Insider Trading

[mordecai]

How does Objectivism regard insider trading?

What effect does it have on the economy? Posistive? Negative?

If negative : Could one call insider trading fraud and by such ban it by law?

If insider trading is negative but there is no moral basis to ban it, will it not criple the economic system as it is today? Would trade decrease as a result of less trust in eachothers?

Are there any moral implications?

[y_feldblum]

Moral

Positive

No

Abitrary speculation

[mordecai]

thank you for your quick reply, allthough I was hoping for somewhat more detailed answers.

Care to elaborate?

[y_feldblum]

The concept insider trading as opposed to outsider trading is invalid. There is no such thing as outsider trading; there are only degrees of how close to the inside one is.

[1] All mutually voluntary trade between two individuals is moral. There is no reason to consider insider trading (where one party knows more than another) as immoral (unless one party defrauds the other - but that isn't limited to insider trading), since it is by nature voluntary, uncoerced.

[2] The "economy", like "society", (gotta love scare quotes) is nothing more than the sum of the individual relationships among individuals. Both individuals party to insider trading benefit or they wouldn't have volunteered to trade.

What would happen to the GDP? Well, people are now engaging in an additional form of trade: the GDP (as a placeholder for total personal wealth or something actaully meaningful) will increase.

[3] One cannot call insider trading as such fraud; it is only fraud if one of the parties deceives the other.

GreedyCapitalist: Want to buy my company?

Mordecai: Only if it's not on the verge of bankruptcy.

GreedyCapitalist: [lies] It's not.

Mordecai: Ok, I'll sign.

[4] I can't answer the fourth question, it's asking me to hypothesize what the universe would be like if gravity were repellent, not attractive. Whether I knew the answer or not, the answer would not make the slightest difference: gravity is and will always be attractive. If something that weren't the case were, what would be?

To cripple the economic system means to initiate force against the individuals who engage in trade to force them not to trade - that is the moral basis to ban crippling the economic system.

If people trusted each other less, perhaps they would trade less; but, how does the degree of difference of knowledge lead people to a difference in degree of trust?

[Old Geezer]

"If people trusted each other less, perhaps they would trade less; but, how does the degree of difference of knowledge lead people to a difference in degree of trust? "

The only case where this applies is where the insider trading is the result of infromation obtained from a breech of contract. (such as a lawyer involved in a sensitive lawsuit discolosing information so he can make money off of inside information...)

in that case my ability to trust that particular lawyer goes down, but not my ability to trust in trade in general.

In any case, the enforcement of legally binding contracts IS okay, and insider trading laws/constructs would not be required.

[y_feldblum]

Breach of contract is a kind of fraud (which my post covered).

The value traded in insider trading is not the difference in knowledge; that is only the context of the actual trade. Although I was not explicitly clear in this, my question did not consider the context of a prevalence in trading fraudulently-gained information.

[Richard_Halley]

remember as well, even had insider trading been a bad thing, we would quickly find that companies would add clauses to all employee contracts strictly laying out how they are allowed to trade that companies shares.

the point is: regardless of if it is good or bad, insider trading is not fraud, and, therfore, is none of the governments business.

[poohat]

The concept insider trading as opposed to outsider trading is invalid.  There is no such thing as outsider trading; there are only degrees of how close to the inside one is.

[1] All mutually voluntary trade between two individuals is moral.  There is no reason to consider insider trading (where one party knows more than another) as immoral (unless one party defrauds the other - but that isn't limited to insider trading), since it is by nature voluntary, uncoerced.

Hold on, what exactly is involved in the concept of fraud that isnt just 'one party knowing more than the other'? If insider trading is permissible because it just comes down to being a knowledge thing, what grounds do you have on which to condemn fraud?

Some fraud (although certainly not all) involves deceit in addition to 'knowing more than the other party', but it seems a bit strange to make lying illegal.

[4] I can't answer the fourth question, it's asking me to hypothesize what the universe would be like if gravity were repellent, not attractive.  Whether I knew the answer or not, the answer would not make the slightest difference: gravity is and will always be attractive.  If something that weren't the case were, what would be?

I'm not sure I understand what youre trying to say here, could you clarify? It seems like youre claiming that all attempts at prediction are fundamentally useless, but I suspect you mean something less absurd.

edit: I would say that the debate regarding whether insider trading adversely affects the economy (which is certainly a valid question, regardless of how you try and duck it) should not be a major factor when discussing its legal status. To take a similar example, the issue of whether or not slavery actually causes a nation to prosper shouldnt be a factor when it comes to assessing whether slavery is a 'good thing' - the primary issue is moral, not economic.

[Capitalism Forever]

Some fraud (although certainly not all) involves deceit in addition to 'knowing more than the other party', but it seems a bit strange to make lying illegal.

