In August 2010, the Institute of Economic Affairs published a monograph “Does Britain need a Financial Regulator?” .Written by Professor Philip Booth and myself, with a particular focus on Stock Exchanges around the world, our conclusion was no, it does not.
Within days of publication we were vilified by several commentators, including a barrage from readers of my blog article on the website of Conservative Home.
Given the subsequent performance of the Financial Services Authority in several areas perhaps we can now hope for a little more support. Take, for example, the fiasco of the FSA report on the demise of the Royal Bank of Scotland (the latest trick being the appointment of the insider Sir David Walker), or the FSA veto (yes, veto) of a proposal to put all RBS directors up for re-election, thus ensuring that Sir Fred Goodwin stayed for another six months and a doubling of his pension. Or take the FSA’s own almost unbelievable empire building, supported by the government and heavily driven by levying unlimited fines of its own choosing. Or its clampdown on communications between journalists and their city contacts. And, of course, its complete failure to foresee the financial crisis because of its total lack of nous. (I have kept an interesting e-mail exchange between myself and Hector Sants on this but that had better stay private.)
Financial entities and in particular Stock Exchanges, would be far better left to their own devices – as they once were, making their own rules which had to attract both corporate listings on the one hand and buyers and sellers on the other, thus leading to a race to the top; emphatically not a race to the bottom which State regulators everywhere would have us believe.
As an example of possible rules for a private Stock Exchange, take the contentious case of insider trading. There is no reason why such a feature should be a criminal offence. As the US lawyer Richard Epstein wrote, “for a company to legitimize insider trading all it needs is a provision in its charter saying “if you want to deal in shares with this company, please understand that every employee and every director is entitled to trade on insider information to their heart’s content. If you do not want to trade with us you are free to buy shares in our competitor which does not allow that option”2.
I can just imagine Lord Turner shouting the odds here; “Make insider trading a matter for contracts between the company and its investors? You must be joking. You’ll be suggesting that companies have control over their Memorandum and Articles next!”
In fact the criminality lies with the regulator. There are clear reasons why insider trading would often be helpful; under free markets, there is a raft of devices which would enable shareholders to control insiders. Not the least of these is a thriving takeover market. It is all of a piece that the FSA looks upon such a market as necessarily hostile. In the majority of cases any hostility is directed at incompetent management, where a takeover would enable shareholders to dismiss the incumbents in favour of a new and better management. In other words the FSA protects incompetence at the expense of shareholders.
Another incontrovertible point is that an insider not trading may be just as important a signal as trading, but naturally it can’t be spotted!
The activities of successful speculators in short-selling have many similarities to insider trading. In both cases the essential point is that such activities get market prices nearer to where they should be faster, so that those profiting, far from making a quick buck at the expense of others, are effectively sharing their knowledge with the rest of the world. It is the unsuccessful speculators and insiders that we should worry about, but fortunately they don’t last long!
It is true that for the present the FSA has nothing on the USA’s Securities and Exchange Commission. Formed in the early 1930s, it is even more scary, and the IEA monograph referred to herein highlights some dreadful abuses of power. For example, our research suggests strongly that at least two of the most notorious jailed insider-dealers (Martha Stewart and Kenneth Lay) were not guilty even as charged. But that’s cold comfort at best for those of us on this side of the pond.