Thursday, September 1, 2016

Meta-information and insider trading

This is a question that pops up from time to time. But I will do it by stylised example.
A small cap miner has announced a very significant gold find. The stock has moved from 10c per share to a dollar per share. 
The problem is that if the find really is as described it is obvious that stock is worth $5 per share. 
It doesn't trade at $5 per share because there is such a widespread history of small cap miners overstating (or even flat lying about) gold deposits. If you regularly bought the stock of small-cap miners announcing big finds you would probably go broke. 
Now imagine you are the drilling contractor who drilled the gold. So you know exactly where the drill samples were taken with certainty. 
And suppose you took those gold samples to the lab run by your brother without any third party intervention. And so between you you know with certainty that the drill samples are real and the gold in them was accurately measured. 
The results have been completely announced to the market. So the market has been fully informed. 
But you know one thing with certainty that other people don't know. You know the results have not been faked.
So you buy the stock and it is a five bagger. 
Note that every piece of information you have is public except one piece. The one piece is that the company is telling the truth.

Your information is meta-information. It is information about the quality of information.

So are you guilty of insider trading?

This is not an idle question. At the moment Herbalife (to pick a controversial example) is a cheap stock if the company is telling the truth. (And that is where my research has been focused.)

If you knew with certainty that the company was telling the truth you would buy the stock.

This situation comes up regularly with controversial stocks and is in background in almost all stocks I buy or short.

I spend a fair bit of my time trying to work out the quality of information given to me. A lot of the time spent stock-picking is spent on the search for meta-information. 

Discussion wanted both as to where legality begins and ends and (if anyone is game) on methods of assessing the quality of information.

John Hempton

PS. I am fascinated by edge-cases in insider trading. This one illustrates the difference between American and Australian law.

A gold explorer operating on their own privately owned tenement makes a big gold discovery.
The discovery is alas right on the boundary of their tenement and it is open and spreads (pretty obviously) into the neighbours' tenement. 
The neighbours tenement is owned by a listed company (in this case a penny stock).  
They go and buy this penny stock aggressively whilst the majority holder of the penny stock sells aggressively thinking nothing is there.

Under Australian law this was found to be insider trading. Under American law I suspect it would be fine. The person owning the private tenement is clearly not an insider in the penny stock - but they do have material non-public information.

Okay - lets extend this. Suppose the drilling contractor works all this out too. And they join in the trading but the owner of the tenement (who hired the drilling contractor) has not freed the contractor to trade the (third party) penny stock. Is the drilling contractor okay under American law?


John said...

Godel is right.

When you see insiders are buying, this is meta-information (that the gold is real). Yet, it itself is information.

Anonymous said...

Fun with epistemology.

Unknown said...

I have no inclination to bet one way or another on Herbalife, but the subject generates a lot of interesting reads, this blog being a source for some of the best of the best.

Jim Calle said...

The contractor does not appear to be within the definition of "insider" as used by the SEC. Unsure about elsewhere. Absent a contractual prohibition on acting on such information or the contractual creation of a fiduciary duty to the hiring company, it doesn't appear to be insider trading. I would think a company would create contractual obligations and prohibitions for any third-party contractor potentially exposed to proprietary information.

Unknown said...
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Unknown said...
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Unknown said...

Agree there are some interesting potential insider trading cases that the current legal framework doesn't seem to handle in a proportional way.

But I'm not sure this is one of them. As the contractor, you have a duty of care and loyalty to the firm that hired you to drill the gold, and it's only through that relationship you can gain the private information: that the firm is telling the true. What's the distinction between this case and O'Hagan?

If you were independent from the firm, took samples yourself, and could then assess that the information was true, then you wouldn't owe the same duty.

But... What if your friend works there, and he would only join an honest company? What if you get the company to send you the auditor's report? What if you took their IR head out for a golf weekend to obtain said report? What if you went on some dates with said IR head? What if, instead of directly receiving the report, a friend forwards it to you, and you suspect-but-don't-know they offered bribes to obtain it? ...murkier waters

(Not a lawyer and not legal advice!)

OmnipotentAss said...

You don't know for sure that your gold actually extends onto land you don't own. If you buy the penny stock you are merely speculating. You know nothing about his land, and even if there is gold you have no idea if they would discover or ever attempt to drill it. If they did and found the pay streak ended at the property'd lose big.

Dave said...

