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Insider leaks can be good data for investors

india Updated: Nov 02, 2009 22:08 IST

The recent case in the US of prominent hedge fund manager R Rajaratnam has put the spotlight on insider trading. Rajaratnam, who apparently knew the who’s who of the tech industry in the US, had a group of people who were well-placed to systematically feed him information that enabled him to trade profitably.

It is not surprising that prominent members of his network were of South Asian origin. It is an open secret that insider trading is rampant in India and that it almost routine to find promoters running their stock up and down.

Not just that, many small investors, especially those who recently lost money, have a conspiracy theory in which money is always made in stocks by those who have inside information at the expense of those who don’t.

All this is likely to be true, but it actually doesn’t matter. Or rather, insider trading matters but its impact may actually be neutral to positive. To understand this, one must distinguish between official insider trading (involving management trading in its own stock) and what the likes of Rajaratnam do. This type of insider trading is based on information sold by insiders to brokers and investors. In the Rajaratnam case, some of these insiders were not even senior managers. They were just employees or even outsiders like vendors and consultants who happened to have non-public information that could move a stock.

I think that this kind of insider trading is not only unstoppable, but actually useful. Investors are best served by more and more high-quality information getting factored into a stock price. It is known among investors and the media that official corporate information is often a highly sanitised feed designed to keep investors bullish.

If there’s anyone out there, insider or outsider, who is leaking information that is injecting a dose or reality into a stock’s price, it is good for investors, whatever the motive of the original leak.