Legislation and Legitimation: Congress and Insider Trading in the 1980s

Abstract:     
Orthodox corporate law-and-economics holds that American corporate and securities regulation has evolved inexorably toward economic efficiency. That position is difficult to square with the fact that regulation is the product of government actors and institutions. Indeed, the rational behavior assumptions of law-and-economics suggest that those actors and institutions would tend to place their own self-interest ahead of economic efficiency. This article provides anecdotal evidence of such self-interest at work. Based on an analysis of legislative history - primarily Congressional hearings - this article argues that Congress had little interest in the economic policy effect of insider trading legislation in the 1980s. Rather, those laws were motivated primarily by a desire to legitimate the existing political and economic order.

The policy and doctrinal grounds for prohibiting insider trading are unclear. Yet Congress devoted a great amount of attention to increasing the penalties for insider trading in the 1980s. Meanwhile, more serious economic issues went unaddressed. What explains this odd focus? Congress routinely explains corporate and securities legislation as motivated by a need to bolster investor confidence and protect the capital formation process. In the 1980s, legislators argued that insider trading scandals were undermining investor confidence. That argument is unconvincing, however, because those scandals were contemporaneous with unprecedented stock prices.

An alternative explanation for the 1980s legislation is that Congress sought political legitimacy: not investor confidence in the markets, but voter confidence in the political-economic system. Our government has a symbiotic relationship with a capitalist system under which the power of business and finance sometimes rivals that of the state. This arrangement is acceptable to most voters during prosperous times, but can undermine the legitimacy of the political-economic system in times of perceived economic crisis. Government crafts its responses to such crises to protect its legitimacy. The process of self-legitimation does not consist merely of responding to exogenous preferences of constituents. It also includes attempts to mold constituents' preferences to be more consistent with the self-interest and problem-solving abilities of Congress.

Keywords: Securities regulation, insider trading, legislation, congress, politics, regulation

JEL Classifications: G38, K22, H11, L50, P16

Accepted Paper Series