This is one good reason for the obsession over progressive dividend policies etc. A sort of board guarantee about the veracity of disclosures. Works more in theory than practice of course.

scott said...

seems like the info is non-public, material but carries no baggage of being held in confidence, trust or fidicuiary duty. so not insider trading. not a lawyer, but im pretty sure you need all 3.

Talorc said...

It is interesting that Australian insider trading law completely lacks the fiduciary duty test the US has.

Its basically being in possession of material non public information, likely to have an effect on value and trading the security. There is no fiduciary test, so you could literally overhear the conversation on the bus, trade on it, and be insider trading. (how you would ever get caught is another question)

The easy fix of course - get rid of the "non public" bit by publishing. Everyone is a publisher now! Just post on twitter with the $XXX tag - Bloomberg integrates twitter feeds now, so it is reasonable to assume the "market" has seen it. Then wait a reasonable time - how long is reasonable in a HFT world? Pretty short.

Tsachy Mishal said...

Every insider in every company has meta information and they are allowed to trade

Tsachy Mishal said...

Seems insiders at HLF have sold a few shares since the decision. Nothing big.

Dmitry said...

I fail to see any way to reliably prove as much as the existence of this meta-information.

To illustrate within your illustration, we first need to prove that $4 discount between present and "fair" price is based specifically on the threat of misstatement/fraud by management, as opposed to any other imaginable or unimaginable reason, because only within this basis the meta-information about lack of fraud is material.

And secondly and most nightmarishly, we need to prove the actual privileged nature of the information. E.g. that the same management that is, as implied by 80% stock discount, is 80% likely to defraud general public in announcement, is somehow materially less likely to defraud their contractors (such as presenting samples from different fields, bribing low-ranked employees etc) to the same effect.

If I remember correctly, big4 audit firms successfully argued in courts that they cannot guarantee the lack of fraud with their audits.
This seems to logically violate the notion that auditors have material privileged information of company announcements being kosher.
And the information a driller/expert/etc has in this regard is, essentially, an audit.

Best regards,

James B. Shearer said...

In the second example you also have to worry about fraud law. If you buy shares in a public market you are probably ok but if you buy in a private transactions any misrepresentations you might make about why you buying could be deemed fraud. I believe this has come up with people buying oil rights.

Unknown said...

In my own startup world, one of the cool things about friends and family rounds is that you DO have meta information regarding the character of the principals. I'd imagine that gives more information about the truth of their statements. I wonder if anybody has studied whether this improves the investment quality?

- Randy K

Dmitry said...

Interesting test would be to look at the opposite situation.

So you are a driller contracted to do some probing, and you came up with naught. A little later, the very same miner announces a big find on the very same land.

In this case you possess not only some meta-info, but an actual bit of factual knowledge (your drilling results). However, this bit is "absence of proof", not a proof of absence. So here's the challenge whether it's material.

So, it gives you reasons to "doubt" the announcement? Quite likely. Any more then the 80% doubt already on the market? Big question!

Besides, let's for the sake of argument imagine that the drilling company already correctly disclosed this fact of yours: "we've had drillers, they came up with nothing, so we contracted other drillers and - volia!"

Now there's an interesting avenue of thought regarding this whole matter: for you, I'd imagine, the quality and thoroughness of your own research (test drills, in the particular example) carries much higher credibility then someone's public announcement. However that's not the case for the general public, where it's "word vs word" (absent clear factual proof, which in many cases doesn't and even can't exist).

So you think, there's basically no way you would've missed gold, so the finding must be bogus. And implicitly, this is where your insider meta-knowledge lies.
But I, an external observer and investor, already factoring 80% overstatement/fraud chance into the price, have no way to "receive" this info, since as many there are bad mining companies, there's as much or more equally bad drillers who wouldn't find an ice patch on Antarctica. And 99,(9)% of them would definitely "stand by their findings" as long as possible and far too long afterwards. Admitting mistakes is generally quite underused move.
(If you are exceptionally honest with yourself, you could be considering, even theoretically, the possibility of this, too.)

I would be interested to hear whether any objective, carrier-independent element could be found about such kinds of meta-information at all.

Best regards,

Anonymous said...

Excellent post, very profound. Am an avid reader of the blog.

I have a similar example and would like your take on it:

Say a small pharma company has produced a type of drug that increases muscle mass (a safer version of a steroid). The drug is still in Phase 1 or 2 and is not yet commercialized therefore it isn't a prescription or scheduled drug. However, given that it is considered a “research chemical”, it leaked into the public and thousands of meatheads and aspiring bros around the globe are taking it and raving about its results and manageable side-effects. In other words, you know for sure that the upcoming trials being conducted by the company will yield positive results. is that meta-information?

