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Inside Scientific Information?

Here’s a question that came up in the comments the other day, after I wrote about the recent publication suggesting possible immune-response problems with the Cas9 protein used in CRISPR. That paper sent the stocks of the major companies in the area down about 10% (well, mostly, and only after people had a weekend to really hear about it). But it did have a substantial effect. A reader asked if it would have been legal for the authors of such a paper to have taken a short position in the stocks before the paper came out. (Let’s note up front that the paper came out as a preprint, so there are no agreements with publishers involved).

Insider trading is, of course, illegal. But all the insider trading cases I can think of involve, well, insiders. You have examples like Sam Waksal tipping off Martha Stewart, but in that case, someone inside the company is basically making you an insider as well, with the same responsibility not to trade on material nonpublic information. But although the CRISPR immunogenicity story was material, and it was nonpublic, it involved no corporate insiders at all. What then?

One close analogy might be the R. Foster Winans case. He was a columnist (“Heard on the Street”) for the Wall Street Journal in the 1980s, and passed on advance word of the columns to a broker. Winans himself said that his conduct, while unethical, was not illegal, and there were amicus curiae briefs filed on his behalf from broadcasters and press organizations. The appeals court held that securities law proscribed misappropriation of material from the publishers of the Journal, but when this went on to the Supreme Court it ran into a 4:4 tied vote (because of the retirement of Lewis Powell), so that’s by no means an unassailable position. (Winans and his conspirators, though, were convicted of mail and wire fraud charges, which are broad enough to apply in all sorts of cases where the underlying acts may still be murky).

The whole topic of knowing something about a company before anyone else does is a fraught one, since most of the ways that can happen are clearly illegal – but not all of them? The rationale for sanctions against insider trading is a reasonable one – the idea is that it undermines confidence in the market as a whole, because one could never be sure about entrusting ones capital to what could be a rigged market. But that principle (while it applies most immediately and obviously to corporate insiders) does not have to apply only to such. It shades over into the area of understanding something about a company before anyone else does, which is what stock analysts are always hoping to do, but presumably from information that everyone else has available to them (which is why it doesn’t happen all that often). From what I’ve seen, this is more likely to happen in the cases made by short sellers, since they’re more open to the bad-news possibilities that more optimistic investors may be willfully blind to. But there are controversies, there, too. I remember a case of a short-selling investor who (I believe) camped out behind a particular company and counted delivery trucks and came to the conclusion that the company’s statements about their sales could not possibly be true. But as I recall it, he actually got into hot water for this – I’m trying to find the details of this case (from the early 1990s, I think), but so far have been unable to locate them.

I’ll give one more example, from my personal experience. Years ago, I heard from a colleague (in real time) who was attending a European medical conference that Company X and Company Y, who were developing a new drug in the field of the meeting, were unexpected no-shows while the first poster session was being set up. The several slots they were listed for were all blank, and the word was that the posters had been pulled. That immediately suggested to me (and to my colleague) that something had gone wrong with the development program, and it crossed my mind that it might be interesting to invest with that in mind. But I didn’t, because of just the uncertainties that I’ve been mentioning. I had no idea if what was happening over in a side room at a medical conference one morning would be considered public information or not, or if a person could get into trouble trading on it, and I had no desire whatsoever to end up talking with the SEC about this topic. So I did not act on this, and I did indeed miss out on what would have been a lucrative trade (especially for Company Y, who were by far the smaller of the two and much more affected by the news). Would that have been a legal move? I still don’t know.

This all gets much easier when you’re talking about your own company, of course. Years ago, I heard a corporate legal counsel say “Don’t trade company stock on material information. And if you’re wondering what material information is, it’s anything that makes you suddenly think about trading the company’s stock”. That’s a pretty good rule – but how it applies, if it does, to third-party scientific publication is what I’m wondering now. Thoughts?

 

58 comments on “Inside Scientific Information?”

  1. Insilicoconsulting says:

    No it should not be categorised as illegal. Would we penalise someone if they were to analyse any information in the public domain and come to conclusions regarding pitfalls in a technology ? The additional step here is to have performed experiments with public money. But it could always be argued that the possibility of immune response could and was theoretically anticipated and they could have just made the short on that basis and waited for someone else to publish in due time.

