There is concern though on Wall Street that a lot of these people that create this legislation don't have any real experience in this world. So do you think that sometimes they take it too far? Or more importantly, they don't truly understand the dynamics of the Wall Street environment? Well, I'm sure there are times when they take it too far. And I've had my own experience with regulators. Although I'm an academic, I don't know that they always have been enlightened. I remember, for example, in 1996, I wrote a paper advocating indexed bonds. So I talked to people in the U.S. government saying we should see inflation-indexed bonds issued by the government. And I thought that they were intelligent people that I spoke with. But I thought that maybe they were being awfully slow to adapt to important new idea. Why was that? I think it's difficult for them to innovate as regulators. They maybe need more public discussion to support it. They end up being, as I said, rules-based. So that means that they might be skeptical of new things, they're not that complicated or that new. But the person I talked to, actually he wasn't a regulator he was in treasury, but I'm thinking of government mentality. He joked with me when I talked to him on the phone in 1996. He said, "If the U.S. ever issues inflation-indexed bonds, we'll be sure." This is a joke, he said, around treasury. "We'll be sure to send the prospectus to the members of the American Economic Association because they will want them. Nobody else will want them." Well, it turns out he was wrong and we now have a substantial number of U.S. government inflation-indexed bonds. But I think innovation requires a spirit of innovation. I think it's really, I think it is there among our regulators. But I think that the government has to make the career as regulator attractive enough that it brings in people who are motivated. In order to understand business, what you may be saying they have to be motivated a bit like an entrepreneur. They have to have the sense of excitement that's something new. But they can share in the excitement but they're not making money off of it. They're a salaried employee. And I think it's possible to get excited about an innovation that you are involved in as a regulator. I thought I actually saw this somewhat. But in order to make that happen, we have to have a government that supports regulators. It should be a career that young people aspire to not as a revolving door steps on to a private job but as a real career. Now by the way, the revolving door going as a regulator to the private sector is not all bad either, or the other way, because that's how people develop their sense of professionalism. And it's good if a regulator had worked in the private sector or go the other way. But I do think it's also important that regulators have a sense of career as a regulator, that I don't do this as a stepping stone to something else. I'm doing this because it's interesting and valuable to society. So as a student here, you have a sense of idealism in what you do I hope. Are you thinking of becoming a regulator? Personally, no. Nobody here is thinking here if we can. Well, I want to put that thought into your minds if I can. Okay. Insiders versus outsiders is another SEC concept. So insiders are people with special knowledge because of connections about a company. Inside information represents wealth. If you know something that the general investing public doesn't know, that's an opportunity for you to trade on that information. So the SEC wants to block that. They want to block insider trading. So among the things that the SEC has done is issue regulations about disclosure like Regulation FD which they issued in 2000. The Regulation FD came long after Louis Brandeis. They had telephones when Brandeis wrote, but they didn't have the internet. They didn't have the kind of access that is now possible. So Regulation FD requires that when a company tells any material fact to an analyst, it must be also immediately told to the general public. So, typically, companies will have open analysts' discussion where you can log in and listen to the discussion with the analysts. But some countries really haven't had insider trading laws. Germany did not have them at all until 1994. Some people, like Hayne Leland, have argued that insider trading is good. Why don't we just let it go? And the inside traders will compete against each other and maybe they won't make so many profits after all, and everything will leak out, and everything will be known. But the general opinion is that, it's not a good thing. You don't want people who are in a company trading on company secrets. That just doesn't sound right and it discourages people from investing if they think they are being disadvantaged by insiders. So the SEC has asked companies and stock exchanges to help them to try to find insider trading. So the stock exchanges have sophisticated computerized system. And SRO, there's self-regulatory organizations that follow the SEC directive to themselves regulate against insider trading. So I'll give you an example of insider trading. In 1995, a secretary at IBM Corporation was asked to xerox some documents related to a secret plan to take over Lotus Corporation. Lotus Corporation was, I guess, the first major spreadsheet company. Now, it's been taken over. It's no longer important. But, anyway, she told her husband who was a beeper salesman. We used to have beepers. You don't need those anymore with your cell phone but it was something in