Insider Trading: What is Legal isn’t Necessarily Moral

Cato’s Walter Olson has a splendid article on the recent controversy over alleged insider trading by some politicians

Mr. Olson writes, (italics original)

Washington has been buzzing for the past 48 hours over revelations that some of Capitol Hill’s best-known lawmakers have been making fortunes speculating in the stocks of companies affected by official actions, typically while in possession of market-moving inside information. Rep. John Boehner (R-OH), Senatorial wife Teresa Kerry and others made bundles trading in health companies’ stocks shortly before Congressional or executive-branch action affecting the companies’ fortunes. After closed-door 2008 meetings in which Fed chairman Ben Bernanke briefed Congress on the gravity of the financial collapse, some lawmakers dumped their own stockholdings or even placed bets that the market would fall. Rep. Nancy Pelosi (D-CA) got access to highly desirable IPO (initial public offering) stock placements, some in companies with business before Congress. And so on. Studies have found that lawmakers as a group reap far above-average returns on their investments—suggesting either that these politicians are among the world’s cleverest investors, or else that they are profiting from inside information. All this has been turned into a front-page issue thanks to Throw Them All Out, a book by Hoover fellow Peter Schweizer, whose findings were showcased the other night on 60 Minutes.

So the question is: is all this legal? While there’s some difference of opinion on the issue among law professors, the proper answer to that question is most likely going to be, “Yes, it’s legal.” As UCLA’s Stephen Bainbridge points out, existing insider trading law, developed by way of a long series of contested cases under the Securities and Exchange Commission’s Rule 10b-5, assigns liability to persons who are not corporate insiders if they are violating a recognized duty of loyalty to those for whom they work. As applied to the investment whizzes of the Hill, this implies that trading on inside information might be a violation if done by Congressional staffers (since they owe a duty of loyalty to higher-ups) but not when done by members of Congress themselves.

First of all, I am not certain about the validity of the alleged statistics. Unless the analysts, who uncovered the controversial wealth derived from supposed insider trading, have been privy to the personal accounts of the aforementioned politicians or entirely trust disclosures as being forthright, these figures should be seen with cynicism.

How do we ascertain if under the table deals (concessions, bribery and etc.) are being passed off or camouflaged as investment gains? In short, what distinguishes money laundering from insider trading?

Second, what is legal isn’t necessarily moral.

Are insider trading laws moral?

As Professor Philosopher Tibor Machan writes, (bold emphasis mine, italics original)

It is conventional wisdom to treat this version of insider trading as morally wrong because it supposed to adversely affect others by being unfair. As one critic has put it, “What causes injury or loss to outsiders is not what the insider knew or did, rather it is what they themselves [the outsiders] did not know. It is their own lack of knowledge which exposes them to risk of loss or denies them an opportunity to make a profit.” By the fact that these others do not know what the insider does know, they are harmed since they are not able to make use of opportunities that are in fact available, knowable to us.

But what kind of causation is it that fails to make a difference when it does not exist? If someone’s knowing a good deal has no impact on what another does, it cannot be said that any harm upon another had been caused by that someone. Certainly, had the other known what the insider knew, he or she could have acted differently. By not acting differently, he or she could easily have failed to reap advantages the insider did reap. But nothing here shows that the insider caused any harm, only that he or she had a better set of opportunities. Unless we assume that valuable information known by one person ought, morally—and perhaps legally—be distributed to all interested parties—something that would beg the most important question—there is no moral fault involved in insider trading nor any causation of harm.

In short, insider trading is fundamentally about asymmetric information or "a situation in which one party in a transaction has more or superior information compared to another" (investopedia.com) and its effect on the marketplace.

I might add that even if there have been symmetry of information, people’s interpretation of information have factually been nuanced or different such that diversity of thoughts leads to variable actions, and thus voluntary exchange. In reality, there will never be symmetry of information because of the variable factors people read or construe information.

So how does one establish “fairness” in information?

Again, Professor Machan, (bold added, italics original)

As this applies to insider trading, if I have a prior obligation to share my information with others, that is, a fiduciary duty to clients or associates, then it is not that the information is “from the inside” but that it is owed to others that makes my dealings morally and possibly legally objectionable. It is only in such cases that fairness is obligatory, as a matter of one’s professional relationship to others, one established by the promise made or contract one has entered into prior to the ensuing duty to be fair. It is only then that one cause injury by refusing to do what one has agreed to do, namely, divulge information prior to using it for oneself. Accordingly, Hetherington’s objection to insider trading is without moral force. What he should have objected to is the breaching of fiduciary duty, which may occur on occasion by means of failing to divulge information (possibly gained “from the inside”) that has been—perhaps even contractually— promised to a client.

