When I first read Professor Manne's Insider Trading in 1996, I thought his arguments were hogwash. I was the indexer for The Collected Works of Henry G. Manne. But Martha Stewart's experience made me look again at Manne's view that insider trading should not be illlegal.
The Martha Stewart case
The imprisonment of Martha Stewart was shocking. Martha, a fabulously rich, very productive businesswoman, was arrested for a pre-authorized sale of stock that saved her a whopping $45,000 in losses. She spent five months in a women's prison.
Others, all men as far as I know, have been accused not of avoiding losses but of making millions of dollars on insider trading. These men have only been fined and/or forbidden to serve on boards of directors or to work at stock exchanges.
This is not just an American issue. The Financial Times article, "Japan insider deal ruling raises wealth of questions," noted recent rumblings about a $600 (50,000 yen) fine on the Chuo Mitsui Asset Trust and Banking company as compared with an individual trader who paid 1.15 billion yen in a 2007 case.
Can a law so disparately punished really be called "fair"?
Proving insider trading
The FT article on Japan also notes how widely countries vary in regard to proving insider trading. The U.S. is said to be the most stringent, allowing charges only "if the information has been obtained in violation of a legal duty to keep it quiet." But while only traders can be charged in Japan, in the U.S. anyone involved in the leak can be charged.
Collateral damage occurs as attorneys, consultants, secretaries, and all kinds of other people get caught in the net. The government relies on wiretaps, informers, and simply prosecuting on other grounds, such as getting Martha Stewart on obstruction of justice. Anyone involved can not be charged too. In the McKinsey & Company scandal involving information passed by Rajat Gupta to Raj Rajaratnam, the trader who first passed information to Gupta has not been charged with any wrongdoing.
Can a law so convoluted to enforce be called "fair"?
A ubiquitous crime rarely caught
Insider trading refers to gaining a profit or avoiding a loss by possessing privileged access to inside information about a company's proposed actions. Insider trading is the most common financial crime, yet there are only 500 civil and few criminal suits brought in the U.S. each year.
How many of us have been given an insider tip by friends, family, or coworkers who know about the workings of a large U.S. corporation? If your cousin tells you his CEO gave a speech saying the company's stock will go up, should you both go to jail if you buy that stock? Why not?
How can a law so infrequently enforced really be called "fair"?
A level playing field for investors?
When I realized investing was parimutuel betting and not casino gambling, I had to wonder why insider trading is a crime. To be successful, parimutuel betting relies on human intelligence rather than pure luck. What does this mean for the notion that investors should have a "level playing field," the reason some insider trading is illegal.
Can investors ever start on a level paying field? Do you have access to high-speed computer(s) with sophisticated algorithms? Did you spend four years or more in college studying finance and economics? Can you understand statistics? Are your friends traders? Do you spend hours each day investing? Have you learned how if you invest in a mutual fund for fifty years at a 2 percent fee, the fund will get 64 percent of your "winnings"?
Professor Manne's book defines Americans, quite a few legally, who may possess inside information about large corporations. The ones that stuck in my mind were Congresspersons trading legally on inside information. I was outraged. But here's what I think now. We Americans have been conditioned to start salivating whenever we imagine someone else has benefited from something we haven't. We leap to judgment and think "That's terrible".
"Somebody's-getting-away-with-it" is the kind of story CBS's 60 Minutes loves. It's the kind of story the right trots out when it wants to drug-test welfare moms.
These archetypal tales are prime examples of the sin of envy.
Why insider trading is "bad law"
In his 1982 essay, "Hawks, Doves, and Free Riders," Gordon Tullock acidly remarked that laws making insider trading illegal merely benefit experts who get inside information first and can legally trade with it. Tullock calls this free riding (freeloading) off of the rest of us. Not only does "insider trading" law benefit free riders, there's no blanket "fiduciary duty" that requires all brokers, let alone other insiders in the financial, corporate, and government sectors, to put the interests of those they serve first.
I can't call this fair. Can you?