Academic journal article Philosophy and Public Policy Quarterly

Insider Trading: A Moral Problem

Academic journal article Philosophy and Public Policy Quarterly

Insider Trading: A Moral Problem

Article excerpt

Insider trading is a crime that can have sensational results. Its perpetrators risk finding themselves behind bars for many years and vilified in popular opinion, while their firms and the people heavily invested in them risk financial ruin. Even so, doubt may be raised about our understanding of insider trading, a doubt that should prompt concern about the justice of insider trading prosecution and about the harsh moral judgments people often make of insider traders. The doubt comes from trying to identify the moral wrong in insider trading.

Perhaps the most influential insider trading case is SEC v. Texas Gulf Sulphur, in which officers of Texas Gulf Sulphur learned of their company's rich ore strike in Canada and traded on this information before the news became public. These officers, who engaged in securities transactions on the basis of material, nonpublic information, are paradigm insider traders. It is clear that they committed a legal wrong. We will find more challenging the matter of identifying the moral wrong in their conduct.

Harm

The argument from harm maintains that insider trading is wrong because of the social harm it causes, given that we understand "causing harm" expansively, as causing a failure to attain optimal social welfare or social good.

In a securities market there are winners and losers, people who get good prices and people who get bad prices. Other things equal, the person with the best information about what is being bought or sold stands in the best position to find bargains and get the best price. Competing against corporate insiders, who possess superior information, thus increases the risk that one loses. Ordinary traders will balk at the risk of trading against insiders, and insider trading, then, will undermine confidence in securities markets and deter investment, increasing the price a firm must pay to raise capital and hindering both a firm's development and a society's economic growth more generally, according to the argument from harm. As a society, we have good moral reason to protect ourselves against this kind of economic harm, and laws prohibiting insider trading afford the relevant protection. On this view, insider trading is wrong because it fails a cost/benefit test, depriving us of a peculiar kind of benefit, a social good whose continued existence requires the cooperation of many people in maintaining a credible securities market.

An empirical claim forms the core of the argument from harm: that insider trading will significantly deter investment. Influential research lends some support to this claim. A leading article on insider trading compares the cost of capital (the price that firms must pay to raise money in a securities market) in (mostly developing) countries both before and after they begin enforcing insider trading laws, and concludes that because this cost generally decreases after insider trading laws are enforced, social welfare improves when insider trading diminishes. Does the article show that insider trading is socially harmful? Its authors acknowledge that they locate no causal link between insider trading and changes in social welfare, but merely non-causal correlation. Even the best social science research, then, expresses no confidence about whether insider trading deters investment in ways that prove socially harmful. Moreover, there is good reason to wonder whether insider trading will deter investment. Securities traders are accustomed to the idea that other traders may possess advantages in information, even if it is not inside information, and hardly seem deterred by this idea. Most investors do not believe that the quality of their information is as good as Warren Buffet's, or the stock market wizards at Goldman Sachs. If the investment public is willing to trade against Warren Buffet and the wizards at Goldman Sachs, perhaps it will not be deterred by the prospect of trading against corporate insiders, either. …

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