your pocket that would beep and warn you when information was just coming and you could find out what it is. This was on. Okay. By June 2, he told two friends who immediately bought. By June 25, people spent, it's only a half a million dollars, not a whole lot, but these are a pizza chef, an electrical engineer, a bank executive, a dairy wholesaler, a schoolteacher and four stockbrokers. They figured it all out by subpoenaing telephone records and questioning people. They traced through the whole scheme, and they were penalized for doing it. You're not supposed to do this. So, if someone tells you my wife works at such and such a company and she was xeroxing something, they're going to have a big deal in three days. You don't go out and buy on that because you know you were trading on Insider information, and that's illegal. I give another example. Emulex Corporation. Mark Jacob was a employee at Emulex. And I don't know what happened, he quit or he was fired. And so, he got kind of miffed. And so, he shorted the stock of Emulex Corporation. So he held a negative amount of it. He was hoping it would go bad. But as a short seller, it might go well, in which case you lose. So, he thought, I have to generate bad news about Emulex Corporation. And he could do that because he was formerly an employee of Emulex Corporation. He knew how they act. So, he sent out a fake news release on the internet, and it was picked up by these very susceptible news agencies who don't check. It looked like it came from Emulex Corporation. So, he then sold his stock in Emulex. He cover his short in Emulex right after. That means, to cover your short means you buy the shares back at a low price, so that cancels your short. So, they had to figure out who did it. He thought he was being very clever. He didn't use his own Internet. He went to a public Internet service at El Camino Community College library. And he thought, I'm perfectly safe. They can't trace us to me, but he was wrong. They did. They went to the El Camino Community College library and showed the librarians photographs. Do you remember this guy? And they did. So, he was caught. So, that's Insider trading. Another crime of financial markets is something called Front-Running. So, when you place a large order with your stockbroker, let's say you want to buy a lot of shares in some company. Well, if you're going to buy a lot of shares, it will affect the market price. That's a really big order, millions of shares. Is big news, and if you tell your broker I want to buy this and please do it. So, the broker then has some time and discretion about exactly when do. He tries to find a good price for you. But meanwhile, your broker could trade on his or her own account or tell some other broker. I'm going to put in a big order now. You might want to buy a head of the order. So, the other person can buy at still low price and sell it an hour later at a much higher price. That doesn't sound right, does it? That's called Front-Running. It's also illegal. Decimalization has been claimed to favor Front-Running. It used to be until 2001 that the stock exchanges quoted prices of stocks in sixteenths of a dollar. They moved to pennies. It seems unnatural to be quoting prices in $60 and 16th of a dollar, or at other times eighth, but they move to doing it in a way that seems natural in 2001. It makes it a little bit more possible to squeeze in between, suppose the stock is selling for $30 a share, and then you think after the order, it will be selling at $30.05 a share. That's, if shares are traded in 16th, that's a narrow window, but if it's traded in pennies, you can get between those two prices. So, accounting standards is another thing that the SEC is involved with. It has the statutory right to establish how the company's accounts are done, but it doesn't want to do it. It doesn't want to be the maker of all standards in business. So in 1973, the Securities and Exchange Commission officially recognized an organization called the Financial Accounting Standards Board in Norwalk, Connecticut as the authoritative for accounting standards, but the FASB as we've often said, is not a government agency. I guess it's a nonprofit created by the business community. So, the FASB defines what are called Generally Accepted Accounting Principles or GAAP. We talk about GAAP earnings or GAAP other concepts. So, GAAP defines a concept called net income, which is the bottom line the earnings of a company, and it also defines something called the operating earning, operating income, which is a narrower concept of earnings, equals revenue minus cost of doing business. GAAP would also take off charges for special events. Say, they lost money through a hurricane or a financial crisis, and they think it's not really reflective of our business because we are doing our business as normal and something totally out of the blue came. So, it should be, according to GAAP, in current FASB concepts, the event should be considered part of net income, but let's provide also to investors operating income which gives them a sense of what's happening here with this business. There are lots of other concepts like core earnings, pro forma earnings, EBITDA, which is Earnings Before Interest, Taxes, Depreciation, and Amortization, and adjusted earnings, but these are not GAAP. They're not GAAP because they're not defined by FASB. If you go to the FASB website, you'll get totally confused because there are so many disputes about earnings definitions, and they have to decide amongst them. So.
