M. TODD HENDERSON: I
went here as a student. And I have the great fortune
of being a professor here. I haven’t met a lot
of you, but I will. My name’s Todd and I’m
delighted you’re here. This is Chicago Best Ideas Talk. These talks started as
a way of introducing new students to Chicago to
some of Chicago’s best ideas. We’ve run out of
them, and so they’ve changed it to
something else, which I’ll tell you in a second. But just to tie it back to
the tradition– I believe in tradition– there
was a piece by a guy named Harry Kalven, Jr. and a
guy named Maurice Rosenfield. They wrote a paper in
1941 about class actions. STUDENT: Turn your mic on. M. TODD HENDERSON: Turn it on? Class actions. And they use as their
example securities regulation and the necessity of having
class actions to enforce securities fraud and how
private lawyers could be better than the government. And that will be a theme
that I come back to. They got it wrong. The next feature of the
modern Chicago’s Best Ideas is expose students to the latest
Chicago ideas, not the best. That’s yet to be determined. You guys can go the end,
but probably not true here. And that’s the basis of my
talk, joint work with a guy named Kevin Haeberle, who
teaches at South Carolina. And then also to act as kind
of a trailer for other content you can get at the
Law School and so this is a trailer for Securities
Regulation, for those of you who haven’t
taken it, which is going to be with me in
the winter, [INAUDIBLE]. You should take that course. It’s pretty fun. OK. The punchline from today is the
entire securities regulation apparatus we have should
be dismantled and replaced with something
completely different. The regulation is not
just not worth the cost, it’s unbelievably perverse. If you replace this central
problem of securities regulation with a
market system, we’d get all these benefits, better
disclosure from corporations, better allocation of the costs,
better policing of fraud, and better results
for every American. At the end of the day, I hope
I can kind of convince you that even though this
argument is going to sound unbelievably
Chicago, I’ve got– well, I’m at Chicago. I went here. I’m wearing a University
of Chicago tie. I have a [? free bird, ?] which
is making Dean [INAUDIBLE] have agita up on my slide,
even though this is so Chicago, markets, not regulation. Liz Warren, God bless her
heart, should support my ideas. That seems like a win-win. If I can agree and Liz Warren
agree, this should be policy. STUDENTS: [LAUGHTER] M. TODD HENDERSON:
The central problem of securities regulation is
informational asymmetries. Companies that are raising money
do so in the primary market. Issuers of securities,
that’s companies, sell stocks and
bonds to investors. And when they do
that, the companies have a lot more information
about the company than the people buying it. This is the document that
Facebook filed when it registered to sell securities. It’s 500 pages long. Thousands of man-hours went
into producing this document. The lead lawyer was a
guy named Ted Ullyot, who is a graduate of this
law school and took, I don’t know, a lot of
money out of Facebook for doing this work. But this isn’t the stock
market we normally think of. This initial public offering’s
a very tiny part of it. Another part of it
and what we think of as most of the stock market
today is the secondary market. And that’s the New York
Stock Exchange, investors trading with other investors. And in those trades
too there can be informational asymmetries. After all, some investors
may have better information about the company’s prospects
than other investors. And securities
regulation is primarily designed to reduce
the information between issuers and investors
and between investors in the secondary market. It is premised on a
coerced disclosure regime. Force companies to disclose
information to their investors and force them to
disclose information in the secondary market so
the trades among investors happen on relative
information parity. This regulatory apparatus
is eight decades old and is largely based on
completely unrealistic assumptions about the way
modern securities markets work. OK. So what are the
current solutions to informational
asymmetries in securities? The first one is Regulation S-K.
Regulation S-K tells companies exactly what must be in here. It is a government recipe. It is a command and
control approach to regulate
information disclosure. So normally when we want to ask
people what information they want, or to give
them the information, we can ask them and say,
well, what information are you interested in? The government in securities
doesn’t ask investors. It tries to imagine
what information they would like and
prescribes a recipe, down to every single item
that must be in that document that I just showed you. It’s a guess as to
what investors want or maybe what they should want. Another component of
this information market to [INAUDIBLE]
information disclosures is a very robust
anti-fraud regime. After all, if I’m
an investor, can I trust what Facebook discloses
in this voluminous document? If they’re not held
accountable for the lies that they would
tell in here, then that will cause me as
a potential investor to pay less for the
shares than I would if they could credibly commit
to me they weren’t lying. Imagine there’s two companies,
a good company and a bad company and the good company cannot
distinguish itself from the bad company, the one that’s
going to lie to you. And I don’t know as an
investor whether I’m investing in a good
company or bad company, because they can’t
distinguish themselves. And that would be the
case in the absence of a strong anti-fraud regime. Knowing that, I would
ascribe some probability of being defrauded to
even the good company. That would mean I would
pay less for the shares. And that would raise
that company’s cost of capital, which is bad
for everybody, especially the good company. In other words, the good company
would be cross-subsidizing the bad company. An anti-fraud regime,
if you opt into it, says everything in here is true. And the fraudsters are
going to avoid that market because they know they’ll
be held accountable. So the Kalven idea for
securities regulation is [INAUDIBLE] and
the fraud regime is largely going to be
policed by private lawyers. Plaintiff’s lawyers
using class actions are going to be policing
fraud in securities markets. We have an insider trading law. Insider trading
law prevents people who have inside information
or information they got from insiders from trading. It’s about forcing information
disclosure to correct the information asymmetries. And then finally we
have Regulation FD. Regulation FD stands for
Regulation Fair Disclosure. Regulation FD requires
companies to transmit corporate information at exactly
the same time to all investors. The object, not
surprisingly, it’s fairness. After all, if I’m
a company and I have information that’s
valuable to the market and I disclose it to him before
I disclose it to him, and these two trade, they will
trade on different information. And that’s not fair, so I have
to disclose it simultaneously to the entire market. I can do via Twitter, Facebook,
news dissemination services, so I’m not limited
