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The Hypocrisy of Insider Trading Laws

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Perhaps I’m the only person on earth who can see the hypocrisy of insider trading laws. In my opinion, these laws run counter the notion we accept in every other aspect of society, that life is unfair. In every facet of life, there are people who have access to advantages that others do not have. However, we don’t attempt to make these advantages illegal except when it comes to insider trading.

I’ve often heard the argument that it is not so much about fairness as it is about trust of the system, i.e., that people will not invest their money knowing that others have advantages they don’t have themselves. Baloney! The advantages people have in other things do not cause those without these advantages to not participate. I will cite several examples to show how the lack of similar laws in other aspects of life does not cause any real problems. They will also show how hypocritical it is to create special laws just for the world of investment and not apply the same logic anywhere else.

Let’s look at fraternities, sororities, and other private clubs and organizations. It’s completely legal to join them even though many of them are exclusive in nature and do not allow just anyone to join. Of course, this right is covered by the freedom of association guarantees in the U.S. Constitution. However, being a member often gains a person access to benefits that he or she wouldn’t have by not being a member.

One of these benefits is access to desirable high-level positions within major corporations. Many of these positions are not available to non-members. That’s not fair but I have yet to see a law against it. Despite that, people still apply for good jobs within corporations every day. They don’t sit on the sidelines and not apply just because they believe the insiders are getting all the best positions.

What about inherited wealth? It’s not fair for someone to take advantage of their inherited wealth when most people don’t have this kind of access. However, it’s perfectly legal. Many people with inherited wealth have a brand new car given to them as soon as they are old enough to drive. They have their college tuition paid for. They usually have a nice cushy job awaiting them when their college days are over, regardless of how well (or poorly) they performed academically. They don’t even have to work at all if they don’t want to.

How can this be fair when many other people have to work for everything they get? Until there are laws against it, everyone else will refuse to go to college, work, or pay for anything they get, right? Wrong! Most people realize that there are people with inherited wealth who don’t have to work for anything. People accept that as a fact of life and go on with their lives. They go to college (for which they have to most of the tuition themselves), go to work, and pay their bills every day. Life goes on and no fairness laws are needed here.

What about people who are attractive and/or have charming personalities? Having these assets is just fine, but it’s unfair for people to use them for personal gain when others like me, who are ugly and blunt, don’t have this privilege. However, I’ve never heard of any attempt (in this country anyway) to make a law against using good looks and positive personality traits to one’s advantage. People use these assets to help them land desirable jobs and work their way up the corporate ladder.

They use these assets to help them win friends and get favors the rest of us can’t get. They use these assets to attract higher quality mates than those of us who are lacking can attract. How does this make the rest of us feel? It makes us feel so discouraged that we never apply for a job, attempt to make friends, or perform any normal daily activity, right? Of course not, that would be silly. We go on with our lives just like the folks with the good looks and charming personalities. We are not going to sit out on life, waiting for laws to be passed to restrain all the pretty and charming people from getting a better deal in life.

I could go on and on, of course, but it seems to me that if insider trading is illegal because of the unfairness aspect, we ought to outlaw all other forms of unfairness as well. Sure, insider trading is unfair and very unethical. However, I doubt that the lack of laws against it would cause the markets to collapse. Other areas of our daily lives have not collapsed under the weight of unfairness that legally occurs every day. Also, when we outlaw some forms of unfairness while ignoring or even encouraging other forms of it (some of which are just as unethical), isn’t that in itself unfair?

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About Terry Mitchell

  • Clark Westfield

    Insider trading laws were created in the aftermath of 1929 to restore trust in a system that had been thoroughly manipulated by insiders, not to remedy any perceived “unfairness”.

  • http://commenterry.blogs.com Terry Mitchell

    Okay, Clark, many people have lost faith in our political system, which has “been thoroughly manipulated by insiders.” However, I don’t see any effort to curb insiders’ influence in politics — in fact, they seem to dominate the world of politics. True, there are limits on individual donations and so-called “soft money,” but what has that accomplished?

