What is Really Unethical about Insider Trading?Source: Journal of Business Ethics 9 (1990): 171-182
…For many, insider trading has become the primary symbol of a widespread ethical rot on Wall Street and in the business community as a whole.
For a practice that has come to epitomize unethical business behavior, insider trading has received surprisingly little ethical analysis. The best ethical assessments of insider trading have come from legal scholars who argue against the practice. But their arguments rest on notions such as fairness or ownership of information that require much more examination than they are usually given. Proponents of insider trading are quick to dismiss these arguments as superficial, but offer very little ethical insight of their own. Arguing almost solely on grounds of economic efficiency, they generally gloss over the ethical arguments or dismiss them entirely. Ironically, their refusal to address the ethical arguments on their merits merely strengthens the impression that insider trading is unethical. Readers are left with the sense that while it might reduce efficiency, the prohibition against insider trading rests on firm ethical grounds. But can we assume this? Not, I think without a good deal more examination.
This paper is divided into two parts. In the first part, I examine critically the principal ethical arguments against insider trading. The arguments fall into three main classes: arguments based on fairness, arguments based on property rights in information, and arguments based on harm to ordinary investors or the market as a whole. Each of these arguments, I contend, has some serious deficiencies. No one of them by itself provides a sufficient reason for outlawing insider trading. This does not mean, however, that there are no reasons for prohibiting the practice. Once we have cleared away the inadequate arguments, other, more cogent reasons for outlawing insider trading come to light. In the second part of. the paper, I set out what I take to be the real reasons for laws against insider trading.
I. Ethical arguments against insider trading
II. Is there anything wrong with insider trading
I have argued that the real reason for prohibiting insider trading is that it erodes the fiduciary relationship that lies at the heart of our business organizations. The more frequently heard moral arguments based on fairness, property rights in information in information, and harm to ordinary investors, are not compelling. Of these, the fairness arguments seem to me the least persuasive. The claim that a trader must reveal everything that it is in the interest of another party to know, seems to hold up only when the other is someone to whom he owes a fiduciary duty. But this is not really a "fairness" argument at all. Similarly, the "misappropriation" theory is only persuasive if we can offer reasons for corporations not to assign the right to trade on inside information to their employees, I have found these in the fact that permitting insider trading threatens the fiduciary relationship. I do believe that lifting the ban against insider trading would cause harms to shareholders, corporations, and society at large. But again, these harms stem primarily from the cracks in the fiduciary relationship caused by permitting insider trading, rather than from actual trades with insider. Violation of fiduciary duty, in short, is at the center of insider trading offenses, and it is with good reason that the Supreme Court has kept the fiduciary relationship at the forefront of its deliberations on insider trading.