by how I can do that, but it has to be
simultaneous disclosure. This is a vast, vast
regulatory apparatus. And no one has any
idea how much it costs. I have looked and
searched in vain. I’ve asked every think-tank
and interest group if they have any
ideas, and no one has tried to put an
estimate on this. So we have this giant
regulatory apparatus which is designed to
get information out of the companies and into the
hands of investors, thousands of suits of all these different
kinds, lawyers at every firm, every business that
issues securities has hundreds of employees
who deal with nothing but these four bullet points. So we have a huge cost. And presumably
there’s some benefit. But this is Chicago, so
we don’t take anything that the government does
and just say, oh, well, it must be that the
benefits outweigh the costs. We should put this to scrutiny. We should ask
ourselves, what are the benefits of
this system, and are they outweighed by the costs
or do they dwarf the costs? Could we do it in a better way? OK. What are the problems
with this current system? So first, the disclosure
is highly inefficient. If the goal of the disclosure
is to give investors information they need to make
investment decisions, then why in the world are we
prescribing the kinds of things that investors get by having
bureaucrats and politicians guess as to what they want? For instance, the
Congress and the SEC have recently passed two
new disclosure requirements for firms. One is that firms
have to calculate the ratio of pay of the CEO
to the average employee. I can stand here today and tell
you with absolute certainty no investor cares
about this number. I should note, before
I sound like I’m a shill for corporate
CEO pay, although I am, I should note we Americans
might really care. We all might want to
know the pay of CEOs relative to average
workers, just like I want to know how much Angelina
Jolie is making for her latest movie relative to the
person who does her hair. That may be a relevant,
politically salient thing. But it has nothing to do
with investors qua investors. Conflict minerals. Companies now have to
certify in their disclosures that all their products are
free of so-called blood diamonds or conflict minerals. Again, this may be the
most important issue facing America today– it’s not. But even if it was, this has
nothing to do with investors. Investors don’t care
if blood diamonds are part of your supply chain. These are political issues that
have corrupted the securities disclosure regime. And there are hundreds
of them in this document. If we as a society want
these things to be disclosed, we should have all
companies disclose them instead of muddling them
up in the securities world. The form of disclosures. The font, pagination, type has
not changed on this document since I was a law student. And we didn’t have the internet
when I was a law student. That means this is
like stone tablets to the high-speed traders
that prowl the canyons of Wall and Broad Street in New York. They want information,
modern investors want information in
machine-readable forms that they can just put
into their algorithms. They don’t want this. And yet, this is what they get. This is what the bureaucrats
in Washington think, Courier 12-point. That’s exactly what people
are demanding these days. STUDENTS: [LAUGHTER] M. TODD HENDERSON:
Timing of disclosures. The timing of disclosure
is because companies are forced to disclose,
but they’re only forced to disclose at
particular periods, and only when the
bureaucrats tell them they have to disclose. Companies are very gun-shy
about additional disclosures. The minimum standards
set by the SEC become not just–
they were intended to be floors of disclosure, but
they quickly become ceilings. Firms have legal
risk from disclosure. They can be sued under
the securities laws if there’s anything
in this document that is a misstatement or omission. They can be sued, so
disclosure has costs. It has no benefits. How does the company benefit
by disclosing new information to the market? After all, in the secondary
market, investors trading with investors,
the company’s not profiting from those trades,
so they have very little upside and disclosure risk,
which means we’re going to get less disclosure. We’re not going to see lots
of disclosure, potentially not as much as the optimal. The cost allocation. Whatever the size and cost
of the securities regulation regime is– I did a
McKinsey-style pull it out of my butt, back of the
envelope kind of estimate, and I think it’s probably a
couple hundred billion dollars per year. Who pays that? Well, it’s a tax that is
paid by all investors. Every American who is an
investor in a US corporation pays, which means
every American pays, because almost everybody
works for a corporation. They produce most of our GDP. So the disclosure
regime is something that’s paid for by coal
miners and pensioneers and teachers and
firefighters, et cetera? But who benefits
from disclosure? Who benefits from disclosure. Well, everybody benefits
from disclosure insofar as disclosure helps
ensure that capital is allocated efficiently
and corporate governance is of a relatively high quality. Everybody in society
benefits from that. But one group of investors
benefits in something else in addition to that. And those are the people who
are the traders, who make trades based on changes in
corporate information. That’s not you and me
who invest in 401(k)s. That’s not average Americans
whose optimal strategy is to buy stocks and hold
them until they retire. The people who
benefit in addition to capital allocation
and corporate governance are high-speed
traders, hedge funds, and other people who make as
their living buying and selling shares in the short-run based
on changes in information. Those people are the
people who profit from coerced
corporate disclosure, but they pay no more than
the average shareholder does on a proportional basis. This is the part that Liz
Warren should really like. If we could figure out a way
to make the information traders pay, as opposed to the average
traders, that would be a win. It would be better than a tax
on Wall Street trades, which is something that several
Democrat politicians have proposed. Disclosure is unchecked. The Regulation S-K had
in 1990 7,500 words. Last year, 130,000. 15,000 words were
added to the Code of Federal Regulations in
Regulation S-K in the last year alone. So this is system
of more disclosure must be a good
thing, politicians and political apparatchiks at
the SEC adding more and more disclosure items
into these documents has a huge cost on corporations. Corporations have to
collect this information. They have to certify
that it’s true, otherwise they face liability. These are huge costs. There’s other costs,
the litigation risk that comes with making
even innocent mistakes. There’s even more costs. The more disclosure
we give people, the less people pay
attention to the disclosure that already exists. Disclosure is not free and
it’s become, unfortunately, a dumping ground for the
political whims of our rulers. Investor fairness. This disclosure
regime is premised on being fair for investors. Well, why do we give
people information– think about going to the store