To sum you up: Knowing more than the other party should be a crime, but lying should be legal.

Well, in case you ever get elected to some office, I hereby declare that I don't know more than anyone else.

[Richard_Halley]

Poohat: Whenever you see that I write a "the point is" clause, you should take care to read it. If I could quote myself:

regardless of if it is good or bad, insider trading is not fraud, and, therfore, is none of the governments business.

This sort of makes your edit superfluous, does it not?

CF answers the rest of your question well enough for me.

[poohat]

Poohat:  Whenever you see that I write a "the point is" clause, you should take care to read it.  If I could quote myself:

This sort of makes your edit superfluous, does it not?

CF answers the rest of your question well enough for me.

I wasnt replying to your post, I was qualifying my position just in case anyone took the first part of my post to mean that I supported the criminalization of insider trading (although CF seems to have done this anyway, but nevermind).

The point remains though; why is 'additional knowledge' acceptable in the case of insider trading, yet unacceptable in the case of 'fraud'?

[Richard_Halley]

Fraud is not merely "an additional knowledge." It is lying.

Lets say I am a used car salesman:

You come to me to buy a car, which I know is likely to breakdown soon, but you point at it and say "I want that one," then proceed to hand me the money and drive away.

You have just bought that car as is, and there is no fraud involved.

However, if you come to buy my car, ask: "how soon can I expect this car to breakdown?" And I reply: "this car is in perfect condition, like new." You buy the car and drive away.

Here you have bought the car under the conditon that it is "like new," since it is not, I have defrauded you.

It is not a matter of my having more knowledge, but of my lying.

[DavidV]

GreedyCapitalist: [lies]

[DavidV]

Fraud is not merely "an additional knowledge."  It is lying.

It is not a matter of my having more knowledge, but of my lying.

Fraud is more than just lying – it’s the act of engaging in deliberate deception in order to gain an unearned value from a voluntary transaction.

[Richard_Halley]

Quite so, GC.

[Bearster]

There are some criteria for objective law:

1) It should be knowable by everyone in advance, whether an action is legal or illegal

2) The law applies to all people equally

3) The law prohibits the initiation of the use of force (or fraud, its corollary)

4) The law doesn't depend on mind-reading

How many of these criteria are met by a law declaring it to be illegal for me to sell shares of my company on March 1, but not on March 2 if I have filed a form no later than Feb 1 and disclosed my intent publicly, but in the same instance it would be perfectly legal for John Smith to sell shares of my company at any time, without any special disclosure forms?

[Tom]

Why is insider trading illegal?

Because some people think we should "remedy" the "problem of imperfect economic information" by sentencing people for longer jail-time than rapists.

Yet experimental economics says that a healthy economy doesn't require perfect information.

So what's going on?

Back in the 80s, Michael Milken was making a fortune off of junk bonds. Then he was convicted of insider trading because his returns were much higher than all his peers and the jury couldn't (or wouldn't) believe that anyone could make that kind of money honestly. Think about that. The court interpreted success as dishonesty. They took success as evidence of guilt. They have taken success as the essential characteristic of criminality.

What is their motivation?

There haven't been any guilty verdicts yet for the rogues from Enron, WorldCom and Tyco. Ken Lay still hasn't been charged with anything. And those are the guys accused of looting the corporate kitty and vaporizing their employees' retirements. While her crimes may pale in comparison, the lasting impact of the Stewart case may be that it will become the new standard for judging all fat cats who don't play by the rules.

Quoted from this article.

[AutoJC]

Fraud is more than just lying – it’s the act of engaging in deliberate deception in order to gain an unearned value from a voluntary transaction.

Exactly. Using that logic, then, one can only wonder why it is that insider trading is a crime.

After all, the act of trading shouldn't necessarily be regulated in terms of why an issue is being traded.

That's not to say that a particular trade couldn't have been performed due to information meant to deceive other investors. But laws covering fraud already can deal with this.

I'll also offer the opinion that Martha Stewart was lynched.

[Proverb]

It currently stands, as my understanding holds, that it is illegal to trade stock with privileged information. Also, from my understanding, the biggest argument for these laws is that privileged trading is unfair to people without the 'inside' information.

Is there a moral base to these laws?

Does the fact that (hypothetically) I know a CEO of a company who talks business over golf, hold me liable for the average investor's lack of info?

What defines a line between privileged information and information available to employees with stock options for intsance, or public information.

Say for instance that I don't have access to the internet and am trading stock. Can I sue someone if they have access to information on a company that I trade, if the information is only available on the internet?

Am I missing something, or are these laws another on the list of pseudo-socialist American laws?

Edited July 31, 2005 by Proverb

[DavidOdden]

It currently stands, as my understanding holds, that it is illegal to trade stock with privileged information. Also, from my understanding, the biggest argument for these laws is that privileged trading is unfair to people without the 'inside' information.

