50 Pages Posted: 24 Jun 2003
2002 was the year of corporate scandal. Officers and directors of Enron, WorldCom, Tyco, Adelphia and others were accused of gross fraud and theft in blatant violation of the federal securities laws, let alone basic moral and ethical norms. Corporate irresponsibility contributed to the destruction of the venerable accounting firm of Arthur Andersen, the commencement of seven of the largest bankruptcies in U.S. history, and unprecedented financial harm not only to the employees of and investors in specific issuers, but also the American securities markets generally.
In the midst of this gargantuan skullduggery, a very different story fascinated the public eye. In December 2001, Martha Stewart sold less than 4,000 shares of ImClone stock the day before the announcement of bad news, enabling her to avoid approximately $40,000 in trading losses. The popular press has pilloried Stewart; late night comedians have all but branded her a crook.
If one based one's opinion solely on television, one might assume that the allegations against Stewart clearly constituted illegal insider trading and that successful legal actions by the Securities and Exchange Commission (the "SEC") and the Department of Justice ("DOJ") are a foregone conclusion. If one reads more carefully, however, the reality is not so simple.
In fact, it is far from clear whether Stewart's alleged acts were immoral or unlawful, let alone illegal, and it is hard to identify any harm her acts directly caused anyone. Indeed, the only clear harm to date has been to Stewart personally and the shareholders of Martha Stewart Living Omnimedia.
To state what should be obvious, Stewart is not an insider of ImClone and is, therefore, incapable of engaging in classic insider trading. Nor could she have breached any duty of confidence and, engaged in the "outsider" trading under the more controversial "misappropriation theory." Moreover, to date no facts have been made public that would support a claim that Stewart was a tippee of a classic insider. A prosecution of Stewart would probably require a court to adopt a new interpretation of the law beyond precedents. More disturbingly, if the DOJ and SEC go forward, they will probably be reduced to charging that Stewart's protestations of innocence constitute the fraud upon which she is to be considered guilty! In other words, to the securities lawyers, the public reaction to the Stewart affair appears wholly out of proportion, particularly when compared to the obvious corporate improprieties of 2001.
I suggest that the public reaction to the Stewart "scandal" may not be so much righteous outrage, but the ignominious sin of envy - the pain one feels in seeing another experience joy. It is the mirror image, shadenfreude - the joy one feels in seeing another experience pain. In this essay I will use the Stewart episode as a jumping-off point for analyzing the two competing legal theories of unlawful securities trading on the basis of material non-public information: the so-called "classic" theory, and the controversial "misappropriation" theory - more accurately termed "outsider trading" - recently adopted by the U.S. Supreme Court in the case of U.S. v. O'Hagan. Although the misappropriation theory is widely criticized, I believe that no one has to date convincingly explained precisely why it seems so intuitively "wrong."
I posit that the distinction between the ethics of classic insider trading and misappropriation precisely reflects the distinction between the two often confused - but distinct - passions of jealousy and envy. Although the terms are often incorrectly used interchangeably, jealousy is the fear and anger one feels when considering the possibility that a rival either may take, or has taken, that which rightfully belongs to one. Envy, in contrast, is the anger and pain one feels in observing the good fortune of another.
Similarly, classic insider trading reflects the fear of investors in a public company that rivals - specifically the company's management and other fiduciaries - will take what rightfully belongs to investors - non-public information in the possession of, and concerning, the issuer. The misappropriation theory, in contrast, involves the resentment by the investment public that other persons have the good fortune to enjoy something to which the public has no right - non-public information obtained from third party sources who are the legally recognized owners of the information.
The ethical status of jealousy and envy are completely diverse. In jealousy one wants to protect what one has or should have. In envy, one wants to destroy the possession of another. Jealousy is the assertion of one's own rights of possession. Envy is the wish to destroy the enjoyment of another whether or not it is rightful. Jealousy may not be an attractive emotion, but even God admits that He is jealous. Envy, however, is one of the seven deadly sins. Indeed, it is second only to pride in its potentially corruptive effect on the soul. As etymology reveals, envy - invidia - is the most invidious sin.
In this Article, I propose an internally consistent analysis of insider-trading law based on any given allocation of property rights in non-public information. The misappropriation theory is incoherent and internally inconsistent because it attempts to ground insider trading law on trade secret principles. In contrast, classic insider-trading theory based on a determination that beneficial interests in certain information belong to the investing public generally - it reflects a rare egalitarian moment within our generally individualistic, libertarian property regime. The public is, therefore, rightfully jealous if any insider having privileged access to this information attempts to exploit it for her own advantage without sharing it with the public. In contrast, trade secret law is premised on the determination that the right to control and commercially exploit certain information resides exclusively to specific individuals and that the public generally has no such rights - it is fundamentally individualistic and monopolistic. For the government to assert that the investment public is defrauded through the use of this information to trade in securities reflects envy.
Suggested Citation: Suggested Citation
Schroeder, Jeanne L., Envy, Jealousy and Insider Trading: The Case of Martha Stewart. Cardozo Law School, Public Law Research Paper No. 72. Available at SSRN: https://ssrn.com/abstract=419580 or http://dx.doi.org/10.2139/ssrn.419580