Article Review (4 paragraphs)

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Question description

Please choose ONE of the two attached article and then do as below:

Assignment Purpose: To practice clear understanding of an author’s argument before critically analyzing it.

Style: MLA

No references

Your assignments will be checked for originality by Turnitin.

The paper will be given a title and will consist of only four paragraphs:

  • The first paragraph will briefly summarize what you take to be the author’s main idea. This should be the author’s philosophical idea(s)—there is no need for biographical or other information about the author.
  • The second paragraph will explain some portion of the author’s argument that you agree with. You should give several reasons why you think the author is right.
  • The third paragraph will raise a specific problem with the assigned reading and give reasons to show that the specific problem is serious. Be careful not to discuss a question that the author answers explicitly.
  • The fourth paragraph will offer evidence from the reading to show how the author might answer the question. (Again, do not discuss a question that the text answers explicitly.)

ETHICS Is Business Bluffing Ethical? by Albert Z. Carr FROM THE JANUARY 1968 ISSUE A respected businessman with whom I discussed the theme of this article remarked with some heat, “You mean to say you’re going to encourage men to bluff? Why, bluffing is nothing more than a form of lying! You’re advising them to lie!” I agreed that the basis of private morality is a respect for truth and that the closer a businessman comes to the truth, the more he deserves respect. At the same time, I suggested that most bluffing in business might be regarded simply as game strategy—much like bluffing in poker, which does not reflect on the morality of the bluffer. I quoted Henry Taylor, the British statesman who pointed out that “falsehood ceases to be falsehood when it is understood on all sides that the truth is not expected to be spoken”—an exact description of bluffing in poker, diplomacy, and business. I cited the analogy of the criminal court, where the criminal is not expected to tell the truth when he pleads “not guilty.” Everyone from the judge down takes it for granted that the job of the defendant’s attorney is to get his client off, not to reveal the truth; and this is considered ethical practice. I mentioned Representative Omar Burleson, the Democrat from Texas, who was quoted as saying, in regard to the ethics of Congress, “Ethics is a barrel of worms”1—a pungent summing up of the problem of deciding who is ethical in politics. I reminded my friend that millions of businessmen feel constrained every day to say yes to their bosses when they secretly believe no and that this is generally accepted as permissible strategy when the alternative might be the loss of a job. The essential point, I said, is that the ethics of business are game ethics, different from the ethics of religion. He remained unconvinced. Referring to the company of which he is president, he declared: “Maybe that’s good enough for some businessmen, but I can tell you that we pride ourselves on our ethics. In 30 years not one customer has ever questioned my word or asked to check our figures. We’re loyal to our customers and fair to our suppliers. I regard my handshake on a deal as a contract. I’ve never entered into price fixing schemes with my competitors. I’ve never allowed my salesmen to spread injurious rumors about other companies. Our union contract is the best in our industry. And, if I do say so myself, our ethical standards are of the highest!” He really was saying, without realizing it, that he was living up to the ethical standards of the business game—which are a far cry from those of private life. Like a gentlemanly poker player, he did not play in cahoots with others at the table, try to smear their reputations, or hold back chips he owed them. But this same fine man, at that very time, was allowing one of his products to be advertised in a way that made it sound a great deal better than it actually was. Another item in his product line was notorious among dealers for its “built-in obsolescence.” He was holding back from the market a much-improved product because he did not want it to interfere with sales of the inferior item it would have replaced. He had joined with certain of his competitors in hiring a lobbyist to push a state legislature, by methods that he preferred not to know too much about, into amending a bill then being enacted. In his view these things had nothing to do with ethics; they were merely normal business practice. He himself undoubtedly avoided outright false-hoods—never lied in so many words. But the entire organization that he ruled was deeply involved in numerous strategies of deception. Pressure to Deceive Most executives from time to time are almost compelled, in the interests of their companies or themselves, to practice some form of deception when negotiating with customers, dealers, labor unions, government officials, or even other departments of their companies. By conscious misstatements, concealment of pertinent facts, or exaggeration—in short, by bluffing—they seek to persuade others to agree with them. I think it is fair to say that if the individual executive refuses to bluff from time to time—if he feels obligated to tell the truth, the whole truth, and nothing but the truth—he is ignoring opportunities permitted under the rules and is at a heavy disadvantage in his business dealings. But here and there a businessman is unable to reconcile himself to the bluff in which he plays a part. His conscience, perhaps spurred by religious idealism, troubles him. He feels guilty; he may develop an ulcer or a nervous tic. Before any executive can make profitable use of the strategy of the bluff, he needs to make sure that in bluffing he will not lose selfrespect or become emotionally disturbed. If he is to reconcile personal integrity and high standards of honesty with the practical requirements of business, he must feel that his bluffs are ethically justified. The justification rests on the fact that business, as practiced by individuals as well as by corporations, has the impersonal character of a game—a game that demands both special strategy and an understanding of its special ethics. The game is played at all levels of corporate life, from the highest to the lowest. At the very instant that a man decides to enter business, he may be forced into a game situation, as is shown by the recent experience of a Cornell honor graduate who applied for a job with a large company: This applicant was given a psychological test which included the statement, “Of the following magazines, check any that you have read either regularly or from time to time, and double-check those which interest you most: Reader’s Digest, Time, Fortune, Saturday Evening Post, The New Republic, Life, Look, Ramparts, Newsweek, Business Week, U.S. News & World Report, The Nation, Playboy, Esquire, Harper’s, Sports Illustrated.” His tastes in reading were broad, and