    Very interesting question. smart or unethical ? One of them . Dunno , but certainly not illegal as they were not tipped off by insider info about a flaw that only affects one particular instance of CRISPR.

  2. Benonymous says:

    Why not just ban short trading. Making money out of someone failing seems wrong somehow, and it must be much easier to engineer a stock to plummet than rise. Traders: Invest in something you believe in and stick with it. The current system rewards short term thinking rather than long term investment and I don’t like it at all. [Hides behind sofa ready for flurry of comments from stock traders]

    1. biotechtoreador says:

      “Making money out of someone failing seems wrong somehow, and it must be much easier to engineer a stock to plummet than rise. ”

      It’s just as easy, though I can’t speak beyond biotech, to make money shamelessly promoting technology you realize has no chance of working and then making a profit of selling stock. Short sellers act as, I think, necessary check on this. The pity is sell side research is heavily titled toward BUY ratings (firms, particularly the…..less prestigious ones) will often have 0 Sell ratings: even top tier firms are unlikely to have > 20% sell ratings.

    2. Hap says:

      Except people don’t necessarily invest in something because they believe in it – otherwise, scams wouldn’t be so effective (and pump-and-dumps wouldn’t be so common and effective). What people who are less than honest (either to themselves or others) want is for other people to believe in their stock, whether or not there is actually something to believe in.

      The only way to tell whether there is actually something worth believing in in a stock is to test it, and short sellers help do that. People invested in a stock or selling a stock are unlikely to look for information that says that they are wrong, because if they found it they’d have to tell people, and it would likely cost them money. Who’s going to find that information then?

    3. Derek Lowe says:

      I agree with the other replies you’ve gotten. A lot of people feel the way that you do, though – I’ve had some spirited discussions on just that theme! But to me, that’s only an emotional argument, similar to the idea that drug companies are only making money by exploiting poor sick patients. To get all Aristotle about it, this is an appeal to pathos, disguised as an appeal to ethos, rather than one to logos.

      You’re picturing a world where people invest in things that they think are going up, and just don’t invest in things that they think are going down, which is largely the world we live in. But that does allow for abuses in the “think it’s going up” side, since that’s where all the money is chasing around ideas, and I think it’s valuable to have some people looking for the evidence against. Short-selling is pretty constrained as it is, compared to “regular” buying (margin requirements, ability to borrow shares, fees and interest on same), so it’s not exactly an even fight.

      1. idealism101 says:

        I’m not sure it’s an emotional argument as opposed to a society vs individual argument. The stock market – from a society point of view – provides a way for companies to raise money to do useful stuff. The view these days seems to be that companies exist in order that people can make money out of stocks. From a society view, where’s the value in short selling? people will find the evidence against anyway and not invest, or invest elsewhere. And bad stocks went down perfectly well before short selling. See South Sea Bubble, etc…

        What I’m getting at comes back to the old Merck quote about concentrating on the science and the profits will look after themselves. But companies now seem to care more about shareholders and less about employees, customers etc. I think it’s imbalanced, and I think short selling – and short term rapid trading on both sides – means people are looking for quick profits rather than longer investments. In our industry with >10 year cycle times, that’s a disaster.

        1. Hap says:

          Except based on the amount of pump-and-dumping (and daytraders and automated trading systems, probably), there’s an awful of short-term investors interested in quick bucks. Advocating buying a stock doesn’t necessarily support what it’s doing – in lots of cases, people are looking for bigger fools, or looking to make them, and it doesn’t make people think in (or buy for) the long term. If people want money quick, they’re going to (try to) get it.

          In a positive trading-only market, there is no obvious source for negative information. The people who own the company don’t want to look for it, because if they find it, they have to reveal it. Brokers want the stock fees, so they don’t want to kill the buzz. The people who buy don’t want to, because it would impair their ability to sell the stock. Competitors could, but trying to get dirt on competitors spends time and money they can’t spend trying to succeed (and there are a lot of competitors, so you’d have to spend a lot of time for little likely gain). The point of getting information out is to minimize the size and effects of bubbles (bubbles tend to suck down other companies that may have done well but were in the wrong place at the wrong time), and without the ability to make money on the information, no one’s going to spend money or time getting it. Short selling is a constant cost, but it likely helps to reduce the number and size of bubbles.