and buying a granola bar. When I was a kid, back
in those halcyon days, you’d go to the store and
you’d buys some cheese puffs, and you had no idea the poisons
you were putting in your body. You didn’t whether
it had gluten or GMOs or how many grams
of fiber were in it. I didn’t know what fiber
was when I was your age. Well, thankfully,
our beknighted rulers have now told us how
many grams of fiber are in our granola bars. We can all sleep at night. My guess is that nobody–
the average person never looks at a food label. They pay for it, just
like all shareholders pay. That food label
doesn’t– it’s not free. And so everybody pays for it. And, you know, probably
the Lincoln Park set looks at food labels. But of course, it’s being
paid for by coal miners in West Virginia. That’s its own kind of problem. But at least that kind
of forced disclosure that’s paid for
by everybody could be justified on the grounds
that maybe it causes people to change their behavior. I never would have looked
at how many calories were in the Double Baconator. But now that you’ve forced me, I
now will update my preferences. OK. That’s a plausible story. I don’t believe it for a second
in the food labeling context, but OK, maybe. It is not only not true in
securities, it’s perverse. We don’t want people
trading on information. There is a theory that goes
back to a University of Chicago professor named Harry Markowitz
called modern portfolio theory, which tells
people– this is 1953– tells people the optimal
strategy for investors is to buy and hold
for the long term. Buy a portfolio of the entire
economy, some index that represents America writ large,
and over a 30-year period, you will get a 6.5%
return on your money. That’s what everybody
should be doing. If you’re an investor and you’re
not doing that, you’re wrong. And if you think that there
are people out there who can pick stocks and
systematically beat the market, you’re wrong. You are as likely to
go to Vegas and win. The returns are– there
have been some studies on this– almost identical. You go to Vegas, you get back
$0.97 on every $1 you spend. You go to Charles Schwab,
you get back about $0.97 on every $1 that you spend. So we have known
this since the 1950s. The optimal strategy
for average Americans, ignore all corporate news. Dollar cost average. Invest a certain amount every
month that you can afford and forget about it
until you go to retire. What is forcing
average Americans to get information
disclosure that companies do? It, first of all, gives them
information they don’t need, information we don’t
want them to have, because we know it’s
sociallly suboptimal for them to be trading in
individual stocks. It’s costly for them. And, especially when it’s
pitched in terms of fairness, it may encourage them
to act in ways that we know are going to harm them. It would be better
to put a giant sign up on Wall Street that says,
unfair in the short run, really good for you
in the long run. That would align
people’s incentives with what we know mathematically
is in their best interest. In terms of deterrence
of fraud, the system that Kalven and
Rosenfield imagined has been abject failure. It is true that private lawyers
have stronger incentives to bring cases than
the government might. They don’t face
budgetary constraints. Private entities
attract better talent than the government does. But the problem is the economics
of the litigation system encourages nuisance
suits that basically are used to extort payments
from companies that go into the pockets of lawyers. There have been 4,000
lawsuits since 1995, securities fraud lawsuits. Companies have paid $90
billion to settle these claims. And almost none of
them have anything to do with corporate fraud. There is zero evidence
that any of these suits actually deter corporate fraud. In addition, companies
have very weak incentives to police insider trading. Insofar as insider
trading is a bad thing, corporate executives
trading on information, the company cannot profit from
any information that corporate executives use to trade. The company has to
give it away for free. It has to give it
away for free and it has to give it
away simultaneously to all investors. So if the CEO has
inside information and she’s trading
on it, she’s not harming the
corporation in any way. Maybe indirectly it generates
some lawsuit or something, but not really harming them. But imagine if companies could
sell corporate information. Instead of giving it away for
free, what if they could sell valuable corporate information? Well then, if the CEO was taking
that corporate information and selling it for– using
it for her own purposes, that would harm the corporation,
because presumably the company would be able to charge
less for the information it sells the market
as a result. This is– I’ll preview it
when we’re [INAUDIBLE]. OK. So my view of the current
system is it doesn’t work. It’s costly. It has very bad incentives
about getting the investors who really want and use information
the information they want in a form they want
it and when they want it. It deceives the most
vulnerable investors into believing they
can beat the market. Doesn’t act adequately to
police and deter fraud. OK. So to sum up my proposal, I will
start with some assumptions. I’m a welfarist, which means my
objective function here is not to max out shareholder value
or CEO power or anything other than what I
think is social value, so I’m coming to this from
a social welfare lens. Corporate information
is corporate property. The information contained
in this document was generated by Facebook. It belongs to Facebook. There’s nothing
public necessarily about this information. And corporations, our
starting principle should be that people
who produce information can use that information. The Supreme Court, the
noted right-wing justice RBG, the Notorious RBG, said as
much in a case called O’Hagan. Corporate information is
corporate property for them to use as they see fit. This may be heretical at Yale. Are they still even
having classes at Yale? It seems like maybe they’ve
stopped thinking there. But insofar as they are
having classes and insofar as they did learn
anything, at Yale these arrows would be reversed. Of course government bureaucrats
than markets at deciding things like what should be in the
content of disclosures. But here at Chicago,
our starting position is markets are better
than command and control. Does that mean markets
are going to provide perfect solutions at all times? Of course not. Of course. Even the 1-Ls in
here know and have seen many examples of places
where there are real market failures, pollution just
being a classic example, but there are many of them. But our starting
position should be that markets are going to
do better than similarly situated command and control. The SEC’s fairness
rule, Regulation FD, unsupported by any evidence that
it actually improves fairness. In fact, by duping people into
believing markets are fair, it probably is unfair. Maybe that’s what
the SEC was up to, but we’ll come back
to that in a minute. Information
technology, computers. I now have one on my wrist. They enable trading in
ways that would have baffled people in the 1990s. And information technology has
