Posts tagged with: Commodity Futures Trading Commission

tradingplacesFor most of my life, much of what I’ve learned about the world came from watching movies. This was especially true in 1983, when I was in junior high. That was the year I learned about astronauts (The Right Stuff), thermonuclear war (War Games), and ewoks (Return of the Jedi). I also learned about financial crimes—specifically insider trading— from the Eddie Murphy/Dan Akroyd comedy, Trading Places.

If you’ve forgotten the plot, here’s a brief summary by Gary Gensler, the former Chairperson of the Commodity Futures Trading Commission. In testimony before Congress, Gensler said,

In the movie “Trading Places,” starring Eddie Murphy, the Duke brothers intended to profit from trades in frozen concentrated orange juice futures contracts using an illicitly obtained and not yet public Department of Agriculture orange crop report. Characters played by Eddie Murphy and Dan Aykroyd intercept the misappropriated report and trade on it to profit and ruin the Duke brothers. In real life, using such misappropriated government information actually is not illegal under our statute. To protect our markets, we have recommended what we call the “Eddie Murphy” rule to ban insider trading using nonpublic information misappropriated from a government source.

Turns out I wasn’t wasting my time on a silly comedy—I was learning about a future commodities regulation.

Yet aside from the “Eddie Murphy” rule, I don’t actually know that much about insider trading. I also hadn’t given it much thought since watching Gordon Gekko get rich off inside information in Wall Street (1987). But this week I listened to an intriguing Planet Money podcast about the topic. The show’s hosts, David Kestenbaum and Jacob Goldstein, ask a question that I hadn’t considered before: What makes insider trading wrong?

Let’s first define what we mean by the term. As the Securities and Exchange Commission explains,

Dodd-Frank regulations, originally scheduled to take effect on July 16, are intended to create market stability. Instead, they are doing just the opposite.

Regulations aimed at financial derivatives, incorporated into the Dodd-Frank Wall Street Reform and Consumer Protection Act that was signed into law last July, have recently been rescheduled to take effect on December 31. The regulations are aimed at reducing the risk of derivatives, a contentious issue among those debating the root cause of the financial crisis. A Reuters’ report suggests this legislation will create uncertainty and a legal void for the derivatives market. Fears that trades could be challenged or invalidated may send the market for swaps (over-the-counter derivatives) into “legal limbo,” according to NASDAQ News.

Scott O’Malia, a commissioner of the Commodity Futures Trading Commission, told Reuters,

I have concerns that this proposal will not provide the appropriate level of legal certainty, and if it is to last only a few months, will likely only serve to further confuse and frustrate the markets and market participants.

Legal delays and uncertainties are only a small part of a much larger problem. Saturated with 2,253 pages of confusing regulation, Dodd-Frank is considered to be the most drastic financial revision in 80 years.

Former U.S. Senator Judd Gregg, now an adviser to Goldman Sachs, says Dodd-Frank goes too far for our good. He argues the regulation will hurt job creation and smother economic growth:

The consequences will be a massive transfer of economic activity overseas and an equally massive contraction in the liquidity and credit that keeps U.S. business competitive and vibrant.

Though intended to stabilize the financial market, Dodd-Frank is creating more uncertainty and instability at our liberty’s expense. Regulation will harm competition and stifle individual freedom. In an attempt to correct the immoral behavior on Wall Street, the government is compromising the dignity of the individual by reducing financial choices.

In a commentary titled “Credit Crunch, Character Crisis,” Samuel Gregg, the Director of Research at the Acton Institute, discusses the financial and moral costs of similar risk-controlling regulation in the past:

A longer-term problem is that this failure may facilitate calls for more financial regulation, much as the Sarbanes-Oxley Act was a response to America’s 2000-2001 corporate scandals. The evidence is growing that Sarbanes-Oxley has proved extremely costly for business. Even Sarbanes-Oxley’s authors now concede many of its provisions were badly drafted.

According to a University of Pittsburgh study, Sarbanes-Oxley’s discouragement of prudent risk-taking and its generation of additional compliance-costs have contributed to many firms listing themselves in the City of London rather than Wall Street. This has also been facilitated by Britain’s Financial Services Authority’s shift away from Sarbanes-Oxley-like procedural approaches to financial regulation, towards principles-based regulation which focuses on (a) the behavior reasonably expected from financial practitioners and (b) good outcomes.

In the end, however, no amount of regulation — heavy or light — can substitute for the type of character-formation that is supposed to occur in families, schools, churches, and synagogues.

These are the institutions (rather than ethics-auditors and business-ethics courses) which The Wealth of Nations’ author, Adam Smith, identified as primarily responsible for helping people develop what he called the “moral sense” that causes us to know instinctively when particular courses of action are imprudent or simply wrong — regardless of whether we are Wall St bankers or humble actuaries working at securities-rating agencies.

Perhaps the recent financial turmoil will remind us that sound financial sectors rely more than we think upon sound moral cultures.

Gregg’s economic and moral analysis suggests regulation cannot build character. The implicit goal of Dodd-Frank is to achieve moral ends on Wall Street through coercive means — expanding government oversight. We must remember virtue cannot be artificially manufactured by increased regulation; rather virtue requires freedom to choose the proper course of action. Moral character in the business world should be encouraged by a proper incentive structure, but even more importantly by the values taught in our social institutions.