Insider trading and market integrity

Insider trading isn’t just about fairness; it’s also about the moral foundations of markets.

Chris MacDonald 0

(Photo: artpartner-images/Getty)

Cheng Yi Liang, a chemist for the U.S. Food and Drug Administration, has been found guilty of insider trading and sentenced to five years in prison. (I first blogged about this case back in March, when Liang was arrested.)

As it happens, the Liang verdict dovetailed nicely with the topic recently covered in the Management Ethics class I teach at the Ted Rogers School of Management. The class was led by a terrific guest speaker, compliance consultant and retired RBC compliance officer Georges Dessaulles.

The Liang case serves as a great example of one of the points Dessaulles emphasized in his presentation, namely that when it comes to insider trading, highly placed executives are far from the only concern. In the Freeport McMoran case in the mid-90s, for example, the central figure was a consulting geologist, not an employee of the mining company itself. In the 2001 case related to Nortel’s acquisition of Clarify, the central figure was an executive working at a public relations firm that had a contract with Clarify. And now, in the Liang case, the guilty party not only didn’t work for the company in question, he also had no contractual or other financial relationship with the company. Instead, he was a scientist at a regulatory agency. Other cases have involved administrative assistants, or even employees at companies printing corporate reports.

This highlights an important point about the ethics of insider trading. The stereotypical cases of insider trading involve executives making use of undisclosed knowledge to gain an unfair advantage over outsiders in buying or selling stock. In taking unfair advantage, executives not only perpetrate a basic injustice, but also violate their duties to shareholders. But the kinds of cases cited above point to a different reason for the wrongness of insider trading. In the FDA case, the central figure wasn’t someone with direct obligations to corporate shareholders. There was thus no breach of fiduciary duty (at least not in the usual sense). What’s really at stake, in such cases, is the undermining of the basic principle of free-and-voluntary exchange on which the a free-market economy is based.

The challenge for organizations is to make sure that employees and contractors with access to sensitive information understand the definition of—and penalties for—insider trading. But that’s a serious challenge, especially at big companies. Better still would be for more people to understand the moral underpinnings of free markets quite generally, and to have the moral reasoning skills to figure out the rest from there.

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