made securities markets today an absolutely pros-only game. 22 seconds is the average time
that a stock in the United States is held by an owner. 10 years ago, this
number was 7 years. 22 seconds is the average
time every stock is held. That shows you the
velocity of exchange and how many trades are
happening on Wall Street and how much
corporate ownership is diffused through the society. 15 milliseconds is
the amount of time it takes the market to
incorporate new information. My evidence for that
is the University of Michigan collected
consumer sentiment– they asked people in a
survey about their views about the economy. Are you going to be buying a
refrigerator and PlayStation this year? They had a score. They came up with
a single number and like consumer sentiment
is 30, whatever that is. That information
is hugely valuable, because it’s an estimate
of future economic growth. So the materiality, the value
of this was well established and traders wanted
this information. University of Michigan
sold it to a company called Thomson Reuters. They make a lot
of your textbooks. And Thomson Reuters
released this information at 9 o’clock every month, second
Monday of every month, 9:00 AM. But Thomson Reuters
realized they’ve got something valuable,
market-moving information, and market-moving
information they did not get from
inside any company, therefore not insider trading. What would you do
if someone– this is like the end of Cat in The Hat. What would you do if your
mother– what would you do if you found
yourself in possession of unbelievably valuable
market-moving information that was not illegal for you to sell? You’d sell it, which is
what Thomson Reuters did. They said, oh, we’re
going to be telling those fools in the
public that so we’re releasing this at 9:00 AM. We’ll sell it to you two seconds
early, for a subscription price of $6,000
a month, plus you get this set of steak knives. STUDENTS: [LAUGHTER] M. TODD HENDERSON:
Lots of hedge funds paid $6,000 a month to
get two seconds early access of this information. And researchers
looked at how quickly the stock price of
S&P E-mini futures traded here in Chicago changed
in this two-second period. And the price fully changed
from its level that it was at, the level it should
be at, given the results of the consumer survey,
in 15 milliseconds, including the time it took for
the information to get from the Thomson Reuters building
in Manhattan by speed of light down to Wall Street to the
computer of this high-speed trading firm, who took that
number and processed the change in price and
executed the trades, and then to the Exchange and
in there and through the– that all happened in 15 milliseconds,
which means if you’re Billy Bob and you’re sitting in Des
Moines at your computer terminal and you’re watching Squawk
Box, and you’re just– you don’t even want to blink
and you’re just watching, waiting for the consumer
sentiment to happen and you press Enter as soon
as possible, pre-programmed, it would take you–
you might as well be trading in 2,000
years over your DSL line to the switching station,
up to the satellite, down to your broker, your Edward
R. Jones broker in St. Louis. I mean, no. STUDENTS: [LAUGHTER] M. TODD HENDERSON: No. You shouldn’t be doing it. And even if you
should be doing it, you are hopelessly
out-gunned by people who have made massive
investments in doing this at unbelievably high speeds. OK. The last assumption
is this one, which is we are OK with
staggered starts. We’re OK with staggered starts. If you’ve ever run
a marathon, you’re totally fine with participating
in two separate races. There’s one race which
is for Kenyans and that happens at the front. There’s another race
for weekend warriors and that race
happens at the back. And everybody’s
in the same race, but the race organizes
realize one thing, which is the guys in
the back are never going to beat the Kenyans. And even though we’re
all in the same race, we’re in it for
different reasons. The Kenyans are in it to win
prize money and fame and glory. And the people in
the back are in it because it was a good
incentive for them to exercise. They’re going to feel
really good about bragging to their friend. They’re going to have
accomplished a goal. I don’t know what
people– you’d have to be crazy unless you were
being chased to run that far. STUDENTS: [LAUGHTER] M. TODD HENDERSON:
People have all kinds of skewed utility functions. It’s different than the Kenyans. And the stock market
is exactly the same. The people who are investing,
the hedge fund people, the high-speed traders,
they’re in the same market as me and you, but we’re in
it for different reasons. They’re in it to trade
in the short-run, based on price changes, based
on changes in information. They’re information traders. And we tolerate them
earning big profits because we think
they incentivize the creation of information
in the first place, because they’re trading
creates liquidity. All kinds of stories
you could tell, and I don’t know whether
they’re all right or not and I don’t know whether the amount
of investment in society [? that you make in those days
?] is socially optimal or not. No idea. But that’s what they’re doing. That’s totally
different than what I give TIAA-CREF $1,500 a
month to invest in my 401(k). I’m never going to look at it. My statements that I get
that the government requires they send to me go right
into the garbage can. And I teach securities law. And when I turn 75, God willing,
I will open up my account and say, OK, honey. We’re living in
France or El Salvador. STUDENTS: [LAUGHTER] M. TODD HENDERSON:
So do I propose? I propose we allow
companies to sell their corporate information,
to create a market. Companies would
come to the market, and instead of having to
disclose corporate information for free, they
would say, imagine, we have some corporate news. We will disclose it at
noon to those people willing to pay for it. You pay us, I don’t know,
could be a subscription, like Thomson Reuters did. It could be a bespoke contract. Depending on the value
of the information they would set the
market price based on whether they thought
the information was valuable or not. And they would sell
that information. People who paid the
subscription price would get access
to the information and could trade on it. And people who didn’t subscribe,
depending on whether you’re paternalistic or not, we could
treat them– we could say, you’re not allowed to trade. That would be paternalistic. You don’t have the information,
you shouldn’t trade. Or we could say, you know what? Go ahead and trade
if you want to, but there’s a big sign up
here that says, you know, adult swim. If you’re not an adult, you’re
not a high-speed trader, get out of the
pool, because you’re going to get kicked in
the face or whatever. You’re swimming with
sharks, so if you’re not wearing a chain-mail
suit, get out of the pool. This transparency, which
is just caveat emptor, would actually help
non-informed traders, because they could
know there was a period of acute
informational asymmetry coming, and I could withdraw
from the market. I have an order in place
to buy or sell securities, but now I know at
noon, from noon until noon and 15
milliseconds I’m going to get taken
to the cleaners and so I can withdraw
