Insider trading, private corruption and behavioral ethics

Both the contours and the purposes of the prohibitions against insider trading have been the subject of considerable dispute – indeed, the lack of clarity regarding insider trading enforcement may be unique among major laws in the business crime field, at least in the US.  Needless to say,  uncertainty regarding any criminal law is unfortunate, as it can serve to deter desirable, as well as undesirable, activity,  and also be the cause of unfairness – which, beyond being harmful to those touched  directly by a prosecution, can delegitimize the law in question.

In “Insider Trading as Private Corruption” – which will be published next year in the UCLA Law Review –  Prof. Sung Hui Kim offers what she describes as a new doctrinal approach to insider trading law:  such law should be viewed as “a form of private corruption, defined as the use of an entrusted position for self-regarding gain.” She explains: ” The corruption theory not only provides answers to the normative skeptics but, as compared to the two leading alternatives, the property theory and the unjust enrichment theory, better fits the core features of the received doctrine… Even better, the corruption theory provides relatively concrete guidance in hard cases, which is the sort of pragmatic theory that the SEC and the courts desperately need.”

Although I handled quite a few insider trading cases in the 1980’s and 1990’s (as a defense lawyer, before switching to full-time C&E work), I’m not familiar enough with the types of “hard cases” that those who trade securities (particularly professional traders/investors)  currently face to have an informed view of how pragmatic this theory is.   But, I do find the private corruption approach compelling from a doctrinal perspective  because, as described in this recent post:

– there are powerful behavioral-ethics-related challenges to promoting compliance with insider trading law having to do with the lack of immediacy of the harm in the offense;  and

– a corruption/conflict-of-interest based approach to promoting compliance in this area seems well suited to addressing these challenges.

In particular, such an approach can help show – hopefully in a powerful way that overcomes such obstacles – what the harm really is with insider trading.  Related to that point, Kim describes (on page 32 of the article) a behaviorist experiment “which found strong correlations between the high levels of perceived public sector corruption in the country and the tendency to view insider trading as acceptable. The more corrupt citizens viewed the country, the less objectionable were the inside trades, and vice versa. Although far from definitive, these correlations provide additional support to the idea that insider trading is best understood as a species of private corruption.”   She also notes: “A key benefit of seeing insider trading as private corruption is that it allows us to see the harms of insider trading more generally as the harms of corruption.”

More generally, given the unprecedented world-wide campaign against public sector corruption, I think broader law enforcement/compliance strategies using (where reasonably applicable) a corruption-based approach – like Kim has done with insider trading – should be considered.   Indeed, that is what I have tried to suggest in this piece about abuses in the gifts and entertainment area  being viewed as “soft-core corruption.”

For a post on private sector corruption generally please click here.  And here is one on the somewhat related topic of “informal” fiduciary duties.  Finally, here is a post on implications of behavioral ethics for the securities law notion of scienter.