        2. Patrick says:

          To run with the society argument, surely there is a collective interest in stock prices being as closely matched to the ‘actual value’ of a company as possible. Both interested individuals and huge numbers of mostly disinterested people (via pension funds etc) lose out when stocks are overvalued.

          And while I’m certainly not an expert on the South Sea Bubble, I would have thought any mechanism that allowed bubbles to be corrected more quickly is a net positive to society.

          In any case, short sellers take a bet against a company because they believe it is overvalued, not out of spite towards the company or its employees. I don’t think the emotional or moralistic argument really has a lot to offer.

          Publicly talking down a company with the intent of benefiting from a short position, however, is another matter, and maybe there is an argument that it should be outlawed.

        3. NJBiologist says:

          “The stock market – from a society point of view – provides a way for companies to raise money to do useful stuff.”

          Also true:

          The stock market–from some executives’ point of view–provides a way for companies to raise money to compensate executives (without a requirement to do useful stuff).

          I worked at a company with significant short interest for a while. The shorts had a better understanding of the company’s prospects than the folks who just read management’s reports.

          1. tangent says:

            And shorting provides a way for the companies doing useful stuff to get more of the money, compared to companies doing non-useful stuff, than without shorting. In theory.

    4. fajensen says:

      “”” Why not just ban short trading. Making money out of someone failing seems wrong somehow “””
      What about banning selling a stock entirely? Because, when I sell a stock it is because I know it is a lemon and the sucker who buys it from me will be stuck with a loser and I make money from that – I enjoy doing it too.

      I also enjoy buying stocks in heavily shorted companies – they go up the most and the fastest when the shorters loose their shorts – in that case it is immoral to buy stock!?

      Nah, Diversity is good for stability. Also in regulated Markets.

  3. anoano says:

    Write a dummy article that looks real on a side effect of drug X, preprint and make it viral via anonymous twitter accounts, short on company making X. Get the money while company X sorts it out. Buy stock when it’s low and get money again when all back to normal and it goes up again.
    Putting fake news on social media to affect stock has been done before.

    1. Derek Lowe says:

      This would be wildly unethical, but the near-equivalent has, as you say, happened many times. I don’t think anyone’s gone to the trouble of faking up a whole scientific paper, but I wouldn’t be amazed if someone has, either.

    2. biotechtoreador says:

      I have heard a story (that I’ve never been able to confirm, so it may be completely apocryphal) about someone planting a false presentation (literally in an envelope left on a table) with negative “information” about DNDN at an AUA meeting a few years ago (~2008/9) the day before the company was going to present. I recall a large crash in the share price which then reversed the next day when the company presented data that were positive. Lotta people made money if they were short prior to the crash and covered, and a lot of people made money if they bought the dip….

    3. fajensen says:

      Buy up a dud company trading on the pink-sheets market. Then change the name to something with “BlockChain” or make an announcement on EDAGAR about how the company is refocusing on leveraging BlockChain Technology.

      Sell everything into the ramp from the stupid trade-bots gobbling up everything with BlockChain remotely in it. Retire to Nice and only do lectures and conferences for ever.

      Worked even for KODAK!

  4. biotechtoreador says:

    I think David Maris (https://dealbook.nytimes.com/2011/06/01/for-one-whistle-blower-no-good-deed-goes-unpunished/) is the analyst you’re referring to. Super smart guy, and quite the story.

    1. Derek Lowe says:

      That’s not the one I was thinking of, but I’m really glad you brought that one up (I’d forgotten it). As that article shows, Maris was right on the facts, right on the stock, and right on the law, and got hammered for it. Not a very appealing Wall Street story, is it?

  5. Peter Kenny says:

    A potential scientific inside information scenario could arise if your company has synthesized and evaluated a compound discovered eleswhere (e.g. a start up that is enthusiastically talking up their only compound prior to IPO.)

  6. Tom says:

    This may be a stupid question, but what about information that’s published but not open-access? Can information be considered public if it’s behind a paywall?

    1. Derek Lowe says:

      Not stupid at all, but my understanding is yes, that’s considered public information, if it can be accessed by anyone who’s willing to subscribe.

    2. Ursa Major says:

      I don’t know but I would guess yes. It certainly counts for intellectual property, e.g. prior art or copyright. It would probably be considered the same as a news story in the WSJ, where you have to get through the paywall (or buy a physical copy, if they still have those).

