Talk Is Cheap. The title of this 1988 Keith Richards’ music album could well be the paradoxical message of the recent Galleon insider trading scandal and the potential lessons it offers for emerging market regulators such as the Securities and Exchange Board of India (Sebi).
After the Galleon insider trading story broke last month, a young rising equities analyst in Mumbai came to me and said: “I’ve been led to believe proprietary information is the key to success in this business, but evidently that is illegal. Is our business just plain illegal then?” It struck me as bizarre that an otherwise extremely smart analyst could not comprehend something as simple as “insider trading”. But this seemingly unobtrusive question from the analyst was a lot more profound and prompted a question: How do we educate today’s young market participants about the shades of grey in this business?
In a society such as ours that is loud and vibrant with dozens of business newspapers and television channels, information is cheap and commoditized. My dipstick survey of around 20 well-educated, professional equity analysts shows an appalling lack of understanding of the meaning of “material, non-public information” or “insider trading”. Pondering over the question, it dawned on me that there is no process in place today to ensure, first, awareness and, then, compliance with some basic rules that govern well-functioning capital markets.
In an information arbitrage business such as investing in equities, possessing “proprietary” information is perceived to be the cornerstone for success. As most money managers will gloat when asking you for your money, they will beat the market with “superior information and analysis”. What does superior information and analysis entail? Every mutual fund and investment bank revels in the size of its research team: These large teams of research professionals are paid to produce exactly this superior information and analysis.
Moreover, whose responsibility is it to ensure that these professional market participants are educated on the nuances of the blurry lines separating what’s legal, what’s ethical and what’s plain wrong?
The unanimous answer to this question is likely to be a regulator such as Sebi. But it’s not the lack of Sebi guidelines that’s worrying; rather it’s the implementation of those. The first basic step is to increase general awareness among securities professionals of both the actual rules and the spirit behind these rules. A good starting point will be to make it mandatory for securities professionals to be licensed.
Most developed capital markets, such as those in the US or the UK, require mandatory licensing of securities professionals that attempts to highlight various regulatory nuances. Earlier the Securities and Exchange Commission and now the Financial Industry Regulatory Authority in the US require securities analysts to pass four levels of examinations to get licensed. If nothing, this licensing process will help clarify currently prevalent misgivings such as “if my friend’s friend voluntarily tells me about an acquisition for his publicly listed employer, since I did not solicit the information, I am free to use it in any manner I want”.
While cynics will argue that the larger issue is one of morals and ethics, and cannot be solved by regulatory licensing, I am merely arguing for a starting point—not for boiling the ocean in an attempt to uplift moral standards in the country. Awareness is the first step, and compliance follows after. Requiring securities professionals to undergo a fairly rigorous licensing process not only increases awareness among market participants, but also demonstrates to the greater society the onerous responsibility of every individual in this business. I urge Sebi to consider steps such as mandatory licensing of securities professionals and, thereby, send a broader message to every corporate participant in India that “talk is not cheap” and can prove to be very expensive.
Published on 04 November, 2009 in Mint