There are other examples also of yet to be released drugs under research that are being taken by people in the black market, so one can gauge their efficacy (or not) before the conclusion of the trials.


Anonymous said...

Great blog. Thank you very much for writing.

One question: why have management not been more aggressive at acquiring their own shares? Michael Johnson increased his by a significant amount at end of 2014 but everyone else's holdings have been flat at best and usually sell their derivatives as soon they receive them.

Anonymous said...

WOOOOW FINALLY a first interesting non biased blog in MONTHS.
PLZZZZZZ continue like that make us think instead of always obsessing on Herbalife and Ackman!

MerMonz said...

I argue (caution I am NOT a lawyer) that it is insider trading if the information allowed you to profit from information NOT available to everyone.

The quality of the information is why you placed the trade, not public; thus, insider trading.

But what I find strange is that trading on insider information is only predicated on whether you profit from the trade (I guess, taking away ill-gotten gains is the motivation).

I reason that any information you have, not public, that helps you profit from a trade is insider information.

Mike said...


Excellent topic. Thank you for raising it. It is not always clear where the line lies between trading on "scuttlebut" (as Philip A. Fisher uses the term in his book Common Stocks and Uncommon Profits), or hard-earned independent research obtained via vigilant analyses of publicly available information - if the public chooses to exercise the required use of "shoe leather" (as John Hempto has described it on this blogspot), and material inside information not available to the public. For instance, what if a company takes material actions or utilizes business practices with material impacts that are not detailed in published press releases or SEC filings, but because the decisions and practices are so readily apparent to the public if the public wishes to investigate, does it really matter whether the stock picker learned of said unpublished/undisclosed actions with material implications via say one of the company's employees not authorized to speak about the matter publicly, or discovered it via one of tens of thousands of distributors to whom the practices are communicated by the company formally and informally, directly and indirectly. This isn't a rhetorical question, as I don't necessarily know the definitive answer. I have heard Management respond to analysts direct question with answers such as "we can't comment on that because we view it as an "undisclosed competitive advantage" or "proprietary information" or our "secret sauce", but is it really any of the sort if the information is made readily available to thousands of independent distributors?

Best Regards,


Mike said...


"This is not an idle question. At the moment Herbalife (to pick a controversial example) is a cheap stock if the company is telling the truth. (and that is where my research has been focused.)

"If you knew with certainty the company was telling the truth, you would buy the stock"


1. "Cheap stock" is a relative term. Cheap when compared to what? Other companies within the MLM industry? Other nutritional supplement companies not within the MLM industry? Other companies with similar margins and growth rates irrespective of industry? I think this is both a quantitative and qualitative metric upon which two educated professionals may reasonably disagree, and both be either wrong or right. Was Valeant "cheap" or "dear" at $100 per share, $200 per share? I suspect many private investors, if informed about either Philidor or certain drug pricing or accounting practices would have understandably have disagreed on the consolidated materiality of said issues; however, the Market as a whole, when publicly informed, clearly had a definitive immediate opinion in the aggregate, notwithstanding two investors may have debated that question before it hit the press.

2. Telling the truth about what? (Emphasis added to "what".) About the argument surrounding pyramids vs. triangles? About everything? In such a complex business model spread over such complex regulatory landscapes, I suspect that without being a long-tenured, high ranking senior Executive with adequate background and experience and education, it may be difficult to be clear or definitive about many material issues that may significantly impact the stock price if made clearly available to the Market or public at large.

3. I am not certain one would either buy or sell the stock if one knew with certainty the company was telling the truth about something or everything; however, I suspect that knowing with certainty may be impossible (for all but a select few insiders with sufficient cumulative knowledge and experience with said business practices and the relevant laws and regulations (and even then my experience is that even those persons rarely really understand and know with certainty) except about something very specific and quantifiable information about a very specific and we'll defined or quantifiable question or issue.

Thank you again for your many contributions on these and other topics. They are helpful and informative.

For full disclosure, I was long HLF before the present controversies hit, but when the several questions arose, and realizing how many such unanswered questions I had, I exited the position (at a loss) and have not taken a position long or short since.

Best Regards,


Mike said...


Relative to your second request relative to assessing the quality of information...

"Discussion wanted both as to where legality begins and ends and (if anyone is game) on methods of assessing the quality of information."