  • Maurice

    Not sure which insider trading laws you don’t like. Insiders can trade – they just have more restrictions on them.

    One thing you did not point out is that most officers (insiders) of a company are making their own options awards. This seems more unfair than requiring public disclosure.

  • http://commenterry.blogs.com Terry Mitchell

    Maurice, what I’m talking about is the fact that people who make trades, having inside knowledge that the public does not yet have, can get into trouble with the law. What bothers me is that it doesn’t have to be high-ranking company officials trying to manipulate the stock (the type of thing these laws were obviously written to prevent) — anyone who has gotten hold of inside information and then acts on it to make a profit is subject to prosecution. However, people use inside information/contacts all the time to get jobs, be accepted to prestigious colleges, get the best deals on merchandise, etc. and don’t have to worry about running afoul of the law. Why the double standard?

  • Aku

    I doubt this will satisfy you Terry, but here it goes. I am also sorry if I go over territory that is basic knowledge for you. I do this to present a fuller argument to everyone that will read this.

    The stock market operates on the assumption that it is efficient. One of the under-girding principles of market efficiency is the availability of information. IF trades are made on information not available to the market it degrades market efficiency, creating inefficiencies which will eventually lead to larger market problems.

    Milton Freedman actually supported the position in the article, but for different reasons. Freedman felt that an insider trade, in and of itself, was a distribution of information and allowed the market to adjust accordingly. I, personally, am somewhat sceptical of Freedman’s points, depending on the scale of the trades in question.

  • Maurice

    Terry

    Insider trading is not illegal. You can be an insider with insider knowledge and still buy and sell stock. Perhaps you are thinking of Martha Stewart. She got into trouble because of falsifying records. She was sentenced as follows:

    1 count CONSPIRACY
    2 counts FALSE STATEMENTS
    1 count OBSTRUCTION

    Had she filed the proper paper work, not altered records and perjured herself her trade would have been legal.

  • Aku

    Insider trading, when one in possession of knowedge not available to the general public and makes trades based on that knowledge, certanly is illegal.

    To quote the Feds:
    Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.

  • Doug Hunter

    I’m not really following any sort of logic here. Unlike insider trading, inheritance and genetic traits are outside of the ability of an individual to control.

    A better analogy is a real estate transaction. If you know there are major repairs needed or hidden damage to a structure you must notify the buyers before selling the home. Lemon laws and the like apply to many other transactions. I agree there are grey areas but to allow blatant fraud or overt misrepresentation in business transactions risks undermining the system of trust that must exist for the economy to function.

    Besides, you need the facade of trust and security to keep those workers pumping money into their 401K’s. If not, the good old boys on wall street wouldn’t have anyone to steal from but each other.

  • Maurice

    Aku #7

    you are right about laws regarding insider trading. I am saying that if you file the proper paper work you can be an insider and still trade. It could be compared to driving. If you have a license, registration, insurance, and up to date tags, you can legally drive your car.

    Here is a link to the listing of insiders that trade Micron stock. You will notice that most are either Officers or Directors of the Micron.

  • http://commenterry.blogs.com Terry Mitchell

    Okay, Maurice, let’s suppose I was an insider who wanted to make a trade today on information that was going to be available to the public tomorrow. Could I always get instant approval for my trade? Could I always go ahead and legally make my trade and file the paperwork later? If the answer to either question is yes, then you might have a point.

  • Clavos

    Terry,

    In your hypothetical, if you’re an insider who trades, you only register once, you don’t have to have specific permission for each and every trade. But if you violate the laws in your trades and are caught, you’ll be prosecuted.

    As Maurice pointed out above, insider trades take place every day, and are published; any decent trading site online will show you which insiders of XYZ Corp. traded today; whether they bought or sold, and how many shares.

  • http://commenterry.blogs.com Terry Mitchell

    But if you’re registered, how could you violate the laws?

  • Clavos

    Terry,

    Aku spells it out (with an explanation from the Fed itself) in #7.