Is All Insider Trading Unethical?

Insider trading is the buying or selling of securities by someone who has access to information that isn’t available to the public. The problem with insider trading is one of fairness. It is unfair to other investors if someone uses inside information to gain an advantage. An individual can use inside information to gain an advantage for himself or he could tip-off someone else. An individual can tip-off someone in one of two ways: purposefully (i.e. he tells someone directly) or incidentally (i.e. an outsider overhears a conversation between the insider and someone else). This means that insider trading isn’t isolated to company executives and upper management; brokers, family members, friends or a company’s employees can become insiders This doesn’t mean that an insider can’t trade his company’s securities; he can, but the Securities and Exchange Commission (SEC) has very strict rules concerning these trades and watches them very closely.

So, is insider trading unethical? I believe that for insider trading to be unethical, the trader must have a fiduciary responsibility to the organization he is trading in. In this respect, fiduciary responsibility makes one the caretaker of another’s rights or assets. The fiduciary has an obligation to carry out his responsibility in good faith and honesty, with integrity and loyalty to the interests of the organization. This good faith imposes an ethical obligation for the fiduciary to protect the organization’s interest to the exclusion of anyone else’s interests, including his own.

For example, an executive officer of a pharmaceutical company, who learns that the Food and Drug Administration (FDA) is about to announce the disapproval of his company’s experimental cancer drug, and subsequently sells his stock, is betraying a fiduciary trust. He is using inside information to gain an advantage over other shareholders. This act could have a negative effect on long-term owner value in that shareholders could lose faith in the organization and the management’s integrity. He is also violating the principle of ordinary decency by failing to deal fairly and honestly with shareholders.

What if the executive’s son, who is also a shareholder, overhears his father discussing the FDA disapproval with another insider, and subsequently sells his shares? Does this present an ethical dilemma and if so, for whom? Does the son have a fiduciary responsibility to the organization his father works for? No, he doesn’t. Does the son have a fiduciary responsibility to his father? Again, the answer is no. So, although the SEC would consider the act illegal, I don’t feel the son would be acting unethically. But what of the father’s disclosure of inside information to his son, is this unethical? I believe it is. After all, the father does have a fiduciary responsibility to the company and his disclosure of inside information, inadvertent or not, betrays his organization’s trust. The result of this disclosure is no different than the executive capitalizing on this information and selling his own shares.

I believe the presence of fiduciary responsibility is the determining factor of the ethics of insider trading. Insider trading is unethical if the trader has a fiduciary responsibility to an organization and uses inside information to gain advantage over others. This betrayal of trust fails to maximize long-term owner value and violates the principles of ordinary decency and distributive justice.