In Defence of "Insider Trading"

News has it that Raj Rajaratnam, a Sri Lankan hedge-fund manager in New York, has been found guilty of "insider trading" - which means that he made money because he knew what others did not know. Twenty years in prison seems to be the fate that awaits him. 


Note that many, many market trades require special knowledge and information - as Hayek discusses in this old paper of his, "On the Use of Knowledge in Society." 


Indeed, journalists' "scoops" are precisely of this sort - and no one complains that maintaining secret sources of information is unethical for a journalist.


What then is so wrong about insider trading? Tibor Machan, professor of philosophy and business ethics, has written a journal article on the subject that begins by defining the activity as follows:

Insider trading  per se is obtaining information from non-public sources— private acquaintances, friends, colleagues—and using it for purposes of enhancing one's financial advantage. As Vincent Barry explains, “Insider dealings refers to the ability of key employees to profit from knowledge or information that has not yet become public.” Sometimes such a practice can be conducted fraudulently, as when one who has obtained the information has a fiduciary duty to share it with clients but fails to exercise it, or in some other criminal fashion, as when the information is itself stolen.

Machan goes on to argue:

It is against the common view of insider trading presented in business ethics discussion that I want to argue that it may be one's achievement or good fortune to learn of opportunities ahead of others and there is nothing morally wrong with this.  In fact, acting on such information can be prudent, exhibiting good business acumen, whenever it does not involve the violation of other’s rights.  The conventional view rests on the belief that others have a right to one's revealing to them information one has honestly obtained ahead of them.   But there is no sound general moral principle that requires this.

Machan gives this example of insider trading:

A knows the president of a firm who tells me that they are thinking of expanding one of their divisions or have struck oil in a new field, so  A buys a block of stock in anticipation of the increase of value once the deal is done or the knowledge becomes public.  A is not deceiving anyone, nor is  A defrauding anyone.  A is not taking anything from others that  A wasn’t freely given.  A is acting on special, “insider,” information, that is all.

He then shows us how this financial gain on A's part is not immoral nor unethical:

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.”

Machan derides those who think the above act on A's part is immoral. He says they confuse the market with a game in which all must be given an equal footing from which to start - as in the golf "handicap." Or what others call a "level playing field." Such ideas are nonsensical. 


Those who demand Legislation against what they call insider trading are, according to Machan:

Those who claim otherwise as regard insider trading confuse the market place with a game in which rules are devised or set down with the special purpose of giving everyone an even chance—e.g., when in golf or steeple chasing handicaps are assigned...

Note that in a "private law society" - a world without Legislation - one would be bound by contract to either reveal information to some, or to conceal certain information from others; that is, these "duties" would be covered by Contract. In Rajaratnam's case the news report mentions that his "defense lawyers had stuck consistently to their main theme that Rajaratnam's trades were guided by a trove of research and public information, not secrets leaked by highly-placed corporate insiders." There is no mention of any contract violations Rajaratnam may have committed while trading the way he did. Twenty years in jail for this seems a miscarriage of justice to me. Injustice!


Anyway, do read Tibor Machan's excellent article from which all the above quotes have been extracted, which was published in the Public Affairs Quarterly of April, 1996, and is provocatively titled "What Is Morally Right With Insider Trading," by clicking here. 


Beware this bogey of "insider trading." This is just another of those "crimes" without any "victim." Instead, what we now have is "victimisation." Throw out all such Legislation. Let the stock markets be free!

PS: Here is an article by Robert P. Murphy of the Mises Institute on insider trading and the Rajaratnam case that is well worth reading.