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Tuesday, May 17, 2011

Is Insider Trading "Really" a Crime?

In a piece on Mises.org, Bob Murphy muddles the issue of whether or not something should be a crime with whether or not it would be wrong to do if there were no law against it.

There are different answers to the questions: “Should holding the ball for over 24 seconds be against the rules in pro basketball?” and “Is holding the ball for over 24 seconds against the rules in pro basketball?”

One might answer “no” to the first, but answering “no” to the second indicates that the person answering is confused.

And so with the stock market and insider trading: For better or worse, the governing authority for the securities market has declared insider trading against the rules. One may sensibly work to change that rule, but it nonsense to declare that right now it is not “really” a crime. Since insider traders work hard to hide what they are doing (Rajaratnam went to great lengths to hide his activities), it is cheating. It is gaining an advantage not open to those who play by the rules. It is as though one adjusted the 24-second clock on one’s own court to tick more slowly than the visitor’s clock. It is no defense of such an activity to say, “Hey, I’m against the 24-second clock.”



Murphy tries to deny there are victims when insider trading takes place, but unfortunately for him, he is too good and honest an economist to get away with his own dodge, since he very clearly recognizes just who the victims are: "In fact, the only people who demonstrably lost out were those who were trying to buy shares of the stock just when the trader did so, before the news became public." Yes, that's right: The victims were everybody who played by the rules and paid more for the stock than they had to, due to the cheating of the insider trader.

He claims, "In a free society, there would be no such thing as laws against so-called insider trading."

By "free society," Murphy means one where law is determined on the market. So how in the world can he claim to know this? A large part of Mises, Hayek and Kirzner's argument for markets is that planners cannot know what will emerge from the market process. It certainly is the case that, in addition to prohibiting intrinsically immoral acts, market-driven law will also act to make some actions immoral since they will be made against the law. Consider, for example, an analogous argument to Murphy's: "In a free society, there would be no law against driving on whatever side of the road you want, since there is nothing intrinsically immoral about driving on one side of the road or the other." It should be apparent that this argument is silly: Yes, before a law was passed (and in the absence of a convention creating an informal law), it was not morally preferable to drive side on one side of the road or the other. But the passage of a law declaring "Here, we drive on the right," now makes driving on the right side moral, and driving on the left quite immoral. Similarly, a society with market-driven law will still have institutional rules governing things like stock markets... and one of those rules may well prohibit insider trading. And if such a rule were in place, engaging in the activity would be cheating, and would be immoral.

One sensibly and permissibly may work to have a rule one does not like changed. One may not sign up for a game, knowing the rules and agreeing to play by them, and then secretly try to get around them to gain an edge on others. That is “really” a crime, and morally wrong to boot.

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