from the market. So instead of trying to remedy
informational asymmetries– which is the SEC’s stated
purpose, but they can’t. Instead of remedying them,
we make them transparent and announce them. Danger. Avoid this. So I withdraw for
15 milliseconds. The price adjusts and now I
can trade at the new level. And even if I
thought, oh, there’s profit-making opportunities
there that I– you would never have
gotten them anyway. You were hopelessly outmatched. It would be non-discriminatory. That’s a good thing. We can all be in favor
of nondiscrimination. Anybody can buy. You want to pay $6,000 to
get access to information? That’s fine. We can imagine a world in
which we regulated investors and said, unless you’re
really sophisticated, really rich, we won’t let you buy,
because it’s bad for you. But I’m much less
paternalistic that that. You want to be
stupid, that’s fine. It’d be transparent. Companies would
announce to the market, in just the way they
do now, that they had something for sale, so
anybody who wanted to buy could get in. And there would be this
Pros-Only period, a POP. It could last a few seconds. Some people for some
types of information, maybe it lasts longer. Maybe it’s an hour. Very complicated
information that can’t be reduced to
machine-readable terms could last longer than that. The price, the form of delivery,
the content of the information would all be set
by market forces. If investors want
information more often, firms can meet that demand
for corporate information by charging them for it. The form of delivery,
companies that deliver better forms,
machine-readable, simpler, better tables, things
that help investors, they will be able to charge
more for their products, just like companies that
provide us with everything else, cars and toothpaste
and granola bars, the ones that do it
better can charge more and they survive in
the markets and thrive. The ones that don’t
go out of business. That kind of learning
would make this disclosure radically different. OK. Benefits. Average investors will
have better outcomes. They have lower trading costs. Their trading cost will be
lower because the intermediaries that we trade through– when
I invest in stocks today, I buy an index, I
don’t invest directly. I invest through
someone who makes a market in that
particular security, that is someone who stand willing
to buy and sell at any time from anybody. Those people charge
prices for their services, the market-making
services, based on their estimate of the
informational asymmetries in the market. After all, those
people, if there are acute informational
asymmetries and they’re buying or selling
from anybody at any time, if they’re trading against a
better-informed counterparty, they will lose. They pay $10, the
better-informed counterparty knows it’s worth $5,
they will lose $5 for holding that security
for any period of time. So what do you do if you’re a
market-maker in an area where there’s very high
informational asymmetries? You charge people more
for your services. You charge inventory
risk for your securities to your customers. And in a world where
informational asymmetries are transparent,
market-makers will know that outside of
those periods, they face lower informational
asymmetries and inside very high ones. That enables to sort and
offer the people trading outside of those periods,
outside of the POP, lower transactions costs. Plus, I’m not going
to get fleeced. The stupid noise traders,
Billy Bob whos’ watching CNBC, he’s not going to be fleeced,
because now he knows, the government has told him,
this is unfair, don’t even try. Information traders,
the people who actually read the
information– no one reads this, except a very small
group of people who would not have the government
design it this way if it was designed just for them. In fact, there’s a
company called RavenPack– there are many companies
like this– who specialize in taking this information,
turning it into a form that investors actually use
and t hem charging them for it. That is per se evidence
that this is inefficient. So corporations are forced to
give away their information to RavenPack, who then turns
it into stuff that people want and charges them for it. What kind of rational
system is that? Makes no sense. The people who use information
are the people we should ask. It’s like imagine that we had
disclosures from drug companies that were directed
only to doctors, and yet we required
those disclosures to be written in plain
English, like the SEC requires securities disclosures
to be written. Why do we write them
in plain English? My wife’s a doctor. They speak a completely
different language. Write it in there language. Write it in the expert
language, not in plain English. Plain English
people shouldn’t be reading corporate disclosures. Liz Warren loves this one. Information traders
pay for disclosure, as opposed to
average shareholders. Charge the Wall Street fat
cats for the information they use to make profits. Why not? Why should average
shareholders pay? After all, as I said, both types
of shareholders, information traders and long-term
shareholders both benefit from capital
allocation efficiencies and corporate governance
benefits of disclosure, but only information traders
benefit from short-term changes in information. My favorite part,
information traders become plaintiffs in
securities fraud cases. Right now, if there’s
some misstatement or omission in this document,
who’s the plaintiff? Well, the plaintiff of
record is some average Joe who has five shares of stock. But the real
plaintiff of interest is some lawyer who is
purporting to represent the class of all
shareholders who have been defrauded by
this line, which turns out to have been a half-truth. And to get at this– to
enable this kind of lawsuit, the Supreme Court invented of
whole cloth something called the fraud in the
market theory, a case called Basic versus Levinson. And Basic says,
you as the investor don’t need to show you’ve
relied on this misstatement. After all, how could you? So we’re going to
presume you relied based on the efficiency
of the market. Sounds very Chicago. Unfortunately, that
means the only securities fraud lawsuits that get brought
are ones where the stocks are traded in efficient
markets, big, publicly traded firms traded on the
New York Stock Exchange. Those are the ones where
the plaintiff’s lawyers have the least problem getting
over the Basic versus Levinson issue. But those are also
the companies that are least likely to
commit corporate fraud. Not that they don’t
ever, but compared to small companies traded
in illiquid markets, like the pink sheets,
they’re way less likely to be engaging
in securities fraud. And yet no one sues the
pink sheet companies, because you can’t bring
class actions against them. And by the way, they don’t have
a lot of money even if you did. So the whole idea
of this fiction of Basic versus Levinson
designed to generate securities lawsuits biases the
suits against the people who are least likely
to commit fraud. What happens when you charge
people for information? Now all of a sudden your
plaintiffs in securities fraud suits are identified. Who are the people who
relied on the information? They are, because they