at one time or another he had read almost all of these magazines. He was a subscriber to The New Republic, an enthusiast for Ramparts, and an avid student of the pictures in Playboy. He was not sure whether his interest in Playboy would be held against him, but he had a shrewd suspicion that if he confessed to an interest in Ramparts and The New Republic, he would be thought a liberal, a radical, or at least an intellectual, and his chances of getting the job, which he needed, would greatly diminish. He therefore checked five of the more conservative magazines. Apparently it was a sound decision, for he got the job. He had made a game player’s decision, consistent with business ethics. A similar case is that of a magazine space salesman who, owing to a merger, suddenly found himself out of a job: This man was 58, and, in spite of a good record, his chance of getting a job elsewhere in a business where youth is favored in hiring practice was not good. He was a vigorous, healthy man, and only a considerable amount of gray in his hair suggested his age. Before beginning his job search he touched up his hair with a black dye to confine the gray to his temples. He knew that the truth about his age might well come out in time, but he calculated that he could deal with that situation when it arose. He and his wife decided that he could easily pass for 45, and he so stated his age on his resume. This was a lie; yet within the accepted rules of the business game, no moral culpability attaches to it. The Poker Analogy We can learn a good deal about the nature of business by comparing it with poker. While both have a large element of chance, in the long run the winner is the man who plays with steady skill. In both games ultimate victory requires intimate knowledge of the rules, insight into the psychology of the other players, a bold front, a considerable amount of self-discipline, and the ability to respond swiftly and effectively to opportunities provided by chance. No one expects poker to be played on the ethical principles preached in churches. In poker it is right and proper to bluff a friend out of the rewards of being dealt a good hand. A player feels no more than a slight twinge of sympathy, if that, when—with nothing better than a single ace in his hand—he strips a heavy loser, who holds a pair, of the rest of his chips. It was up to the other fellow to protect himself. In the words of an excellent poker player, former President Harry Truman, “If you can’t stand the heat, stay out of the kitchen.” If one shows mercy to a loser in poker, it is a personal gesture, divorced from the rules of the game. Poker has its special ethics, and here I am not referring to rules against cheating. The man who keeps an ace up his sleeve or who marks the cards is more than unethical; he is a crook, and can be punished as such—kicked out of the game or,—in the Old West, shot. In contrast to the cheat, the unethical poker player is one who, while abiding by the letter of the rules, finds ways to put the other players at an unfair disadvantage. Perhaps he unnerves them with loud talk. Or he tries to get them drunk. Or he plays in cahoots with someone else at the table. Ethical poker players frown on such tactics. Poker’s own brand of ethics is different from the ethical ideals of civilized human relationships. The game calls for distrust of the other fellow. It ignores the claim of friendship. Cunning deception and concealment of one’s strength and intentions, not kindness and openheartedness, are vital in poker. No one thinks any the worse of poker on that account. And no one should think any the worse of the game of business because its standards of right and wrong differ from the prevailing traditions of morality in our society. Discard the Golden Rule This view of business is especially worrisome to people without much business experience. A minister of my acquaintance once protested that business cannot possibly function in our society unless it is based on the JudeoChristian system of ethics. He told me: “I know some businessmen have supplied call girls to customers, but there are always a few rotten apples in every barrel. That doesn’t mean the rest of the fruit isn’t sound. Surely the vast majority of businessmen are ethical. I myself am acquainted with many who adhere to strict codes of ethics based fundamentally on religious teachings. They contribute to good causes. They participate in community activities. They cooperate with other companies to improve working conditions in their industries. Certainly they are not indifferent to ethics.” That most businessmen are not indifferent to ethics in their private lives, everyone will agree. My point is that in their office lives they cease to be private citizens; they become game players who must be guided by a somewhat different set of ethical standards. The point was forcefully made to me by a Midwestern executive who has given a good deal of thought to the question: “So long as a businessman complies with the laws of the land and avoids telling malicious lies, he’s ethical. If the law as written gives a man a wide-open chance to make a killing, he’d be a fool not to take advantage of it. If he doesn’t, somebody else will. There’s no obligation on him to stop and consider who is going to get hurt. If the law says he can do it, that’s all the justification he needs. There’s nothing unethical about that. It’s just plain business sense.” This executive (call him Robbins) took the stand that even industrial espionage, which is frowned on by some businessmen, ought not to be considered unethical. He recalled a recent meeting of the National Industrial Conference Board where an authority on marketing made a speech in which he deplored the employment of spies by business organizations. More and more companies, he pointed out, find it cheaper to penetrate the secrets of competitors with concealed cameras and microphones or by bribing employees than to set up costly research and design departments of their own. A whole branch of the electronics industry has grown up with this trend, he continued, providing equipment to make industrial espionage easier. Disturbing? The marketing expert found it so. But when it came to a remedy, he could only appeal to “respect for the golden rule.” Robbins thought this a confession of defeat, believing that the golden rule, for all its value as an ideal for society, is simply not feasible as a guide for business. A good part of the time the businessman is trying to do unto others as he hopes others will not do unto him.2 Robbins continued: “Espionage of one kind or another has become so common in business that it’s like taking a drink during Prohibition—it’s not considered sinful. And we don’t even have Prohibition where espionage is concerned; the law is very tolerant in this area. There’s no more shame for a business that uses secret agents than there is for a nation. Bear in mind that there already is at least one large corporation—you can buy its stock over the counter—that makes millions by providing counterespionage service to industrial firms. Espionage in business is not an ethical problem; it’s an established technique of business competition.” ‘We don’t make the laws.’ Wherever we turn in business, we can perceive the sharp distinction between its ethical standards and those of the churches. Newspapers abound with sensational stories growing out of this distinction: We read one day that Senator Philip A. Hart of Michigan has attacked food processors for deceptive packaging of numerous products.3 The next day there is a Congressional to-do over Ralph Nader’s book, Unsafe At Any Speed, which demonstrates that automobile companies for years have neglected the safety of car-owning families.4 Then another Senator, Lee Metcalf of Montana, and journalist Vic Reinemer show in their book, Overcharge, the methods by which utility companies elude regulating government bodies to extract unduly large payments from users of electricity.5 These are merely dramatic instances of a prevailing condition; there is hardly a major industry at which a similar attack could not be aimed. Critics of business regard such behavior as unethical, but the companies concerned know that they are merely playing the business game. Among the most respected of our business institutions are the insurance companies. A group of insurance executives meeting recently in New England was startled when their guest speaker, social critic Daniel Patrick Moynihan, roundly berated them for “unethical” practices. They had been guilty, Moynihan alleged, of using outdated actuarial tables to obtain unfairly high premiums. They habitually delayed the hearings of lawsuits against them in order to tire out the plaintiffs and win cheap settlements. In their employment policies they used ingenious devices to discriminate against certain minority groups.6 It was difficult for the audience to deny the validity of these charges. But these men were business game players. Their reaction to Moynihan’s attack was much the same as that of the automobile manufacturers to Nader, of the utilities to Senator Metcalf, and of the food processors to Senator Hart. If the laws governing their businesses change, or if public opinion becomes clamorous, they will make the necessary adjustments. But morally they have in their view done nothing wrong. As long as they comply with the letter of the law, they are within their rights to operate their businesses as they see fit. The small business is in the same position as the great corporation in this respect. For example: In 1967 a key manufacturer was accused of providing master keys for automobiles to mail-order customers, although it was obvious that some of the purchasers might be automobile thieves. His defense was plain and straightforward. If there was nothing in the law to prevent him from selling his keys to anyone who ordered them, it was not up to him to inquire as to his customers’ motives. Why was it any worse, he insisted, for him to sell car keys by mail, than for mail- order houses to sell guns that might be used for murder? Until the law was changed, the key manufacturer could regard himself as being just as ethical as any other businessman by the rules of the business game.7 Violations of the ethical ideals of society are common in business, but they are not necessarily violations of business principles. Each year the Federal Trade Commission orders hundreds of companies, many of them of the first magnitude, to “cease and desist” from practices which, judged by ordinary standards, are of questionable morality but which are stoutly defended by the companies concerned. In one case, a firm manufacturing a well-known mouthwash was accused of using a cheap form of alcohol possibly deleterious to health. The company’s chief executive, after testifying in Washington, made this comment privately: “We broke no law. We’re in a highly competitive industry. If we’re going to stay in business, we have to look for profit wherever the law permits. We don’t make the laws. We obey them. Then why do we have to put up with this ‘holier than thou’ talk about ethics? It’s sheer hypocrisy. We’re not in business to promote ethics. Look at the cigarette companies, for God’s sake! If the ethics aren’t embodied in the laws by the men who made them, you can’t expect businessmen to fill the lack. Why, a sudden submission to Christian ethics by businessmen would bring about the greatest economic upheaval in history!” It may be noted that the government failed to prove its case against him. Cast illusions aside Talk about ethics by businessmen is often a thin decorative coating over the hard realities of the game: Once I listened to a speech by a young executive who pointed to a new industry code as proof that his company and its competitors were deeply aware of their responsibilities to society. It was a code of ethics, he said. The industry was going to police itself, to dissuade constituent companies from wrongdoing. His eyes shone with conviction and enthusiasm. The same day there was a meeting in a hotel room where the industry’s top executives met with the “czar” who was to administer the new code, a man of high repute. No one who was present could doubt their common attitude. In their eyes the code was designed primarily to forestall a move by the federal government to impose stern restrictions on the industry. They felt that the code would hamper them a good deal less than new federal laws would. It was, in other words, conceived as a protection for the industry, not for the public. The young executive accepted the surface explanation of the code; these leaders, all experienced game players, did not deceive themselves for a moment about its purpose. The illusion that business can afford to be guided by ethics as conceived in private life is often fostered by speeches and articles containing such phrases as, “It pays to be ethical,” or, “Sound ethics is good business.” Actually this is not an ethical position at all; it is a self-serving calculation in disguise. The speaker is really saying that in the long run a company can make more money if it does not antagonize competitors, suppliers, employees, and customers by squeezing them too hard. He is saying that oversharp policies reduce ultimate gains. That is true, but it has nothing to do with ethics. The underlying attitude is much like that in the familiar story of the shopkeeper who finds an extra $20 bill in the cash register, debates with himself the ethical problem—should he tell his partner?