The hyperzealous enforcement of so-called insider trading laws by the Department of Justice and the Securities and Exchange Commission justify a twist on the words of Winston Churchill: Never have so many expended so much effort for so little. Insider trading prohibitions in connection with the commercial purchase or sale of securities is akin to requiring war to be fought by Queensbury Rules. They should be abolished.
The Securities Exchange Act of 1934 prohibits a corporate official or associate from purchasing or selling a security while possessing material, non-public information regarding the financial prospects of his or another company - e.g., a large oil or gas discovery or an impending takeover bid. That prohibition is enforced by steep criminal penalties and financial liability.The insider trading prohibition has helped the government slay such Wall Street giants as Ivan Boesky, Dennis Levine and Michael Milken. It is relentlessly enforced by the SEC and the Department of Justice. For more than a decade, both have hectored foreign nations to make insider trading a crime and have negotiated mutual assistance agreements to obtain international cooperation to enforce insider trading prohibitions.
This frenzy of law enforcement would lead a layman to conclude that insider trading is a community menace rivaled only by international drug-trafficking cartels.
But insider trading is innocuous and deserves no legal condemnation.
In ordinary transactions, neither the purchaser nor the seller is required to disclose non-public information that ensures his bargain will be exceptionally rewarding. Suppose an art maven approaches a museum to purchase a Van Gogh portrait with a bid of $50 million. The would-be buyer declines to inform the museum that if the sale is consummated, a Japanese billionaire has agreed to then purchase the portrait from him for $82 million. The sale is made, the buyer immediately resells to the billionaire for a $32 million profit, and the law does not condemn the buyer for failing to inform the museum that a higher price could have been commanded by a direct sale to the Japanese Croesus.
In this hypothetical, the seller was not misled, nor did he sell at a price he believed was unfair. Commercial law offers no redress to the seller simply because a more lucrative return might have come if he had known all facts known to the buyer.
So why should a corporate insider be legally or morally censurable for purchasing a security at a price satisfactory to the seller simply because he knows that within less than a month his company will bid for that security at a substantially higher price? The seller was neither misled nor coerced into a sale. So what is the grievance?
Stockholders may think the corporate official was unduly enriched in the transaction. But if they are offended by such profits, stockholders can ban insider trading in articles of corporation or corporate bylaws. The result, however, would cause corporate officers to demand higher salaries or other benefits that would reduce corporate and shareholder wealth.
Insider trading laws were enacted because politicians needed a scapegoat for the 1929 stock market crash and the ensuing Depression. But to criminalize business practices in securities markets that are innocent in all other lines of commerce is morally perverse and an inexcusable waste of law-enforcement resources when so much genuine crime escapes punishment.