    3. Some idiot says:

      I’m not a lawyer, but in patent terms the answer is very clearly yes. And believe it or not, if you are at home, having a private chat with a colleague about something, with an open window, and someone in a public place (eg footpath) hears you, then that can be considered as publishing/public disclosure as well. And can affect any patent you file based on what you are talking about…

  7. The Iron Chemist says:

    Wouldn’t this introduce a conflict of interest with respect to the publication itself? If the authors were to profit in this manner, that could justify either not publishing the study or retracting it after publication.

  8. commonsense says:

    There is no reason this should be illegal, as long as the authors did not have other information from the inside of the company (let’s not forget the senior author is on the board of one of these companies).
    Making this illegal would unfairly penalize certain types of research/information (scientific) relative to others (say financial). If an analyst looks at available information on the finances of a company and draws the conclusion that the company is going to be in trouble, they are free to take a short position (and smart to do so). But if someone in science uses their skills to assess the likelihood of scientific and therefore financial success, then it’s a problem?
    That would just be another strike against training in, believing in and actually applying science.

    1. It’s a bit more complicated than that. It doesn’t matter if the information comes from within the company being traded, what matters is if the information was derived from a breach in fiduciary duty. If you have a duty to another party to keep the information confidential, you can’t trade based on said info.

  9. Uncle Al says:

    Insider trading is, of course, illegal

    https://theintercept.com/2015/05/07/congress-argues-cant-investigated-insider-trading/

    The US Congress is functionally unconstrained from engaging insider trading.

  10. Mike says:

    Probably not the story you’re thinking of Derek, but a really interesting insider trading case involved employees picking up on cues that a potential sale of the company was happening. A worker at a rail yard noticed a lot of people in suits visiting and helped setup a train for VIPs. As a result, he and his family made a huge bet an acquisition was happening and made a tidy profit of $1M.

    The SEC pursued the case vigorously, but ended up losing in a jury trial.

    http://www.secactions.com/jury-rejects-aggressive-sec-insider-trading-claims/

  11. Isidore says:

    How about a different scenario, one in which scientific research uncovers some problem that will very likely directly and adversely affect one or more companies’ stock price. Would it not make sense for the researchers (who have no involvement in the companies in question and are not privy to any confidential information from them), upon reviewing their findings and becoming convinced that they are correct, to divest themselves of stock they may own in the companies soon to be affected? Clearly they came into possession of material information likely to have a significant financial impact before the general public became aware of it, but did so using their own devices.

  12. This would not be illegal. Illegality entails misappropriating confidential information in order to profit from trading (i.e. some breach in fiduciary duty). Since the data were from their own research, the authors of the study did not have a fiduciary duty to keep the information confidential (just like a hedge fund could do their own research to determine if a stock is under- or overvalued). Thus, there is no breach in fiduciary duty and they would be perfectly within their rights to trade. This and other biotech insider trading scenarios are explained in this article:

    https://medium.com/the-mission/the-wild-world-of-biotech-insider-trading-bf22353c8f1

    1. Isidore says:

      So if the authors would be free to trade they would, of course, be free to short the stock. Which was Derek’s original question, I believe.

      1. above says:

        yes this in essence makes the same argument as commonsense above.

        1. Isidore says:

          You are right, somehow I missed his/her comment, hence the repetition.

  13. Thomas Lumley says:

    Matt Levine at Bloomberg View goes on about this a lot: insider trading law is *not* about using non-public information, it’s about misappropriating it.

    However, it would be unethical (and probably violate the publishing agreement) for a researcher to publish information like this without declaring a conflict of interest.

    And it would be unethical and *might* be insider trading for an editor or reviewer, who obtained the information agreeing to keep it confidential.

    1. Derek Lowe says:

      But if it’s on an open preprint server? Or if, say, you just publish it on your own web site?

      1. Thomas Lumley says:

        No legal problem, AFAICS.
        Professional ethics might require disclosing the short position.

        1. Isidore says:

          So you short the stock the moment after you upload your document on the website or immediately after you submit it to the journal.