—and finally decides to share the money because the gesture will give him an edge over the s.o.b. the next time they quarrel. I think it is fair to sum up the prevailing attitude of businessmen on ethics as follows: We live in what is probably the most competitive of the world’s civilized societies. Our customs encourage a high degree of aggression in the individual’s striving for success. Business is our main area of competition, and it has been ritualized into a game of strategy. The basic rules of the game have been set by the government, which attempts to detect and punish business frauds. But as long as a company does not transgress the rules of the game set by law, it has the legal right to shape its strategy without reference to anything but its profits. If it takes a long-term view of its profits, it will preserve amicable relations, so far as possible, with those with whom it deals. A wise businessman will not seek advantage to the point where he generates dangerous hostility among employees, competitors, customers, government, or the public at large. But decisions in this area are, in the final test, decisions of strategy, not of ethics. The Individual & the Game An individual within a company often finds it difficult to adjust to the requirements of the business game. He tries to preserve his private ethical standards in situations that call for game strategy. When he is obliged to carry out company policies that challenge his conception of himself as an ethical man, he suffers. It disturbs him when he is ordered, for instance, to deny a raise to a man who deserves it, to fire an employee of long standing, to prepare advertising that he believes to be misleading, to conceal facts that he feels customers are entitled to know, to cheapen the quality of materials used in the manufacture of an established product, to sell as new a product that he knows to be rebuilt, to exaggerate the curative powers of a medicinal preparation, or to coerce dealers. There are some fortunate executives who, by the nature of their work and circumstances, never have to face problems of this kind. But in one form or another the ethical dilemma is felt sooner or later by most businessmen. Possibly the dilemma is most painful not when the company forces the action on the executive but when he originates it himself— that is, when he has taken or is contemplating a step which is in his own interest but which runs counter to his early moral conditioning. To illustrate: The manager of an export department, eager to show rising sales, is pressed by a big customer to provide invoices which, while containing no overt falsehood that would violate a U.S. law, are so worded that the customer may be able to evade certain taxes in his homeland. A company president finds that an aging executive, within a few years of retirement and his pension, is not as productive as formerly. Should he be kept on? The produce manager of a supermarket debates with himself whether to get rid of a lot of half-rotten tomatoes by including one, with its good side exposed, in every tomato six-pack. An accountant discovers that he has taken an improper deduction on his company’s tax return and fears the consequences if he calls the matter to the president’s attention, though he himself has done nothing illegal. Perhaps if he says nothing, no one will notice the error. A chief executive officer is asked by his directors to comment on a rumor that he owns stock in another company with which he has placed large orders. He could deny it, for the stock is in the name of his son-in-law and he has earlier formally instructed his son-in-law to sell the holding. Temptations of this kind constantly arise in business. If an executive allows himself to be torn between a decision based on business considerations and one based on his private ethical code, he exposes himself to a grave psychological strain. This is not to say that sound business strategy necessarily runs counter to ethical ideals. They may frequently coincide; and when they do, everyone is gratified. But the major tests of every move in business, as in all games of strategy, are legality and profit. A man who intends to be a winner in the business game must have a game player’s attitude. The business strategist’s decisions must be as impersonal as those of a surgeon performing an operation—concentrating on objective and technique, and subordinating personal feelings. If the chief executive admits that his son-in-law owns the stock, it is because he stands to lose more if the fact comes out later than if he states it boldly and at once. If the supermarket manager orders the rotten tomatoes to be discarded, he does so to avoid an increase in consumer complaints and a loss of goodwill. The company president decides not to fire the elderly executive in the belief that the negative reaction of other employees would in the long run cost the company more than it would lose in keeping him and paying his pension. All sensible businessmen prefer to be truthful, but they seldom feel inclined to tell the whole truth. In the business game truth-telling usually has to be kept within narrow limits if trouble is to be avoided. The point was neatly made a long time ago (in 1888) by one of John D. Rockefeller’s associates, Paul Babcock, to Standard Oil Company executives who were about to testify before a government investigating committee: “Parry every question with answers which, while perfectly truthful, are evasive of bottom facts.”8 This was, is, and probably always will be regarded as wise and permissible business strategy. For office use only An executive’s family life can easily be dislocated if he fails to make a sharp distinction between the ethical systems of the home and the office—or if his wife does not grasp that distinction. Many a businessman who has remarked to his wife, “I had to let Jones go today” or “I had to admit to the boss that Jim has been goofing off lately,” has been met with an indignant protest. “How could you do a thing like that? You know Jones is over 50 and will have a lot of trouble getting another job.” Or, “You did that to Jim? With his wife ill and all the worry she’s been having with the kids?” If the executive insists that he had no choice because the profits of the company and his own security were involved, he may see a certain cool and ominous reappraisal in his wife’s eyes. Many wives are not prepared to accept the fact that business operates with a special code of ethics. An illuminating illustration of this comes from a Southern sales executive who related a conversation he had had with his wife at a time when a hotly contested political campaign was being waged in their state: “I made the mistake of telling her that I had had lunch with Colby, who gives me about half my business. Colby mentioned that his company had a stake in the election. Then he said, ‘By the way, I’m treasurer of the citizens’ committee for Lang. I’m collecting contributions. Can I count on you for a hundred dollars?’ “Well, there I was. I was opposed to Lang, but I knew Colby. If he withdrew his business I could be in a bad spot. So I just smiled and wrote out a check then and there. He thanked me, and we started to talk about his next order. Maybe he thought I shared his political views. If so, I wasn’t going to lose any sleep over it. “I should have had sense enough not to tell Mary about it. She hit the ceiling. She said she was disappointed in me. She said I hadn’t acted like a man, that I should have stood up to Colby. “I said, ‘Look, it was an either-or situation. I had to do it or risk losing the business.’ “She came back at me with, ‘I don’t believe it. You could have been honest with him. You could have said that you didn’t feel you ought to contribute to a campaign for a man you weren’t going to vote for. I’m sure he would have understood.’ “I said, ‘Mary, you’re a wonderful woman, but you’re way off the track. Do you know what would have happened if I had said that? Colby would have smiled and said, “Oh, I didn’t realize. Forget it.” But in his eyes from that moment I would be an oddball, maybe a bit of a radical. He would have listened to me talk about his order and would have promised to give it consideration. After that I wouldn’t hear from him for a week. Then I would telephone and learn from his secretary that he wasn’t yet ready to place the order. And in about a month I would hear through the grapevine that he was giving his business to another company. A month after that I’d be out of a job.’ “She was silent for a while. Then she said, ‘Tom, something is wrong with business when a man is forced to choose between his family’s security and his moral obligation to himself. It’s easy for me to say you should have stood up to him —but if you had, you might have felt you were betraying me and the kids. I’m sorry that you did it, Tom, but I can’t blame you. Something is wrong with business!’” This wife saw the problem in terms of moral obligation as conceived in private life; her husband saw it as a matter of game strategy. As a player in a weak position, he felt that he could not afford to indulge an ethical sentiment that might have cost him his seat at the table. Playing to win Some men might challenge the Colbys of business—might accept serious setbacks to their business careers rather than risk a feeling of moral cowardice. They merit our respect—but as private individuals, not businessmen. When the skillful player of the business game is compelled to submit to unfair pressure, he does not castigate himself for moral weakness. Instead, he strives to put himself into a strong position where he can defend himself against such pressures in the future without loss. If a man plans to take a seat in the business game, he owes it to himself to master the principles by which the game is played, including its special ethical outlook. He can then hardly fail to recognize that an occasional bluff may well be justified in terms of the game’s ethics and warranted in terms of economic necessity. Once he clears his mind on this point, he is in a good position to match his strategy against that of the other players. He can then determine objectively whether a bluff in a given situation has a good chance of succeeding and can decide when and how to bluff, without a feeling of ethical transgression. To be a winner, a man must play to win. This does not mean that he must be ruthless, cruel, harsh, or treacherous. On the contrary, the better his reputation for integrity, honesty, and decency, the better his chances of victory will be in the long run. But from time to time every businessman, like every poker player, is offered a choice between certain loss or bluffing within the legal rules of the game. If he is not resigned to losing, if he wants to rise in his company and industry, then in such a crisis he will bluff—and bluff hard. Every now and then one meets a successful businessman who has conveniently forgotten the small or large deceptions that he practiced on his way to fortune. “God gave me my money,” old John D. Rockefeller once piously told a Sunday school class. It would be a rare tycoon in our time who would risk the horse laugh with which such a remark would be greeted. In the last third of the twentieth century even children are aware that if a man has become prosperous in business, he has sometimes departed from the strict truth in order to overcome obstacles or has practiced the more subtle deceptions of the half-truth or the misleading omission. Whatever the form of the bluff, it is an integral part of the game, and the executive who does not master its techniques is not likely to accumulate much money or power. The Executive’s Conscience It must be admitted…that not all ethical questions in business can be sharply divided between black and white. Often there is a gray area within which honorable men may differ. When the question falls in that category the junior may properly accept the judgment of his superior, and carry out his instruction. But where the action required is unqualifiedly repugnant to his own conscience he has no alternative. He must quit rather than go ahead. The consequences may be devastating in his own life. The threat to his financial security, and to the welfare of his family, may be almost beyond his power to cope with. Nevertheless the answer is clear. He must walk off the job and preserve his honor, no matter what the sacrifice. The key…is the executive’s personal sensitivity to ethical problems. Few men who are able and mature enough to carry significant responsibility in the business world transgress the general code of morality with the conscious intention of doing wrong. The difficulty is that the warning bell of their conscience does not ring as they take their decisions. They plunge into action without pausing to reflect upon the moral implications of the course to which they are committing themselves and their corporations. They have 1. The New York Times, March 9, 1967. 2. See Bruce D. Henderson, “Brinkmanship in Business,” HBR March–April 1967, p. 49. 3. The New York Times, November 21, 1966. 4. New York, Grossman Publishers, Inc., 1965. 5. New York, David McKay Company, Inc., 1967. 6. The New York Times, January 17, 1967. 7. Cited by Ralph Nader in “Business Crime,” The New Republic, July 1, 1967, p. 7. 8. Babcock in a memorandum to Rockefeller (Rockefeller Archives). been carefully trained in engineering, cost accounting, pricing, human relations, and other phases of management, but not in ethics. A version of this article appeared in the January 1968 issue of Harvard Business Review. What industry needs to offset the growing atmosphere of public suspicion is new emphasis on conscience, new discussion of ethical problems at all levels, and greater awareness of the importance of moral considerations in the formation of management policy. Mr. Carr was Assistant to the Chairman of the War Production Board during World War II and later served on the White House staff and as a Special Consultant to President Truman. He is now writing full-time. Among his books is John D. Rockefeller’s Secret Weapon, a study of corporate development. This article is adapted from a chapter in his newest book, Business As a Game, to be published by New American Library in March 1968. This article is about ETHICS  FOLLOW THIS TOPIC Related Topics: SOCIAL RESPONSIBILITY Comments Leave a Comment POST 0 COMMENTS  JOIN THE CONVERSATION POSTING GUIDELINES We hope the conversations that take place on HBR.org will be energetic, constructive, and thought-provoking. To comment, readers must sign in or register. And to ensure the quality of the discussion, our moderating team will review all comments and may edit them for clarity, length, and relevance. Comments that are overly promotional, mean-spirited, or offtopic may be deleted per the moderators' judgment. All postings become the property of Harvard Business Publishing.