Auditors in the U.S. are to apply "professional skepticism" and to "trust but verify" (in other words, not to accept statements made merely at face value, and not to make any determination as to their veracity until they may be supported by facts and evidence). Assessing the quality of information (or source), where any evidence is publicly available, is therefore not overly difficult providing the evidence may be readily obtained via due diligence and analysis. Where the quality of information may not be independently verified, because there is a lack of evidence available to accurately weigh the information (or source); in such cases the quality of information (or source) must be discounted materially, if not entirely. Bias and conflicts of interest are of course to be considered, also.

In his famous speech "The Super Investors of Graham and Doddsville", Warren Buffett makes a statement to the effect that, in addition to the quantitative and qualitative analysis of a company's fundamentals and financials and intrinsic value, one must determine whether they are getting into bed with honest management, and then something to the effect of 'but that's not too hard.' A number of tasks, which for Warren may not be too hard, are for many of us, incredibly difficult; if not impossible.

I find it generally easier to assess the knowledge and understanding possessed by management, than it is accurately assessing their character and integrity and proclivity for honesty versus dishonesty. Thus, and I may be backwards in my approach here, I tend to provide management with the benefit of the doubt UNTIL there is evidence to discount their character and integrity, at which time I am tempted to assign NO character and integrity to that same management until the evidence of lack of integrity may be viewed as an aberration. Statements made on earnings calls transcripts measured against publicly available facts are one of the only ways in which this is possible for me. If I find what appears to be unmistakable contractions between statement and fact, I am want to tend to take the other side of a position, but doing this is also wrought with risk, as just because one thing is incorrect, it doesn't necessarily follow that the opposite side is correct. The truth may be found somewhere else entirely.



Unknown said...

Example 1: ok (assuming nothing omitted from the announcement)

- the market price is only relevant to determine whether non-public information is material (e.g. “information which, if it were widely held, would be material to investment decisions…” or something like that)
- here, the information is now widely held, so any further consideration of where the share price is trading, isn't relevant
- or to put another way, the digestion or indigestion by the market isn’t relevant. It isn’t a fiduciary question or an ongoing obligation but an objective, point in time one - either the information is widely held or not.
- from a public policy perspective…the test needs to be so. The market has to view as 100% true any public announcement made by a company. If potential bidders of the stock place a information risk premium on their process (and who really knows perfectly what is behind the market forces), then that is just capitalism. Maybe the driller will lose his money because the directors are frauds….Maybe no-one will ever buy at $5.

other factors:
- I don’t think it’s relevant that the law extends information to “matters of supposition”….Again, the drill findings have been disclosed. What happens next is not relevant to the analysis
- the driller might land himself in hot water if he discloses to his friends that he is “on this”. His trading intention might, by itself, be considered information (given his connection).
- professional ethical standards (society would frown upon a professional making money this way)…is different to the law.

Extension to a fund manager doing extra research on the information risk premium implied in a listed stock and its disclosures:
- that’s generally what due diligence is (usually in the context of a company’s forecasts)
- the Australian law has a carve out (I think: i’m not an Aussie lawyer) for information that is “readily available”
- in the context of DD on corporate disclosures as opposed to forecasts, you’d just want to make sure the DD doesn’t get into inside know-how or even inside opinions. (“matters of supposition”)….one has to be a little worried about how “readily available” would be read (doing lots and lots and lots of research as a member of the public should be “readily available” IMHO.

Anonymous said...

I am currently of the view that all contracts must be voluntary and well-informed, except in self-defence.

This mandates then that the uninformed seller must be informed, by the informed buyer, as to the nature of that which he sells.

This goes against instinct and culture, but it abides by the ethic stated above.

Lord knows what the law in any given country says.

alexaisback said...

It is Legal in US for Congress

BUT NOW Pelosi's Stock manager or account manager knew about her purchase
interesting did any other of his clients get put into the trade too ?


Herein this 2016 report
Congresswoman makes 3 ML with volatile, and levered, calls and puts on not only the S&P 500, but also on some of the most volatile securities out there, such as the VIX.-

How on earth did she know how to make such trades - no background in trading
she taught psychology for 20 years in an East LA Community College

So did she ask someone HOW ? You bet. And did that spread insider info YES.


Charlotte White said...

meta information is available to employees of the company, therefore it is easy for them to use it to carry out fraudulent trading, resulting in leaving negative impact on the company name.

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