  14. Mike says:

    Printing plant workers have been charged with insider trading after leaking information from magazine and newspaper columns before publication.

    http://www.nytimes.com/2006/10/24/business/media/24trader.html

  15. Anon says:

    If you start with the same public information to arrive at a different conclusion, that’s called research and insight. Fair game and certainly not illegal or even unethical.

    1. Anon says:

      PS. And public information is whatever information the public could have had access to without breaching some law or agreement of confidentiality. That would include showing up at a conference and finding that one of the presenters was a no-show. That would be fair game, because anyone from the public could have attended and found the same information.

  16. Chrispy says:

    It is rare that you have an ironclad case, particularly in drug discovery. I have found that even when the science is clear it is not always reflected in the stock price. There is a very small premium for being reality-based in drug discovery.

    The cases you mention — such as posters pulled at a conference — are public knowledge. It is not illegal to trade on information like this, but it is awfully speculative.

    I never sell stocks short, myself, because it is possible to lose more than you invest. If I invested in biotech I’d only sell short.

  17. Li Zhi says:

    Your scenario is just a bit silly. What’s the “material information” that you have acquired from an insider? Lets say you know someone who knows someone who knows someone who says to buy PFE, does that qualify as insider information? LOL! Keeping in mind of course that they estimate that 99+% of the human race is separated by 6 or fewer degrees of separation, your concern seems a bit, uh, unrealistic.

  18. SoupDumpling says:

    I think the key point here (and I have no idea whether or not lawyers would agree with me, so use your judgement!) is the distinction between information that is “material” vs “proprietary”. Acquiring and acting in information that is material is the basis of the entire trading industry, but that’s legal until it’s proprietary. If I ran experiments in my basement that indicated that FubarCompany’s drug is a sham, it would be legal to trade on that. So the question is whether the information in the paper is proprietary, because if it was, they shouldn’t have published it; the moment it was published it ceased to be proprietary.

  19. steve says:

    All I can tell you is that anyone who has ever been involved with a company – especially a small one – knows that the stocks are manipulated on a daily basis. If you’re OTC then people pump the stock up, take their profits, let it crash and repeat. Even if you’re a big company you’ll see major moves before public announcements. All the investment banks cook their reports to favor the companies in which they invest. I once was told by a former girlfriend who worked at a major investment bank on the buy side that the way she succeeded was to do the opposite of what the sell side guys recommended because they were just hyping their assets. The stock market is rigged and run by insider trading; with few exceptions t’s only the amateurs (like us) that really risk getting caught.

    1. Mol Biologist says:

      Agreed 🙂 Your former girlfriend is a smart peep 🙂 I do not know why Derek does try to sound naive? He is definitely not.

      https://genius.com/The-jealous-sound-naive-lyrics

    2. fajensen says:

      Back in the naughties, before the robots took over, good money could be made by betting against “insiders” by using options with short expiry time left (low time value), which means that their price is very sensitive to changes in the underlying.

      What one looks for is a ramp in the 1-2 weeks before a quarterly report, if there is a ramp, one buy the opposite option with strike at about the beginning of the ramp.

      So, if the ramp is up, then buy PUT’s, if the ramp is down, then buy CALL’s. Much more often than reasonably the stock would whipsaw in the opposite direction of the pre-announcement ramping. Because the short-expiry options are all priced on that “Delta”, they would whip even faster.

      Good times.

  20. Biotechie says:

    Surely the common sense position is that if you disclose information about a company that will influence its stock price, then:

    1) if you do intend to buy long or short stock in that company you then you absolutely need to disclose that you have done so (as a competing financial interest);

    2) why not just make everything simpler for everyone and steer clear of stock in the companies affected by the information you are disclosing? Then there would be no risk of negative perception of your paper because you have some financially to gain from release of the information.

    1. Mol Biologist says:

      The position of common sense is always good. But there is another trend 🙂 Isn’t it? https://news.crunchbase.com/news/portion-vc-backed-startups-founded-women-stays-stubbornly-stagnant

  21. Andrew P says:

    Why not go whole hog here. A short seller suspects that Company X’s technology isn’t what it is hyped up to be, so he funds scientists to debunk it, and shorts the stock before publishing the (successful) research. Let’s say the scientists he funded short it too, and get in on the party. Or if his scientists confirm Company X’s hype, he goes from short to long before publishing. I don’t see anything wrong with any of this.

