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"Insider trading which does not involve market manipulation or abuse of dominant position may well be illegal but it is hardly immoral." Discuss critically both the legality and the morality of insider trading.
Insider trading is defined as "insiders trading on shares of a company for which they have privileged 'material' information not available to the 'public', and for which they seek to gain pecuniary or other benefits" . Past literature has provided numerous studies discussing the application of ethics to insider trading and to what extend one can consider such a practise as moral or immoral. Engelen and Liedekerke make a clear distinction between insider trading and market manipulation that they define as where private information is used in order to make a share value shift from its fundamental value and therefore implies market inefficiency. Under their definition insider trading, on the other hand, can hardly be qualified as immoral and increase market efficiency. The discussion about insider trading therefore leads to the much wider issue of morality Vs legality. Morality refers to the broad general principles which define what is to be regarded as right or wrong. Law on the other hand sets out a code defining how people are required to behave. One should therefore not confuse what a business is legally allowed or not allowed to do with what would be morally right or wrong. The aim of this study is to discuss the relation Morality/Legality applied to the issue of insider trading. Basing our arguments on past literature, we will first analyse the vision of insider trading as immoral and in the second part, we will focus on ideas defending it as illegal but not immoral before applying the arguments to the Sabena Dowd case study.
Insider trading : immoral bahaviour.
The first and most obvious argument that one may find to describe insider trading as immoral is the one of unfairness. Indeed, this is one of the arguments most used in the non-consequentionalists' approach (MENDELSON 1969, SCHOTLAND 1991).Non-consequalist mainly base their arguments on fairness, morality and equality. Under their definition insider trading represents an untehical practise as it is not fair to all participants and therefore prevent the market from being free. (McGee, 2008). Past literature has defined 2 underlying concepts: the absolute equality version and the equal access view2 .Under the absolute equality vision, any information asymmetry implies unethical trading as it based on the idea of general morality implying the obligation to "treat people as we would ourselves".( Levmore, 1982).Using information that is not publicly shared in order to satisfy our own interests is therefore wrong and immoral. The equal access view on the other hand emphasize on the fact that everyone should have access to the information rather than on its possession.
One may also argue that insider trading is a form of property rights violation in a perspective that the information used may be considered as the company's property and should therefore not be used by any individual for personal gain.
It is also often argued in past literature that insider trading causes harm to small investors who do not have access to the valuable information that will be used by bigger organizations widening the gap between small and professional investors. Such inequalities also have a considerably negative impact in the public confidence and will discourage many from market trading.
Insider trading may also be considered as wrong as it may also harm the shareholders, namely when managers deals with negative inside information and therefore make personal gains but diminish the shareholders' profit, which besides being contradictory with their mission as employees may be reasonably seen as immoral behavior. In this perspective, insider trading is highly fraudulent as it is based on an intentional decision to violate another person's property or rights (Webster, 1964).
Another relevant point is the negative impact insider trading has on the general market morality. Indeed, Werhan for instance emphasizes on the necessity of a general morality carried out by certain fairness in competition" and a reasonably restrained self-internet to sustain the market. Far from the pro-insider trading arguments describing the benefits insider trading brings to the market, this idea relies on the fact that the inequality implied is by simply wrong and will tend to negatively influence the market morality as a whole.
No valid proof of immorality
Recent literature has highly criticised the ban of insider trading arguing that far from being immoral, it could actually be beneficial for the market and many criticise the ban of insider trading .
A significant point is the one raised by Engelen and Van Liedekerke (2007) regarding effect of insider trading on the market efficiency. They indeed state that insider trading ( once again it is worth remining that we do not take market manipulation under the definition of the term "insider trading"), far from having the negative impact on the markets claimed by many, actually benefits to the market. "Since insider trading is based upon private information that is crucial for the evaluation of a stock price, bringing this information into the open will automatically imply that the price of a stock moves closer toward its fundamental value. Insider trading will therefor by definition increase market efficiency." ( p 498). According to Carlton, insixder trading will be received as a signal to the other market players and could even transmit informationmore infficienlty and accuralty than the current public announcements ( Mc Gee, 2008).
One argument that defends insider trading is the one that banning informational assymetry is not only unrealistic but also could hurt the market. Mcgee argues that if every trade based on asymetric information was to be banned , there would be no more exachnge in any society. He even goes futher by stating that such an attitude would represent a threat for the society as preventing people from using their talent would harm the community. McGee draws a parallel between inside trading assymetrical information and professionals such as a plumber or a doctor that constantly uses information that the other party ignore ''yet no one accuses these
people of acting unethically merely because they profit from applying the information they have acquired along the way.'' (p. 206)
One way to look at the problem is to ask ourselef the following quations: is anyone harmed by insider trading? Back in the 18th and 19th century, philosphers like J. Bentham and J.S. Mill and argued that if a practise or behoaviour soes not cause any harm to anyone, then it can gardly been described as immoral. One obvisou answer would be that the other party trading with the insider is very likely to be harmed however, it is reasonable to state that the seller or buyer would have as a matter of fact sold or bouht anyway . One could therefore argue that in this case noone is worse of after the trade and that the practise cannot be defined as immoral. ( Ms Gee).