paid for the information. And the fact that they
paid for the information and bought it in the market
is definitive evidence that to them it was
material information and they relied on it. Now we have
professional investors who actually paid
for information and relied on it
as our plaintiffs. We’re unlikely to get much
better securities fraud suits. Just so we’re clear that
this isn’t ideologically motivated or motivated by seeing
fewer securities law fraud suits– because I
have no idea what the optimal number of
securities frauds suits is. I know those 4,000
suits were not targeted at the right
group of 4,000 companies. Maybe there’s 6,000 suits or
maybe there’s 1,000 suits. But I have no confidence
that those 4,000 are optimal. But just to tell you this
isn’t ideologically motivated, something else that
this information traders as plaintiffs would do is
open up a whole new class of securities fraud suits
that currently are forbidden. If a company lies and says,
things are really, really bad, and you hear that line
and you don’t trade, you don’t buy because they told
you things are bad and then it turns out they were lying
and things were really good, the stock price jumps
up, you cannot sue. You can’t sue because
you didn’t buy or sell. In the absence of a link
to buying or selling, the potential pool of
plaintiffs in that suit is the population of
Earth, because everybody could say, oh, yeah, I
heard that information and didn’t buy. That means, given that just
practical impracticability, that those suits are out. And so one whole class
of securities fraud suits is something that
can’t be brought. Once we have people
paying for information, those suits are possible. I paid $6,000 for your news
that things were really bad. I relied on that
and didn’t trade. The class of plaintiffs
is now delimited, and so those suits are possible. OK. I want to leave some
time for questions, so I’m going to say
objections very fast. Will people provide
early access? I think the answer is yes. I’ve provided some
examples of that, Michigan survey, the RavenPack. In the pre-Regulation
FD world, companies did offer early
access, but they did so in a very inefficient way. They couldn’t charge
for it, so what they did is they just did kind
of quid pro quo favors. I’ll give you the information
early, Miss Analyst, and you give me some
favor in return, like giving me a
better recommendation than is otherwise justified. Or I’ll give you
the information, and you do me some
favor by giving me shares in some other company. So it was a very
in efficient market that didn’t have the
benefits that I’ve described. Will investors pay? Well, one argument is
that you will never go bankrupt by underestimating
the hubris of people on Wall Street in
thinking they’re better than their competitors. So even though this
would transparently make information equal access
among high-speed traders, I think they would
probably still pay. They would probably still
pay because they would think, we’re smarter. We can process this
information better or we can do it
faster or whatever. And again, the Michigan
survey suggests this is true. Information I buy
about Company A I could use to sell
or buy Company B, so that would be a value. And moreover, imagine that
the price, the clearing price of corporate information
in my hypothesized market was zero. Imagine that GE has
big corporate news. They come to the
market and they say, we’re willing to sell this early
and everybody says, no, no. We’d rather wait until you
publicly disclose this. If that’s true, that
smart money won’t pay to battle with
other smart money, that suggests that our
entire securities system is premised on fleecing
Billy Bob from Des Moines. That is the only
reason that people wouldn’t pay is if they didn’t
think they’d make a profit. And maybe the only
reason they wouldn’t make a profit is because
the people on the other side would be as well-informed
as they are. That would, as I say, be a
test of the kind of dumb money hypothesis, that really
what the SEC is doing when it says we’re creating
a fair market isn’t creating a fair market, it’s attracting
dumb money, noise traders, Billy Bob from Des
Moines to come, because that money is
profit-making opportunity for the high-speed
traders who are providing some valuable social service. OK. My last one. Will confidence in
the market be reduced? This is what I
call the great lie. The SEC premises almost
all of its regulations on this assumption
that if we tell people that Wall Street is
not fair, that people withdraw all their money. And again I go back to
the marathon example. That’s like saying
if we tell people that the Kenyans
are going to win, then no one’s going
to run the marathon. And I think this is just a lie. I don’t think the
American public is going to withdraw
their retirement savings from the stock
market because they think that in the short-run there
are people who are going to be making money
trading on information that they’re not going
to have access to. So I think we should
tell the truth to people. Don’t invest in the
short-term information game in Wall Street. Dismantle the regulatory
apparatus that’s designed to encourage you to
do that, and instead segregate the market and say Wall
Street’s populated by two types of creatures, weekend
warriors and Kenyans, and they’re running
in two separate races. OK. I’ll take your questions. Please. STUDENT: So I want to go back
to the insider trading point that you made. M. TODD HENDERSON: Yes. STUDENT: A lot of
misappropriation theory if I understand it comes
along with the idea that there’s
something horrifically evil about disclosing
information or using information that other people
categorically don’t have access to. Could you explain a little bit
better how this kind of thing would do better than you’ll go
to prison forever at stopping people from trading
on information that other people
technically don’t have access to or as a favor of their
friend or their relative or as a quid pro quo? M. TODD HENDERSON: OK. Good. So I should say
to be transparent that my prior is that we
shouldn’t ban insider trading and that these rotting in jail
now are [INAUDIBLE] the justice system. But let’s assume that we
don’t want insiders trading on inside information. And again, I think that’s a
very questionable assumption, because– well, I could
go into that, but I won’t. Let’s just assume
for a second we want insider trading to be banned. The current system relies on
the government identifying when corporate
insiders are using corporate information for
their own purposes as opposed to corporate purposes. So the CEO has information. The stock price
is going to gall. She sells the shares in
advance of the release of that corporate information
and makes a profit. And let’s assume
we call that bad. Again, I think that’s good, but
let’s assume we call that bad. We rely on the
government finding traces of that behavior,
bringing a case, proving she knew the information
before it was disclosed, sending her to jail. What would it like in a
world where the company got to sell that information? Again, company knows, just
like she knows, that there’s bad news coming Day 1. Day 2, the company’s going
to sell that information to the market. If it knows, the company knows,
