Deductive Reasoning or Insider Trading? It's a Tough Call

Sometimes people profit from being clever, not inside information.

In plain sight.

Hulton Archive

This post originally appeared in Money Stuff.

We've talked about what I called "insider guessing": The Securities and Exchange Commission and federal prosecutors brought charges against an Equifax Inc. executive who was allegedly able to figure out that his company had been hacked, and who sold a bunch of Equifax stock, but who had never explicitly been told about the hack. The SEC and Justice Department think that this would be insider trading, and I think I more or less agree; in any case, I said that "it's not gonna look great to a jury."

But perhaps that was wrong? A reader pointed me to this amazing 2010 case, in which the Securities and Exchange Commission accused a couple of railroad workers and their family members of insider trading on merger news. No one had told the railroad workers about the merger, but they made a good guess: "as part of the due diligence process, there were an unusual number of daytime tours of FECR's Hialeah Yard involving a tour bus and people dressed in business attire," and they figured that if that many people in suits were touring their rail yard it was probably for sale. So they bought call options, and the SEC accused them of insider trading.

But the SEC lost at trial: In 2014, a federal jury sided with the railroad workers (though some defendants had settled before that). Juries don't issue written decisions so it's a hard to know what their reasoning was, but you can sort of guess at it. If you are confronted with workers in a rail yard who saw tourists in suits and concluded from that that they should buy call options on their parent company's stock, it is hard not to admire them a little. That's clever! I would be inclined to attribute their profits mostly to cleverness, and only secondarily to inside information. You could imagine a spectrum of insider trading, where if your boss just tells you "we are being acquired" and you trade, then that is cheating and illegal, while if you pick up only subtle clues about an acquisition and use bold leaps of deductive logic to decide to trade, then that is just good old capitalism and perfectly legal. That is certainly not legal advice, and I don't think it exactly captures how the law thinks about materiality and inside information -- though arguably it is reflected in the "mosaic theory" of insider trading -- but perhaps it is how juries feel about insider trading.

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