Ó Springer 2009
Analyzing Insider Trading from the Perspectives of Utilitarian Ethics and Rights Theory
Robert W. McGee
ABSTRACT. The common view is that insider trading is always unethical and illegal. But such is not the case. Some forms of insider trading are legal. Furthermore, applying ethical principles to insider trading causes one to conclude that it is also sometimes ethical. This paper attempts to get past the hype, the press reports, and the political grandstanding to get to the truth of the matter. The author applies two sets of ethical principles – utilitarianism and rights theory – in an attempt to determine when, and in what circumstances, insider trading is ethical. The views of Henry Manne, an early proponent of insider trading, are critically examined, as are the major arguments against insider trading. Is insider trading good for the company if it is used as a form of executive compensation which makes it possible to pay lower salaries than would otherwise be the case? Does insider trading cause the stock market to work more efficiently? If insider trading does increase efficiency, is that sufficient to call for its total legalization, or are there other things to be considered? Several arguments against insider trading have been put forth over the last few decades but there are problems with all of them. One of the main arguments is the fairness argument. The problem with this argument is that different people have different definitions of unfairness. A closely related argument is the level playing field argument, which advocates wider dissemination of information so that it is less asymmetric. One problem with the level playing field argument is that it is better applied to sporting competitions than to trading in information. Some economists argue that forcing the disclosure of nonpublic information can actually result in more harm than good and must necessarily involve the violation of property rights. Other arguments examined in this chapter include the fiduciary duty argument, the problem of outside traders, the misappropriation doctrine and the restrictions that insider trading laws place on freedom of speech and press. The article concludes by setting forth some principles or guidelines to determine when insider trading should be punished and when it should not.
KEY WORDS: insider trading, ethics, utilitarian, rights theory, level playing ﬁeld, asymmetric information, ﬁduciary duty
Introduction Insider trading is generally perceived as evil or, at least, unethical. The press and television show people being arrested and led away in handcuffs for engaging in it. The media have nothing good to say about the practice. Politicians enhance their careers by being against it. Commentators make it sound like all insider trading is illegal. Yet some forms of insider trading are perfectly legal (Shell, 2001) and some kinds of insider trading are not unethical. In other words, there is a widespread misperception on the part of the public about insider trading. The following pages discuss the two philosophical approaches that have been taken to determine whether, and in what circumstances, insider trading can be considered ethical or unethical. I comment on the various arguments that have been made over the last few decades and give my opinion on the strengths and weaknesses of the various positions that have been taken in the literature.
Philosophical foundations Utilitarian ethics Two basic philosophical approaches have been used to determine whether insider trading is ethical – the utilitarianism and rights-based approaches. The utilitarian approach, which is subscribed to by the
Robert W. McGee conclude that breaches of ﬁduciary duty make insider trading unethical. They would include it in the equation when attempting to determine whether the gains exceed the losses or whether the act still results in...