that the insider is going to trade on that
information, what’s going to happen to the
value of the information the company’s going to go and
charge people for on Day 2? It’s going to go down, because
people who know that companies are not policing insider
trading will pay less for corporate information,
because the corporate information will already
baked into the stock price by the people trading
on inside information. So I can imagine a
market in which traders, my hypothetical buyers in
this information market, make judgments about
companies’ ability to police insider
trading, and then say, for companies who are
really good at policing insider trading, I know the
information they’re giving me is not already
in the stock price, I’ll pay more for that. That gives companies
some incentive– maybe not perfect incentives. It gives them some incentive
to do their own policing of insider trading. Right now, they have
basically no reasons, because companies can’t charge
people for the information that their corporate executives
are tipping to friends or charging on their own. So it just motivates
corporations to protect their
corporate information, because they can sell it. And obviously, the stuff
you can sell you’re going to protect
better than the stuff that you’ve got to
give away for free. That’s a simple idea. Yeah. STUDENT: So I take it
that your proposal would apply to both large
trading venues like NASDAQ as well as these off- market
exchanges that you mentioned, the smaller sites that maybe
aren’t covered in the Basic v Levinson presumption. So if the problem is
that information– if the problem is information
asymmetries in the sale and resale of securities,
how do dark pools and other alternate trading
venues that deliberately mask information fit
into your proposal? M. TODD HENDERSON: OK. So it’s a good question. It’s complicated. So there are markets in
which average investors are trading simultaneously
with professionals. That is, I go onto
my E Trade account and I execute a buy order
for the S&P 500 index. That trade comes
electronically to the exchange or some market-maker at
the same time as trades from highly-informed people,
people who were paying say for the Thomson Reuters
Michigan information early. A dark pool is nothing just
other than a private securities market in which there
are no average investors. Nobody like me is trading
in the dark pool, right? It is big institutional
players who are trading with each other. And they choose to be dark
for a variety of reasons. They don’t want to leave traces
in the market and whatever. This problem that I’ve
described about fairness of disclosure, whatever, none
of that applies in that market, because we don’t have this
cooling of different types of investors. So I could imagine a world
in which the information is disclosed by a company
and then people are trading in the dark
pools and in the public pools and wherever they’re trading. It doesn’t matter. But the bite of the
benefits of this really inure to
the public markets, that is the caveat
emptor parts of this. The timing and not
forcing companies to give away disclosure,
whatever, that obviously applies in both markets. But the securities
fraud elements of it and the perverse
fairness parts are really for public markets
where you have average people trading. Yeah. STUDENT: Yeah. If I am a professional investor,
before I get that information, how I could decide whether
I should buy the information from the company,
and how would I decide if the price
is reasonable or not? M. TODD HENDERSON: When you go
onto Zappos– you use Zappos? No. Amazon? Do you go to Amazon? Yes? You buy stuff on Amazon? How do you know whether you
should buy that pashmina and whether the
price is reasonable? The answer is– well,
this is in class, so I’m not going to
give you the answer. The answer is this
magical, mystical thing that Adam Smith called
the invisible hand. I don’t know. I go to the grocery store and
I pick up a gallon of milk. How do I know it’s not poisoned? And how do I know that
$3.29 is the right price? It’s called a market. So when first people
go to this market, the first company who
does this– Exxon Mobil has a piece of
corporate information and they’ve got to go first. And they’re like, boy,
how much should we charge? I have no idea. How much do you think
we could charge? And they could estimate it. They could have some
economists in Exxon Mobil do some estimates. And they put out a price
and they say, $1 billion. And then nobody buys
the information. They’re like, oh, OK. That was too high. STUDENTS: [LAUGHTER] M. TODD HENDERSON: And there’s
trial and error and there’s experimentation. And the people that get
it right get it right, they can charge more. The people who
don’t don’t and then we learn and then we develop. And then, oh,
magically, the prices reflect what the market
thinks the thing is worth. And how can I trust that
Exxon Mobil is going to give me something of value? How do you trust that
the pashmina that you bought from Amazon– markets,
they have feedback effects. They have discipline. There’ll be anti-fraud rules. If Exxon Mobil tells
you that they’re going to give you some piece
of corporate information about earnings and they charge
you a bunch of money and then they don’t, you a nice
securities fraud suit. So this market would
be no different than any other market. Yeah. STUDENT: I have a
comment and a question. The comment is that my
general experience– I would conjecture that many
if not most companies would decline to sell the information,
that they would actually just conclude they’re not in the
business of doing that and so they would give it away. They would prefer
to give it away. So the comment is mostly
just to take that [INAUDIBLE] securities regulatory regime,
because you don’t want it to hinge upon the
idea that there’s a contractual relationship
between two parties when many of these folks
I actually think would just decline to
get into that business because it wouldn’t
be lucrative for them. The question is
when William Robert, because that’s how it’s going
to show up in [INAUDIBLE]– William Robert from
[INAUDIBLE], remember him? When he cannot help himself–
this is going to happen within a second or two of a new
regulatory regime coming out. [INAUDIBLE] So he
continues to get fleeced, by behaving exactly
like he did before, and despite the fact that he
attended all of your lectures, all this sort of thing. How are we going to
prevent ourselves from trying to save
the [INAUDIBLE] by reinventing the
whole regulatory system? So is there anyway
to actually tolerate the various kinds
of collateral damage that will continue
to occur in all this. M. TODD HENDERSON: OK. Great. So this is Dan
Correll, Class of ’97, for those of you who don’t
know, and one of our illustrious graduates. OK. So good. So with respect to the
comment, will people supply this, that
was the first point, I think the answer is yes. But I could be wrong. I could be wrong in the
sense that companies will be very risk-averse. And I expect the
first companies that move– so I imagine there’s
some distribution of companies about their risk tolerances
with respect to disclosure. And I would bet there are
some companies out there who would move first and say, we’d