Furthermore, if I have stolen the information—spied or bribed for or extorted it—again the moral deficiency comes not from its being inside information but from its having been ill gotten.

If there has been no established fiduciary duty then fairness or unfairness becomes another abstraction used by politicians as pretext to enforce control over the marketplace. Insider trading, thus, becomes subjective and arbitrarily determined by politicians and regulators

This leads us back to Mr. Olson’s conclusion (bold emphasis mine)

It is tempting to approach the new revelations the way an ambitious prosecutor might, trying to stitch together a test-case indictment from, say, the penumbra of the mail and wire fraud statutes bulked up with a bit of newly hypothesized fiduciary duty here and a little “honest services” there. But that’s not how criminal law is supposed to work: for the sake of all of our liberties, prohibited behavior needs to be clearly marked out as prohibited in advance, not afterward once we realize it doesn’t pass a smell test. But we are still free to deplore the hypocrisy of a Congress that has long been content to criminalize for the private sector—often with stiff jail sentences—behavior not much different from what lawmakers are happy to engage in themselves.

My conclusions

It is unclear whether politicians benefited from insider trading or from other shady deals which has been passed off as stock market investments, thus the alleged outpeformance.

Insider trading, as argued from a moral standpoint, without clear parameters of the how the inequitable distribution or the lack of knowledge affects other parties accounts for as an arbitrary law. Hence these can be used by politicians to harass some participants in the marketplace for political or personal goals, and thus can be construed as an immoral law.

Given that politicians have become above the law, this accentuates the unfairness or the unilateral nature of the ethically flawed insider trading law or regulations

Finally, politicization of the marketplace, bailouts, inflationism, green energy and other market manipulation which predominate today’s have been skewing gains in favor of political clients at the expense of society, so where has the prosecution on insider trading been?

Clearly, what is legal may not be moral as the insider trading law reveals.

P.S. The Philippines has seen its popular Insider trading Scandal via the BW Resources.

Don’t blame this on free markets but one of state corporatism or crony capitalism

As the PCIJ writes, (bold emphasis mine)

The machinations surrounding the operation of the BW Resources Corp. and its affiliated BW Gaming and Entertainment Co. were probably the height of presidential recklessness. To begin with, Estrada was Dante Tan's secret partner in BW, confirms Espiritu. That was why BW became the recipient of so many government favors: an online bingo license given in record time by the Philippine Amusement and Gaming Corporation (Pagcor), the state-owned gaming company; a P600-million loan from the Philippine National Bank that was approved even if the collateral was worthless land; and a contract from Pagcor that ensured the transfer of Pagcor operations to a building that BW was constructing in downtown Manila.

Moreover, as various officials attested during the impeachment hearing, Estrada intervened on behalf of Tan when he was being investigated by the Securities and Exchange Commission (SEC) for insider trading and stock price manipulation. The President also ordered Jimenez and ethnic Chinese businessmen Wilson Sy and Willy Ocier, whose speculative play in the market was believed to have caused BW prices to fall precipitously in late 1999, to return the money Tan had lost to shore up BW prices.

"That was the version of Dante Tan when I confronted him about it," says Espiritu. "That version was also confirmed by the brokers at the Philippine Stock Exchange." Face to face with an angry president, Sy and Ocier agreed to reimburse Tan's losses, according to prosecution lawyers in the Estrada impeachment trial. The payoff was supposedly made not in cash but in 650 million shares of Belle Corp. worth P1.5 billion. The shares were turned over not to Tan but to Estrada, who then supposedly sold them to SSS and GSIS at a profit of P800 million.

Such politically driven stock market manipulation has been fated to meet with divine justice.

President Estrada has been impeached (yes I know Mr. Estrada ran and placed second in the 2010 presidential elections), where the scandal had been part of the impeachment proceedings, and BW Resources crashed back to earth, where crony Dante Tan, reportedly lost lots of money and has fled country and reportedly is in Canada even if the courts eventually absolved him--which again reveals of the nebulousness of the law.

BW Resources (blue chart) [from my previous post]