«Suppose I am touring Vermont and come across an antique blanket chest in the barn of a farmer, a chest I know will bring $2,500 back in the city. I offer to buy it for $75, and the farmer agrees. If he had known how much I could get it for back home, he probably would have asked a higher price - but I failed to disclose this information. I have profited from an informational advantage. Have I been unethical? My suspicion is that most people would say I have not. While knowing how much I could sell the chest for in the city is in the interest of the farmer, I am not morally obligated to reveal it. I am not morally obligated to tell those who deal with me everything that it would be in their interest to know.» (p. 172)
In this case, could it be said that the farmer has been harmed? Or in the contrary has he benifited from Moore's knowledge? One could say that the farmer has reached its goal of selling his chest and not worse off this way. According to McGee and Moore, insider trading cannot be considered as immoral as nbo one has been forced to make the deal and neither has the inside trader the duty to share his information with the other party.
Manne (1966) on the other hand refutes the idea that insider trading as a form of violations of property rights. He ineed sees the personal gains made from insider trading as compensation or bonuses that managers make in addition with their fixed wages.
In response to the critics of insider trading implying information inaccessabilty, Engelen and Van Liedekerke (2007) reply that even though a n equal access to infortmation is fundamental, insider trading by its own does not worsen the situtation. They even state that insider trading increasing market efficiency, the information willbe traslated into a more accurate price and will therefore be more spread over the market.
To the statement that insider trading is immoral because it implies the misappropriation of coporate information for personal use and tehrefore harms the emplyers (Martin, 1986), orther reply that the ban of insider trading leading to a market inefficiency will on the mong run affect the economy as a whole and therefore the business the company of the company as well as all the elements of the market.
As for the negative effect indiser trading may have on the general confidence in the market, namely for small investors, it may be argued that supposing that the market efficiency is improved by the practise of insider trading the market prices will therefore be more accurate, preserving better small investors that should end up being more confident in the market.
Case Study : Sabena Dowd
We will now analyse the applucability of these principles to a case sudy ( see full case in Exhibit).
Sabena Dowd is a an engineer for Super Software, overhears a conversation in the elevator between 2 persons that she identifies investment bankers for another company sahring the building. The two men discuss about excellent investment opportunity the International Thun-dermug Corporation (ITC) may represent. Sabeda decides to check the validity of the information and calls a national brokerage house where her account executive that confirms her that the company represents an "excellent stock". She decides to buy shares of the company and when the following week, The Wall Street Journal announces the acquisition of ITC by the renowned Old Arrogant Foundry (OAF), the stock price considerably grows and Sabena makes a $32,000 profit on the sales of her shares.
Can Sabena be considered as an " insider"?
Under the definitions cited above yes : she does use priviledged information that is not "public" as yet, that she uses to gain pecuniary benefits. Even though, one can state that she did not untentioannly seek for the information , neither did she work for any of the implied companies, the main argument that makes her behaviour immoral is the fact that she used information that was not available to other people. It is therefore reasonable to state that her gaining money out of this information was unfair towards others that did not have access to it.
According to the study of both the pros and the cons of banning insider trading, it seems that the only valid argument that validates the condamention of Sabena is the concern for general market morality. It is true that a free market should imply symetrical information and that Sabena making the most of a priviledge information is unfair towards the all the other persons that did not have access to the information. However, on may argue that she did not do anything immoral : she did not break the law in order to get the information, she did not intentionnaly harm anyone, someone would have bought the stock options when the acquisition was announced anyway, she never forced the seller to sale their share, she only used information that she got by fortune, just like a consumer could hear about a special offer at his / her supermarket and decides to shop today in order to make the most of it. Could anyone describe her behaviour as immoral? Most certainly not.
Past litterature has provided us studies that highlight both pros and cons of insider trading . The conclusion of balancing the aguments from both sides are that the heated dabate occurs as insider trading is a good example of when law and morality may not overlap.The arguments against the ban of insider trading refuted many of the of arguments in line with the law, taking the debate to a much more practical level, stating that the informational assymetry does not have any negative consequences as no-one will be worse off because of it.It therefore appears that insider trading may well be illegal but not necessaly immoral. Such an issue is obvisouly very challenging to solve since even though the immorality of inside traders cannot be proven, the application of law does help a certain preservation of a much needed general market morality.
It is therefore worth mentionnning that one's opinion about insider trading and by extention the concept of fairness is highly influenced by culture. Meir Statman states that"debates on the fairness of insider trading and more general debates about ethics are regularly based on 'thought experiments,' often assuming that one's intuition about ethics is shared by all. We should not shortchange the thought part of thought experiments but we might wish to devote more effort to the experiments part.".
- Philip Antony O'hara (???), Insider Trading in financial markets : legality, ethics, efficiency. International Journal of Social Economics, 28, 10/11/12, p 1046, Retrieved November 28, 2009 from Ebsco.
- Engelen, Peter-Jan, Liedekerke, Luc, The Ethics of Insider Trading Revisited. Journal of Business Ethics; Sep2007, Vol. 74 Issue 4, p497-507, 11p
- Irvin 1987