I don’t really understand why when a firm is a market maker possessing material nonpublic information, the prohibition on all types of its proprietary activity may be counterproductive to the goals of maintaining the confidentiality of information and market liquidity. Could you give me some explaination and examples?
Thank you so much!
Bob Marketmaker provides liquidity for a number of stocks, including Gazornenplatz Pharmaceuticals (GPP). His typical volume in GPP is 100,000 shares per day.
One day, Bob overhears the CEO of GPP talking about a potential merger with Flosso Pharmochemical (FPC). Because this is material, nonpublic information, Bob considers abandoning all trading on GPP until the merger becomes public knowledge. However, here’s what he envisions:
One of his regular clients phones Bob the next morning to sell 20,000 shares of GPP. Bob’s reply: “No can do.”
“But you always buy GPP. What’s wrong?”
“Uh . . . nuthin’.”
You can take it from there.
Thank you S2000, but I didn’t get your point.
in you example, Bob didn’t carry out any trading on GPP although he possess material nonpublic information. But my question is that : why some proprietary tradings based upon material nonpublic information facilitate the goal of maintaining information confidentiality and market liquidity?
Bob’s clients know that he trades 100,000 shares per day of GPP when everything’s normal. So, here’s what the client sees:
Bob’s behavior is suddenly abnormal: a signal that something odd is happening with GPP. True, the client won’t know _ what _, exactly, is happening with GPP, but unless he’s a complete idiot he’ll know that something is happening. That’s the situation that Bob wants to avoid: by halting all trading, he’s letting the public know that there is material, nonpublic information on GPP.
So to just explicitly answer your question, in the above example, Bob would execute the clients trade request even though he has material nonpublic information so that everything will seem normal. In this case, this trading has faciliated the goal of maintaining information confidentiality and market liquidity despite his material nonpublic information regarding the trade.
In a word: _ Bingo! _
Great point! Thank you so much!