Is there a moral base to these laws?

I don't know what the law actually is. There is a moral base to something here, but it's not at all clear that this needs to be a matter of law. Specifically, a CEO is supposed to act on behalf of the shareholders. If CEO Smith knows, as CEO, that his company will be acquiring Megacorp on Tuesday and that this will cause the value of the shares to triple, then he would not be acting in the best interests of the shareholders if he bought up every available share of the company. However, this is really a contractual issue, a matter of fiduciary responsibility, and not properly a matter of law. As an investor, I would insist that the corporation have a rigorously-enforced "no insider trading" rule for its employees (or, they would have to give me a call and let me in on the deal). If most investors agree with me, this will be the policy; otherwise, I'll take my money elsewhere.

OTOH if you have no contractual relationship with the corporation and just happen to get wind of something, then there is no reason why you shouldn't take advantage of whatever you know.

[JMeganSnow]

I see David is replying, we'll see what he says here in a bit

Anyway, just ask yourself these questions: is it "unfair" for someone who has studied medicine to get a job as a doctor, vs. someone who has not?

Then, is it "unfair" for someone who has worked their way up a company hierarchy to the point where they are privy to information (keeping in mind that, in any company, being privy to info means you are probably responsible for making serious decisions as well) to profit from having that information?

The same principle is at work. The only way you could consider it "unfair" for someone to gain from what they know is to drop the context that they have to EARN that knowledge. It doesn't just fall on them from nowhere. They can also potentially damage themselves and their company by misusing the information, because people WATCH what they do with their stocks and investments.

So, insider trading laws are, yes, stupid; more Egalitarianism.

[Groovenstein]

Proverb, let me first say that you have started a big mess with this question. But seriously, the securities laws are very difficult to understand. I'm going to try to work us through them. (I'm not saying "us" pejoratively. I mean to include myself because I don't fully understand them.)

Our starting point is the Securities Exchange Act of 1934 (SEA). The full text of the SEA is available here:

http://www.sec.gov/about/laws/sea34.pdf

Section 10(b ) of the SEA states:

"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange-- . . . to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission [the SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors. . . ."

One of the applicable Rules prescribed by the SEC is Rule 10b5-1. As I understand it, this is the meat of the insider trading law because it defines "manipulative and deceptive device." Let's look at this definition. 10b5-1(a) states:

"The 'manipulative and deceptive devices' prohibited by Section 10(b ) of the Act [the SEA] . . . include, among other things, the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information."

There are, of course, terms within this definition that themselves need to be defined. For example, what does "on the basis of" mean? That's answered in Rule 10b5-1(b ). Are there any affirmative defenses available? 10b5-1(b ) refers us to 10b5-1(c ). When is information "material"? I can't remember the case offhand, but the Supreme Court has said information is material for purposes of Rule 10b5-1 if a reasonable investor would consider it important when considering whether to transact in the stock.

There are a whole host of other questions, and I do not purport to be able to answer any of them definitively, even the information I've given here. As time permits, I will explore further the legal questions you have raised and give everyone my findings. For now, I think it's helpful for our understanding of what the law is to have some starting points.

(Btw, sorry all my b's and c's in parentheses have a space after them, but apparently a b in parentheses results in a sunglasses smiley, and a c in parentheses is a copyright.)

[Groovenstein]

There're also short-swing trading rules under Section 16 of the SEA that forbid you from keeping profits on certain transactions within six months of each other.

[Proverb]

I guess I might have not been clear, but by 'inside trading' I mean:

I am a private shareholder that becomes privy to 'inside' information.

Does any scope of the information change how I am able to act on it?

This is my main question, however in reading your responces I am now interested in wether or not it is proper to have the shareprovider-shareholder be a matter of law.

Thank you Groovestien for the reference. And thanks for the considerations.

[Groovenstein]

. . . by 'inside trading' I mean:

I am a private shareholder that becomes privy to 'inside' information.

Does any scope of the information change how I am able to act on it?

This is my main question . . .

Again, from Rule 10b5-1(a):

"The 'manipulative and deceptive devices' prohibited by Section 10(b ) of the Act [the SEA] . . . include, among other things, the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information."

Notice that the Rule says nothing about the specific title or position of who's doing it. It does, however, say that there must be a breach of duty of trust or confidence.

It sounds like you're talking about what is called "tippee" liability. That is, are you liable if you receive a tip even though you owe no fiduciary duty? In Dirks v. SEC (1983), the Supreme Court said you are under certain circumstances. Tippees are liable if:

1. the tipper breached a fiduciary duty, and

2. the tippee knew or should have known of the breach.

In the context of tippee liability, the Court said that the tipper breaches a fiduciary duty where he gets a personal gain from divulging the information to the tippee.

Does this answer your question, or is there something else I'm missing?