Pearls of Wisdom: There Ought to be a Law Against Insider Trading


Pearls of Wisdom: There Ought to be a Law Against Insider Trading

Trading on inside information should be illegal. In a post-Martha Stewart world, talk about insider trading has fallen by the wayside. We hear from time to time that the government is prosecuting people for insider trading, but not much more beyond that. It is easy to assume from this that it is not something that happens all that often, and when it does it is readily and easily prosecuted. But this is not quite the case.

We do not have any law specifically prohibiting insider trading. What we have is the Securities Exchange Act of 1934, which prohibits “[...]any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” This is a rather broad law and does not sufficiently cover the intricacies of insider trading. The result of this is that it leaves more room for individuals to get away with insider trading on the grounds that it is still technically legal.

As you might expect, there have been many insider trading cases over the years, and some have reached the Supreme Court. The Supreme Court recently said in 2016 that the law prohibits “[...]undisclosed trading on inside corporate information by persons bound by a duty of trust and confidence not to exploit that information for their personal advantage. These persons are also forbidden from tipping inside information to others for trading. A tippee who receives such information with the knowledge that its disclosure breached the tipper’s duty acquires that duty and may be liable for securities fraud for any undisclosed trading on the information.” This means that according to the Supreme Court: trading on inside information is not per se illegal.  What is illegal is trading on inside information when the person disclosing the information has received some personal benefit from the trader or when the trader violated some other law to get the inside information.

At present, a rather high profile insider trading case is just beginning. The New York Times coverage of the case describes it saying, “An issue in the trial will be whether the relationship between Mr. Walters and his source, Thomas C. Davis, a former chairman of the board of Dean Foods and a consultant in an activist campaign involving Darden Restaurants, was sufficiently close to find that tips about the two companies were a gift in violation of the insider trading laws.” This case is a perfect example of someone with inside knowledge, in this case the chairman of the board of Dean Foods, passing along proprietary information with the sole intent of personal enrichment.

That the legality of this issue is even up for debate is silly. Insider trading gives an unfair advantage on the market to those with inside information and those who have relationships with them. It is another way of allowing the rich to continue enriching themselves.

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