What is Really Unethical About Insider Trading? ABSTRACT. Insider trading is illegal, and is widely believed to be unethical. It has received widespread attention in the media and has become, for some, the very symbol of ethical decay in business. For a practice that has come to epitomize unethical business behavior, however, insider trading has received surprisingly little ethical analysis. This article critically examines the principal ethical arguments against insider trading: the claim that the practice is unfair, the claim that it involves a "misappropriation" of information and the claim that it harms ordinary investors and the market as a whole. The author concludes that each of these arguments has some serious deficiencies;no one of them by itself provides a sufficient reason for outlawing insider trading. This does not mean, however, that there are no reasons for prohibiting the practice. The author argues that the real reason for outlawing insider trading is that it undermines the fiduciary relationship that lies at the heart of American business. "Insider trading," as the term is usually used, means the buying or selling of securities on the basis of material, non-public information. It is popularly believed to be unethical, and many, though not all, forms of it are illegal. Insider trading makes for exciting headlines, and stories of the unscrupulousness and unbridled greed of the traders abound. As it is reported in the media - complete with details of clandestine meetings, numbered Swiss bank accounts and thousands of dollars of profits carried away in plastic bags - insider trading has all the trappings of Jennifer Moore is an Assistant Professor in the Department of Philosophy and the Department of Business Administration at the University of Delaware. She teaches and does research in the areas of business ethics and business law. She is the author of several articles in business ethics and co-editor of the anthology, Business Ethics: Readings and Cases in Corporate Morality, published by McGraw-HilL Journal of Business Ethics 9: 171-182, 1990. © 1990 KluwerAcademic Publishers. Printed in theNetherlands. JenniferMoore a very shady business indeed.: For many, insider trading has become the primary symbol of a widespread ethical rot on Wall Street and in the business community as a whole. 2 For a practice that has come to epitomize unethical business behavior, insider trading has received surprisingly little ethical analysis. The best ethical assessments of insider trading have come from legal scholars who argue againsf the practice. But their arguments rest on notions such as fairness or ownership of information that require much more examination than they are usually given.3 Proponents of insider trading are quick to dismiss these arguments as superficial, but offer very little ethical insight of their own. Arguing almost solely on grounds of economic efficiency, they generally gloss over the ethical arguments or dismiss them entirely. 4 Ironically, their refusal to address the ethical arguments on their merits merely strengthens the impression that insider trading is unethical. Readers are left with the sense that while it might reduce efficiency, the prohibition against insider trading rests on firm ethical grounds. But can we assume this? Not, I think, without a good deal more examination. This paper is divided into two parts. In the first part, I examine critically the principal ethical arguments against insider trading. T h e arguments fall into three main classes: arguments based on fairness, arguments based on property rights in information, and arguments based on harm to ordinary investors or the market as a whole. Each of these arguments, I contend, has some serious deficiencies. No one of them by itself provides a sufficient reason for outlawing insider trading. This does not mean, however, that there are no reasons for prohibiting the practice. Once we have cleared away the inadequate arguments, other, more cogent reasons for outlawing 172 Jennifer Moore insider trading come to light. In the second part of the paper, I set out what I take to be the real reasons for laws against insider trading. The term "insider trading" needs some preliminary clarification. Both the SEC and the courts have strongly resisted pressure to define the notion clearly. In 1961, the SEC stated that corporate insiders such as officers or directors - in possession of material, non-public information were required to disclose that information or to refrain from trading. 5 But this "disclose or refrain" rule has since been extended to persons other than corporate insiders. People who get information from insiders ("tippees") and those who become "temporary insiders" in the course of some work they perform for the company, can acquire the duty of insiders in some cases. 6 Financial printers and newspaper columnists, not "insiders" in the technical sense, have also been found guilty of insider trading. 7 Increasingly, the term "insider" has come to refer to the kind of information a person possesses rather than to the status of the person who trades on that information. My use of the term will reflect this ambiguity. In this paper, an "insider trader" is someone who trades in material, non-public information - not necessarily a corporate insider. I. Ethical arguments against insider trading Fairness Probably the most common reason given for thinking that insider trading is unethical is that it is "unfair." For proponents of the fairness argument, the key feature of insider trading is the disparity of information between the two parties to the transaction. Trading should take place on a "level playing field," they argue, and disparities in information tilt the field toward one player and away from the other. There are two versions of the fairness argument: the first argues that insider trading is unfair because the two parties do not have equal information; the second argues that insider trading is unfair because the two parties do not have equal access to information. Let us look at the two versions one at a time. According to the equal information argument, insider trading is unfair because one party to the transaction lacks information the other party has, and is thus at a disadvantage. Although this is a very strict notion of fairness, it has its proponents, 8 and hints of this view appear in some of the judicial opinions? One proponent of the equal information argument is Saul Levmore, who claims that'"fairness is achieved when insiders and outsiders are in equal positions. That is, a system is fair if we would not expect one group to envy the position of the other." As thus defined, Levmore claims, fairness "reflects the 'golden rule' of impersonal behavior - treating others as we would ourselves.""~ If Levmore is correct, then not just insider trading, but all transactions in which there is a disparity of information are unfair, and thus unethical. But this claim seems overly broad. An example will help to illustrate some of the problems with it. Suppose I am touring Vermont and come across an antique blanket chest in the barn of a farmer, a chest I know will bring $2 500 back in the city. I offer to buy it for $75, and the farmer agrees. If he had known how much I could get for it back home, he probably would have asked a higher price - but I failed to disclose this information. I have profited from an informational advantage. Have I been unethical? My suspicion is that most people would say I have not. While knowing how much I could sell the chest for in the city is in the interest of the farmer, I am not morally obligated to reveal it. I am not morally obligated to tell those who deal with me everything that it would be in their interest to know. U.S. common law supports this intuition. Legally, people are obligated not to lie or to misrepresent a product they are selling or buying. But they are not required to reveal everything it is in the other party's interest to know) l One might argue that this is simply an area in which the law falls short of ethical standards. But there is substantial ethical support for the law on these matters as well. There does