  22. PaulL says:

    There seem to be many investors who do research on a company, and then assert that the company financials are shonky, or something is going wrong in the management layer. They also short the company at the same time. Seems to me that is directly analogous, and that it is legal. And I find the case of a researcher completing their own research, and then putting their own money at risk, much more ethical than what appears to me often to be investors drumming up bad news simply to make a profit.

  23. Jürgenosch says:

    Interesting thought.
    What if you buy options for both? Not only for failing of a company stock but also for the rise? Would that also be considered illegal? Say you invest 5000$ equally but end up making 50000 $ with one of the options? Your net gain is still significant.

    1. Derek Lowe says:

      That is what’s called a straddle – buying a put option (stock will fall) and a call option (stock will rise) on the same stock, same strike price and expiration date. It’s a common option strategy, and is pretty sound (although relatively expensive to run, like all option-based ideas).

    2. Anon says:

      This strategy can work only if:

      a) you are sure overall volatility will rise more than the market expects, but don’t know which way it will go (up or down); AND
      b) you leave a gap between your options where you can lose money if the stock ends up not moving much, otherwise it’s a zero-sum game, or less as others take commission for the transaction; OR
      c) you buy the put and call options at different times and stock prices, and are lucky enough to do at in the right time and sequence.

      Basically, you still have to be luckier, or better at predicting than the market, and luck isn’t a strategy, while prediction favours those with inside information.

  24. Michael says:

    Here is a current example of a fevered brawl involving the medical company Mimedx and a well organized cadre of shorts.

    Mimedx: https://www.mimedx.com/content/short-selling-commentary
    The shorts: https://viceroyresearch.org/

  25. Scott says:

    Not a lawyer, but the HR guy who had to give a quick&dirty estimate on whether something might be insider trading or not.

    As a product of your own research of publicly available information, I think that’s legal and ethical.

    But when the publisher of a paper (not the author) takes action on information not yet publicly available, it might get “interesting” (read: “throwing lots of money at lawyers to stay out of jail”).

    As mentioned, people working at the printing shop can get busted for insider trading, despite the fact that they don’t work for the company in question. I think the reason the guy at the railroad yard stayed out of prison because the operations at the yard were in public view.

    But a scientific paper pre-publishing is by definition not public. You’d be skirting things if you made your investment decisions when the paper was accepted for publication (because it’s still not public).

  26. Wallace Grommey says:

    The Federal government should tax each and every stock transaction. This would essentially be a VAT that would hit those able to pay and likewise inject a little damping on lightning trades and volatility.

  27. Donald D. Uck says:

    Reminds me of short-attacks by hedge funds. One example that happend last year.
    The US hedge fund Muddy Waters Capital sold the German company Ströer short and then published an “analysis” or how one newspaper put it “a tendentious “report” with more than 60 pages and addresses the business case” of Ströer which had only one goal: to let the Ströer stock drop.

    In my opinion here it would be more or less a similar situation. The researcher would go short and publish something which hurts the company they sold short. Only that maybe or hopefully their article/results are more reasonable and proven than a hedge fund report. In any case I do not see an indication for insider trading because they are by no means insiders but they found something and think that this’ll be bad for Company XY.

  28. Anonymous says:

    I haven’t read all 56 prior replies, but I think I can post this comment here (“Inside Scientific Information?”) or under “Scooped, I Suppose the Word Is” (17 Jan).

    Robert Gallo allegedly had his co-worker start a company to manufacture reagents (and kits?) based on results from his NIH lab that were then sold back to the NIH and other labs for a nice profit. (The technologies and profits should have gone to the US public, not Gallo, et al.)

    Then, it was quite a scandal to discover that Gallo published his discovery of HTLV as the cause of AIDS but that he was aware that his virus was identical to the previously reported discovery by Luc Montagnier of LAV (the same virus by a different name). Sort of like publishing the X-ray of a natural product without attribution to the X-ray already published by others. Actually, worse, because Gallo knew it was the same virus. The disclosure of the sleaziness prevented Gallo from sharing the Nobel Prize.

  29. lighterfluid says:

    Don’t you usually have to disclose any financial interest in the results of a study as a potential conflict of interest at the time of publication? It may be legal on the stock trading side, but it might raise some eyebrows from the publication/science end of things.

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