Fairness and Insider Trading

Tuesday, January 1st, 2002 at 12:00 am by Ian B. Lee
Ian B. Lee, Fairness and Insider Trading, 2002 Colum. Bus. L. Rev. 119

In the thirty-five years since Henry Manne’s belittling reference to ‘an anonymous lady law student,‘ who, in a classroom discussion of insider trading, ‘stamped her foot and angrily declaimed, ‘I don’t care; it’s just not right,’‘ many commentators have adopted his view that ethical considerations are alien to the debate, a ‘refuge for the intellectually bankrupt.‘ The insider trading debate is, we are told, ultimately an economists’ debate, a question of market efficiency and executive compensation. The question asked is whether the allocation of insider trading privileges ought, for efficiency’s sake, to be left to private ordering or whether there is a role for regulation to remedy alleged deficiencies in the markets for capital and managerial labor.

My objective is to rehabilitate fairness as a concept relevant to the debate about insider trading. A common objection to the invocation of fairness in this context is that it is devoid of principled content. It is said that insider trading is often asserted to be unfair without any explanation of what is meant by unfairness. One of my challenges is to elucidate the possible meaning of fairness in the context of the securities market. In addition, I hope to show that there are reasons which may properly be described as grounded in fairness militating in favor of equality of information. Other goals, such as the pursuit of economic efficiency, may be capable of justifying a departure from ideal fairness, but they do not make fairness irrelevant. The concept of fairness is so poorly regarded in much of the literature on insider trading that, if I succeed in the modest project of reestablishing fairness, independently of efficiency, as a valid goal of insider trading regulation, it will be a significant step.

This paper is about the use of nonpublic information in securities transactions. This is the practice to which I refer when I use the term ‘insider trading‘ although, as others have pointed out, insider trading in the securities markets presents similar issues to those involved more generally whenever parties conclude contracts under asymmetric information.

In Part II of the paper, I provide a summary description of the positive law of insider trading and the economic debate that has taken place since Manne’s groundbreaking book on the subject in 1966. As excellent and detailed summaries exist elsewhere, the description will be brief. In Part III of the paper, I propose a conception of fairness as a constitutive value of a certain kind of morally attractive market. Part IV argues that parity of information is a core requirement for a fair market.

Although this paper is primarily concerned with fairness, I consider in Part V a variety of efficiency-based objections to parity of information, since I think that it is important to understand whether adopting a rule out of a concern for fairness might lead to a loss of welfare to society or even to the very individuals whom the rule is intended to protect. Among others, I discuss the following arguments: that insider trading is a victimless crime; that mandatory sharing will undermine incentives to acquire information; that informational equality is inconsistent with the securities market’s inherent inegalitarianism; and that prohibiting insider trading harms outside investors by preventing them from concluding the bargains they prefer. While I find that the conventional objections to parity of information are overstated, I acknowledge that a case might be made for qualifying the rule in some circumstances.

Author Information

Visiting Research Fellow at the Faculty of Law, University of Toronto; also an associate attorney with Sullivan & Cromwell