seem to be a real difference between lying or misrepresentation on the one hand, and simple failure to disclose information on the other, even though the line between the two is sometimes hard to draw) z Lying and misrepresentation are forms of deception, and deception is a subde form of coercion. When I successfully deceive someone, I cause him to do something that does not represent his true will something he did not intend to do and would not have done if he had known the truth. Simply not revealing information (usually) does not involve this kind of coercion. In general, it is only when I owe a duty to the What is Really Unethical About Insider Trading? other party that I am legally required reveal all information that is in his interest. In such a situation, the other party believes that I am looking out for his interests, and I deceive him if I do not do so. Failure to disclose is deceptive in this instance because of the relationship of trust and dependence between the parties. But this suggests that trading on inside information is wrong, not because it violates a general notion of fairness, but because a breach of fiduciary duty is involved. Cases of insider trading in which no fiduciary duty of this kind is breached would not be unethical. Significantly, the Supreme Court has taken precisely this position: insider trading is wrong because, and when, it involves the violation of a fiduciary duty to the other parties to the transaction) 3 The Court has consistently refused to recognize the general duty to all investors that is argued for by proponents of the fairness argument. This is particularly clear in Chiarella v. US, a decision overturning the conviction of a financial printer for trading on inside information: At common law, misrepresentation made for the purpose of inducing reliance upon the false statement is fraudulent. But one who fails to disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so. And the duty to disclose arises when one party has information "that the other party is entitled to know because of a fiduciary or other similar relation of trust and confidence between them."... The element required to make silence fraudulent - a duty to disclose - is absent in this case. . . . We cannot affirm petitioner's conviction without recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information. Formulation of such a broad duty, which departs radically from the established doctrine that duty arises from a specific relationship between two parties.., should not be undertaken absent some explicit evidence of congressional intent.... ~¢ The court reiterated that "there is no general duty to disclose before trading on material nonpublic information" in Dirks v. SEC. :s It is worth noting that if this reasoning is correct, the legal and ethical status of insider trading depends on the understanding between the fiduciary and the party he represents. Insider trading would not be a violation of fiduciary duty, and thus would not be unethical, unless (1) it were clearly contrary to the interests of the other 173 party or (2) the other party had demanded or been led to expect disclosure. We shall return to this point below. There is a second ethical reason for not requiring all people with informational advantages to disclose them to others: there may be relevant differences between the parties to the transaction that make the disparity of information "fair." Perhaps I invested considerable time, effort and money in learning about antiques. If this is true, I might deserve to reap the benefits of these efforts. We frequently think it is fair for people to benefit from informational advantages of their own making; this is an important justification for patent law and the protection of trade secrets. "Fairness" is often defined as "treating equals equally." But equals in what respect? Unless we know that the two parties to a transaction are equal in the relevant way, it is difficult to say that an informational advantage held by one of them is "unfair." My point here is different from the frequently heard claim that people should be allowed to profit from informational advantages because this results in a more efficient use of information. This latter claim, while important, does not really address the fairness issue. What I am arguing is that the notion of fairness offered by proponents of the equal information argument is itself incomplete. We cannot make the notion of fairness work for us unless we supply guiddines explaining who are to count as "equals" in different contexts. If we try, we are likely to end up with results that seem intuitively unfair. For these reasons, the "equal information" version of the fairness argument seems to me to fail. However, it could be argued that insider trading is unfair because the insider has information that is not accessible to the ordinary investor. For proponents of this second type of fairness argument, it is not the insider's information advantage that counts, but the fact that this advantage is "unerodable," one that cannot be overcome by the hard work and ingenuity of the ordinary investor. No matter how hard the latter works, he is unable to acquire non-public information, because this information is protected by law. 16 This type of fairness argument seems more promising, since it allows people to profit from informational advantages of their own making, but not from advantages that are built into the system. Proponents of this "equal access" argument would probably find 174 .Jennifer Moore my deal with the Vermont farmer unobjectionable, because information about antiques is not in principle unavailable to the farmer. The problem with the argument is that the notion of "equal access" is not very clear. What does it mean for two people to have equal access to information? Suppose my pipes are leaking and I call a plumber to fix them. He charges me for the job, and benefits by the informational advantage he has over me. Most of us would not find this transaction unethical. True, I don't have "equal access" to the information needed to fix my pipes in any real sense, but I could have had this information had I chosen to become a plumber. The disparity of information in this case is simply something that is built into the fact that people choose to specialize in different areas. But just as I could have chosen to become a plumber, I could have chosen to become a corporate insider with access to legally protected information. Access to information seems to be a relative, not an absolute, matter. As Judge Frank Easterbrook puts it: People do not have or lack "access" in some absolute sense. There are, instead, different costs of obtaining information. An outsider's costs are high; he might have to purchase the information from the firm. Managers have lower costs (the amount of salary foregone);brokers have relatively low costs (the value of the ume they spent investigating). . . . The different costs of access are simply a function of the division of labor. A manager (or a physician) always knows more than a shareholder (or patient) in some respects, but unless there is something unethical about the division of labor, the difference is not u n f a i r . 