The Injustice of Insider Trading Laws
By Andrew Bernstein (National Post, July 15, 2004)
Martha Stewart was investigated for the "crime" of insider trading and later convicted of obstructing justice for lying to authorities during the investigation. But the questions no one is asking are: Should Martha even have been the subject of a criminal investigation in the first place? Should anyone be investigated for insider trading? Is insider trading objectively a crime?
In a free society a company belongs to its owners--the shareholders--not to the government. The owners have the moral, and must have the legal, right to decide if corporate executives--their employees--will be permitted to trade on or disseminate "inside," i.e., proprietary information. Indeed, the owners have the moral right to decide if corporate executives will even be permitted to own stock in the company.
Prior to the establishment of the SEC in the 1930s, the government properly did not violate the right of a company's owners to control, by means of corporate by-laws, the practices of corporate executives regarding stock ownership and inside information. The government recognized that proprietary information belonged to the company's owners. However, this respect for property rights began to erode as regulations and prohibitions on insider trading were gradually imposed.
Opponents of insider trading claimed that the practice is unfair because information is not available equally to all market participants. For example, if an executive is permitted to purchase stock on the basis of news that he alone knows will increase its value, an "injustice" is done to other shareholders or potential shareholders who do not possess that information.
But by what standard is this unjust? Contrary to the egalitarian premise giving rise to opposition to insider trading, individuals have no more right to information they have not earned than to wealth they have not earned. Should a talented analyst, for example, be forced to make his research publicly available if it would otherwise give him a competitive edge on the market? The mere fact of participating in the financial markets does not confer upon one a right to the hard-won knowledge of others.
In a free market, corporate policy on insider trading would be knowledge available to the public. If a potential investor held that the practice involved too much risk to the value of a stock, he could refuse to purchase the stock of companies permitting the practice. And companies desiring to prohibit the practice among their employees would be free do so by contractual agreement. They would have the moral and legal right to bring civil charges against an executive who violated his contractual obligations.
Interestingly, however, under the freer, more capitalistic system of the past, shareholders only rarely prohibited their employees from trading on inside information. The owners generally considered it a legitimate form of compensation and recognized that if such a privilege were abused they could ban the practice and/or fire the offending party.
For example, for decades the great railroad builder, James J. Hill, took no salary for his work as President and CEO of the Great Northern Railroad; he was compensated exclusively by the increase his productive work added to the value of his stock. Should the government have had the power to prohibit him from buying on the good news his work made possible--contrary to the choices of the company's shareholders who agreed to compensate him in this way?
By its very nature, insider trading has a minimal effect on the value of a stock. The overwhelming preponderance of a stock's gain or loss is determined by the nature of the information itself, not on the act of inside trading on it. ImClone's shareholders, for example, lost $900 million because of the FDA's arbitrary decision (later reversed) to not approve the company's cancer-fighting drug, Erbitux, not because of the stock sale of Martha Stewart (or even the much larger one of Sam Waksal).
Laws against insider trading violate the right of shareholders-owners to decide the manner in which their company will be run. It is right that a company's owners decide what practices their executives will be permitted to engage in regarding the proprietary information that belongs to them.
Martha Stewart is an enormously productive businesswoman caught up in a network of immoral laws. It is far more just to repeal the laws than to punish one who obstructed an investigation that was wrongful from its inception.
Andrew Bernstein, author of The Capitalist Manifesto, is a senior writer for the Ayn Rand Institute in Irvine, Calif. The Institute promotes Objectivism, the philosophy of Ayn Rand--author of Atlas Shrugged and The Fountainhead.
For more articles by Andrew Bernstein, and his bio, click here.