insider information basis as long as they file selling plans with the authorities. Employees who do that can sell their stock on a set dates. This avoids any risk of insider-trading liability.
In the following Medium post, we will focus on information trading in crypto, therefore we invite you to follow our media channels to make sure not to miss any of our updates.