Greed, Envy, and the Criminalization of Insider Trading
88 Pages Posted: 19 Sep 2012 Last revised: 26 Jan 2015
Date Written: September 18, 2012
In October 2011, a U.S. District Court sentenced Raj Rajaratnam to 11 years in federal prison for insider trading. This was the longest sentence for insider trading in U.S. history, but it was significantly less than the 19 to 24-year term requested by the government. Such harsh prison terms (equal in some cases to those meted out for murder or rape) require sound justification in a liberal society. Yet jurists, politicians and scholars have failed to offer a clear articulation of either the economic harm or the moral wrong committed by the insider trader.
This article looks to fill this gap by offering a rigorous analysis of insider trading, its criminalization, and its punishment from multiple economic and moral perspectives. This analysis reveals that of the three forms of insider trading currently proscribed under Section 10(b) of the Securities Exchange Act, two are economically harmful and morally impermissible, but surprisingly one is not (Non-Promissory Insider Trading, where the insider trades on material non-public information while having made no promise not to trade). Having reached this conclusion, alternative justifications or explanations for criminalizing Non-Promissory Insider Trading are explored.
Virtue theory is considered as offering an alternative justification for the criminalization of Non-Promissory Insider Trading. In particular, the vice of greed is considered. It is concluded that while insider trading does often reflect the vice of greed, a moralistic contempt for this character flaw cannot justify the criminalization of otherwise morally innocent conduct because this would violate the firmly held liberal Harm Principle famously articulated J.S. Mill.
But even if the criminalization of Non-Promissory Insider Trading cannot be justified, it remains for it to be explained. The socio-psychological theory of cognitive dissonance (as articulated by Dan Kahan and Eric Posner) is entertained as an explanation for how morally innocent conduct such as Non-Promissory Insider Trading might first become criminalized and then later perceived to be immoral by a population. Under the theory, actors generally regarded as moral innocents may initially be targeted for punishment as scapegoats in the wake of a disastrous or harmful social event. Over time, to avoid cognitive dissonance between the belief that conduct is morally permissible and the act of punishing it, society’s shared belief in the moral permissibility of the conduct is simply dropped.
This theory of cognitive dissonance fails to explain, however, why Non-Promissory Insider Traders would be targeted as scapegoats to begin with. The moralistic contempt for the vice of greed in insider traders (already discussed) offers one motivation, but the public’s own vice of envy concerning the easy money made by insiders may offer another. Since neither motivation supplies a justification for criminalization in a liberal democracy, and since envy in particular has its own harmful effects on society, the Article concludes on the cautionary note that we should perhaps rethink our laws and reconsider our attitudes concerning Non-Promissory Insider Trading.
Keywords: insider trading, law and economics, securities, law, utilitarianism, deontology, punishment, criminalization, Securities Exchange Act, fraud, misappropriation, SEC, securities exchange commission, Rajaratnam, securities fraud, cognitive dissonance, greed, envy
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