Picture this: The accounting department of Walmart, the No. 1 company on the Fortune 500 list, has announced a four-day open house for any stock analyst, trader, hedge fund manager, financial journalist, or even any Walmart employee who would like to spend day after day paging through sales data, supplier contracts, and logistics schedules.
The attendees will group together into pickup trucks and drive across the country, stopping at individual Walmart stores to personally count the number of boxes in the back room — Pampers diapers, Dawn dish soap, big screen TVs.
While there, they will take note of how much foot traffic each store is receiving, and how efficiently the lines move through the cash registers. At the end of their four-day tour, they will all meet up together over dinner and drinks and, by aggregating all their observations, come up with a prediction for the next quarterly earnings report.
If the participants of this “Walmart Tour” used the knowledge they gained from the trip to make stock trades before the observations were publicly released, or before the next quarterly earnings report was published, that would be illegal. It would be insider trading because the participants (or at least the accountants who invited them on the tour) had a duty to the company and its shareholders not to release or take advantage of information to which the public does not have equal access.
Now, this week, if the participants of the annual Pro Farmer Midwest Crop Tour, who are riding around the country in pickup trucks counting corn kernels and soybean pods, decide those commodities are underpriced or overpriced compared to the tour’s hands-on analysis of supply, those participants are legally allowed — and welcome — to make futures or options trades in the corn and soybean markets before the tour results are announced or before the next monthly supply and demand report from the government.
Why is it illegal for a scientist to tell her friend that her company’s latest drug trial isn’t going well, but it isn’t illegal for a wheat farmer in Kansas to tell the whole world on Twitter that several counties’ crops were damaged by frost?
The answer, like so many things in life, is complex. It’s rooted in layers of government regulation, or lack thereof. The simplest explanation is just that stock trading is regulated by the Securities and Exchange Commission, which has a long history of court cases prosecuting people who have “taken advantage” of the public’s lack of private corporate knowledge, while commodity trading is regulated by the Commodity Futures Trading Commission, which doesn’t.
In a 1968 court case, the SEC established rules that a person who has “access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone MAY NOT take advantage of such information knowing it is unavailable to those with whom he is dealing.” This is referred to as the equal access theory. No, you cannot use material, non-public information to guide you as you trade shares of companies.
There was never any equivalent lawsuit brought under the Commodity Exchange Act, so there is presently (in the United States) no similar rule. Yes, you can use whatever material, non-public information you can get your hands on to guide you as you trade commodities.
And why shouldn’t you? That’s the whole point, the whole promise of speculation in commodity futures. It’s also the goal of physical trading in grains and metals and lumber and petrochemicals and all other commodities — to amass better knowledge or better analysis of an asset’s value, then to put your capital at risk and use those predictions to sell overpriced goods or buy underpriced goods from other traders with less clever outlooks. That’s how a market efficiently prices an asset.
Anyone can glean their own analysis of commodity supply and demand. Crops are visible from public roadways during any windshield tour of the Corn Belt.
So it’s impractical — maybe even impossible — to visualize how insider trading could even exist in commodities. There are no shareholders to betray. The information for a commodity market doesn’t exist in any one company’s files; it exists as millions of data points from thousands of individual producers and thousands of individual end users.
The speculator who might take advantage of commodity market information is probably not an insider at all, but rather an outsider who, unless he’s out on the Pro Farmer Midwest Crop Tour this week, may have never set foot in a corn field during his entire life.
Trying to visualize the enforcement of anti-insider-trading rules in the commodity markets quickly becomes a nightmare scenario. Would CFTC agents in dark glasses prosecute a Missouri farmer, a bona fide hedge participant in the market, who publishes to the internet a photo of his drowned-out soybean field?
Presumably not, but there is increasing clamor for CFTC to adopt and enforce rules against insider trading, especially since foreign exchange trade, interest rate products, swaps, and a whole host of index products and single-stock futures and stock options all technically fall under the purview of the CFTC.
Yet, if there was a blanket law written against sharing private commodity information, where would those agents draw the line? The geologist who shares discovery of a big mineral deposit? The ethanol plant operator who shares a plant’s downtime schedule? The farmer on Twitter?
This commission currently pursues criminal convictions for outright fraudulent practices in the ag commodity markets, like front-running (a broker buying up futures right before he knows a client’s big order will be going through to drive up prices) or violating the “Eddie Murphy” rule (misappropriating secrets from federal agencies, like the impending crop report that was a plot point in the movie “Trading Places”).
Furthermore, CFTC has signaled in recent years its willingness to crack down on market hijinks that, in some cases, may overlap with insider-trading-style practices (see their 2012 rule: “Prohibition on the Employment, or Attempted Employment, of Manipulative and Deceptive Devices and Prohibition on Price Manipulation.”) They may consider it unlawful and prosecute if a trader uses information gained by fraud or violates a pre-existing duty of privacy.
Meanwhile, the European Commission is also requiring market regulations that would ban insider trading in commodities and derivatives markets, although, again, it’s not quite clear what that means in practical, enforceable terms.
Earlier this year, an academic from Wake Forest University named Andrew Verstein published a paper calling for commodity insider trading to be governed by the same restrictions used by the SEC for the stock markets. I don’t personally agree with the conclusions, but it’s a wonderfully in-depth treatment of the subject, if you’re interested in further reading.
In the meantime, let’s be grateful we are in an industry where it is still possible to delight in shared information, like this week’s constant stream of cob measurements and kernel counts made by observers flung across the country from Ohio to South Dakota. As Reuters quoted the University of Houston’s Craig Pirrong in 2014, “Applying insider trading to commodities is mad. It may make sense to prosecute the use of information illicitly obtained, (but) ‘better information’ does not mean ‘inside information,’ and any attempt to apply insider trading concepts to commodities will sow confusion and wreak havoc.”