be willing to charge for this. After all, Thomson
Reuters did it with [INAUDIBLE] that
wasn’t their own. Once the SEC would say, this
is fine, you could do this, I would suspect we would see
some companies try experiments. Some would resist. And if the experiment
was a good one, I think we would see
more and more over time, but I could be wrong. If they gave it away,
we’re not in the business of packaging disclosures, fine. Sell it to RavenPack. Not a company in the world
who currently gives away this information free to
RavenPack to repackage and sell to traders– if you
said to them, look, I’m going to change
that deal, you don’t have to
repackage anything. Have your investor relations
people just do what they do. Now, instead of giving it to
the SEC, go give it to RavenPack and charge them
$5 million for it, I think every company in
America would do that. And then RavenPack
would be the only buyer. They would just resell
at some auction. They could– of
course, RavenPack could, once it got the
information, trade on it. But of course, if the market
knows in a transparent way that, oh, there’s only one
buyer of the information, no one will trade against them. So RavenPack would
then have incentives to get it into the
hands of multiple buyers to create a market. With respect to
William Robert, I don’t view– unlike
most of my colleagues in the academy writ large, I
don’t view the legal project as trying to prevent every
idiot from being stupid with their own money
or their own behavior. However, if you believe that is
the role of law and government, there is a very
simple solution, which is just banning individual
investors defined in some way from
trading during the POP. So just like we keep kids
out of the adult swim, we just put up a
fence and we say, unless you’ve met
this certain criteria, you’re an accredited
investor, you’ve answered these 10 questions
on this survey the right way, you’ve signed up with the SEC,
you have $3 million assets under management, you
can’t trade during the POP. No swimming with the adults. And the cost to you would
be that you would not have liquidity during those 15
milliseconds, a trivial cost. The benefit to you would
be you wouldn’t be fleeced, and during the periods that
aren’t the 15 milliseconds, your trading costs
would be reduced, because the people
you’re trading with, the market-makers,
know there will be lower informational
asymmetries in those periods. OK. One more question. Yeah? STUDENT: Do you think
there should still be public disclosures, and
if so, what would they look like if they’re not being
packaged and sold for investors and who would manage them? M. TODD HENDERSON: Great. So when I’m pitching this
idea with my co-author, you know, I’m like,
look, we could just keep the current [INAUDIBLE]
disclosure regime. That is, Exxon
Mobil goes and says, we’ll charge you for
two seconds early, and then we’ll disclose
it at 9 o’clock. You don’t need that. You could dismantle the entire
public disclosure system qua investors,
because the investors who want the information
paid for it two seconds ago. And every other
investor doesn’t need it and we don’t want them
to get it, qua investors. Yes? So dismantle all of it. The stuff that’s in here,
like that Ted Ullyot went to the University of Chicago
law school and is 46 years old and blah, blah, blah,
blah, blah, insofar as this is valuable for people that
are not investors, that’s fine. Go to the Congress. Convince them to pass a
statute that requires companies of a certain size or whatever
to disclose conflict minerals, and whether they believe
in astrology or Elvis is alive, all the
things that politicians think that are important
about the world. Fine. I’m OK with forcing
companies to disclose stuff. But as investors
and as shareholders, there’s no need for
public disclosure. The people who
pay will be highly motivated to make
sure they’re not defrauded when they’re paying. The information– I
don’t need to know that GE’s earnings per share
were blah, blah, blah, blah, blah. It is utterly– it’s like
knowing where Kim Kardashian went to dinner last night. It is completely irrelevant
to my life as an investor, so don’t tell me, because it’s
one thing if I’m not paying and you’re telling me a bunch
of stuff that I don’t want. But as a shareholder of
American corporations, as a citizen, as someone
who works in a corp– I pay. So don’t tell me stuff, don’t
charge corporations for things that I don’t want or need. I think we have time for one
more if anybody’s– yeah. Please. STUDENT: My question is isn’t
the market in some way already doing this? So just last week
was a great example. We’ve seen Valiant put out
tons of free information to the market, because
effectively their investors have demanded it. But that’s a system that
seems to be working. They’re not giving
it any easier. And it’s clearly
not– I don’t think it’s high-frequency
traders that are clamoring for this
information from Valiant. It’s longer-term
institutional investors that want to know– it looks
like [INAUDIBLE] in the past have been completely wrong. Tell us more. How does that jibe with– OK. Good. So great question. First, to reiterate
a point I made, there are different
types of information that companies disclose. Some of it is things that
high-speed traders can trade on, like machine-readable,
the consumer side of this or that or our
earnings were this or that. Some of it will be narrative. Some of it it will
take longer to process. It will require humans to think
about and make assessments and longer judgements. That type of information could
exist in a separate market. So we could imagine companies
with many markets saying, OK, here’s a bunch of information
about our pending litigation. We’re going to sell that
an hour early to analysts. They’re going to
have it for an hour before anybody else has it. And we’re going to
charge X for that. And we’re going
to charge– we’re going to give other
people information, different kinds of
information, and we’re going to give you two seconds. So I’m completely open to be
there in many types of markets. With respect to the
production of information now, my claim isn’t that the
system is completely broken. My claim isn’t that
there aren’t companies that are sort of
working around this or providing some of
this benefit already. It’s just imagine
what the world would look like if information
were produced disciplined in a market. And the price paid would
be people who are actually using the information. So I don’t know who’s consuming
the valued information. But I want the people
who consume to pay. This is just a classic
[INAUDIBLE] tax. We want the people
who benefit to pay, not the people who are kind of
operating in the background. And I don’t know– I’m
agnostic enough with respect to the questions about what
is the optimal form, what is the optimal timing,
what’s the optimal content of disclosure. How could a law professor
know these things? My only claim is the best way
to get answer to those questions is to actually ask the people
who use that, as opposed to trying to design
a fair system that is aimed at William Robert. OK. Thank you all for coming.
and have a great day. [APPLAUSE]

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