17 One might argue that I have easier access to a plumber's information than I do to an insider trader's, since there are lots of plumbers from whom I can buy the information I seek. TM The fact that insiders have a strong incentive to keep their information to themselves is a serious objection to insider trading. B u t if insider trading were made legal, insiders could profit not only from trading on their information, but also on selling it to willing buyers. Proponents of the practice argue that a brisk market in information would soon develop - indeed, it might be argued that such a market already exists, though in illegal and clandestine form. 19 The objections offered above do not show con- clusively that no fairness argument against insider trading can be constructed. But they do suggest that a good deal more spadework is necessary to construct one. Proponents of the fairness argument need to show how the informational advantages of insider traders over ordinary investors are different in kind from the informational advantages of plumbers over the rest of us - or, alternatively, why the informational advantages of plumbers are unfair. I have not yet seen such an argument, and I suspect that designing one may require a significant overhaul of our traditional ideas about fairness. As it stands, the effectiveness of the fairness argument seems restricted to situations in which the insider trader owes a duty to the person with whom he is trading - and as we will see below, even here it is not conclusive because much depends on how that duty is defined. The most interesting thing about the fairness argument is not that it provides a compelling reason to outlaw insider trading, but that it leads to issues we cannot settle on the basis of an abstract concept of fairness alone. The claim that parties to a transaction should have equal information, or equal access to information, inevitably raises questions about how informational advantages are (or should be) acquired, and when people are entitled to use them for profit. Again, this understanding of the limits of the fairness argument is reflected in common law. If insider trading is wrong primarily because it is unfair, then it should be wrong no matter who engages in it. It should make no difference whether I am a corporate insider, a financial printer, or a litde old lady who heard a takeover rumor on the Hudson River Line. But it does make a difference to the courts. I think this is because the crucial questions concerning insider trading are not about fairness, but about how inside information is acquired and what entides people to make use of it. These are questions central to our second class of arguments against insider trading, those based on the notion of property rights in information. Property rights in information As economists and legal scholars have recognized, information is a valuable thing, and it is possible to view it as a type of property. We already treat certain What is Really Unethical About Insider Trading? types of information as property: trade secrets, inventions, and so on - and protect them by law. Proponents of the property rights argument claim that material, non-public information is also a kind of property, and that insider trading is wrong because it involves a violation of property rights. If inside information is a kind of property, whose property is it? How does information come to belong to one person rather than another? This is a very complex question, because information differs in many ways from other, more tangible sorts of property. But one influential argument is that information belongs to the people who discover, originate or "create" it. As Bill Shaw put it in a recent article, "the originator of the information (the individual or the corporation that spent hard-earned bucks producing it) owns and controls this asset just as it does other proprietary goods." 2o Thus if a firm agrees to a deal, invents a new product, or discovers new natural resources, it has a property right in that information and is entitled to exclusive use of it for its own profit. It is important to note that it is the firm itself (and/or its shareholders), and not the individual employees of the firm, who have property rights in the information. To be sure, it is always certain individuals in the firm who put together the deal, invent the product, or discover the resources. But they are able to do this only because they are backed by the power and authority of the firm. The employees of the firm - managers, officers, directors are not entitled to the information any more than they are entitled to corporate trade secrets or patents on products that they develop for the firm. 21 It is the firm that makes it possible to create the information and that makes the information valuable once it has been created. As Victor Brudney puts it, The insiders have acquired the information at the expense of the enterprise, and for the purpose of conducting the business for the collectivegood of all the stockholders, entirely apart from personal benefits from trading in its securities.There is no reason for them to be entitled to trade for their own benefit on the basis of such information. . . . 22 If this analysis is correct, then it suggests that insider trading is wrong because it is a form of theft. It is not exactly like theft, because the person who 175 uses inside information does not deprive the compa W of the use of the information. But he does deprive the company of the sole use of the information, which is itself an asset. The insider trader "misappropriates," as the laws puts it, information that belongs to the company and uses it in a way in which it was not intended - for personal profit. It is not surprising that this "misappropriation theory" has begun to take hold in the courts, and has become one of the predominant rationales in prosecuting insider trading cases. In U.S.v. Newman, a case involving investment bankers and securities traders, for example, the court stated: In US v. Ckiarelta, ChiefJustice Burger... said that the defendant "misappropriated" - stole to put it bluntly valuable nonpublic information entrusted to him in the utmost confidence."That characterizationaptly describes the conduct of the connivers in the instant case. . . . By sullying the reputations of [their] employers as safe repositories of client confidences, appellee and his cohorts defrauded those employers as surely as if they took their money.23 The misappropriation theory also played a major role in the prosecution of R. Foster Winans, a Wall Street Journal reporter who traded on and leaked to others the contents of his "Heard in the Street" column.24 This theory is quite persuasive, as far as it goes. But it is not enough to show that insider trading is always unethical or that it should be illegal. If insider information is really the property of the firm that produces it, then using that property is wrong only when theft'tin prohibits it. If the firm does not prohibit insider trading, it seems perfectly acceptable.2-~Most companies do in fact forbid insider trading. But it is not clear whether they do so because they don't want their employees using corporate property for profit or simply because it is illegal. Proponents of insider trading point out that most corporations did not prohibit insider trading until recendy, when it became a prime concern of enforcement agencies.2c' If insider trading is primarily a problem of property rights in information, it might be argued, then it is immoral, and should be illegal, only when the company withholds permission to trade on inside information. Under the property rights theory, insider trading becomes a matter of contract between the company, its shareholders and its employees. If 176 Jennifer Moore the employment contract forbids an employee from using the company's information, then it is unethical (and illegal) to do so. A crucial factor here would be the shareholders' agreement to allow insider information. Shareholders may not wish to allow trading on inside information because they may wish the employees of the compa W to be devoted simply to advancing shareholder interests. We will return to this point below. But if shareholders did allow it, it would seem to be permissible. Still others argue that shareholders would not need to "agree" in any way other than to be told this information when they were bwing the stock. If they did not want to hold stock in a company whose employees were permitted to trade in inside information, they would not b W that stock. Hence they could be said to have "agreed." Manne and other proponents of insider trading have suggested a number of reasons why "shareholders would voluntarily enter into contractual arrangements with insiders giving them property rights in valuable information. "27 Their principal argument is that permitting insider trading would serve as an incentive to create more information put together more deals, invent more new products, or make more discoveries. Such an incentive, they argue, would create more profit for shareholders in the long run. Assigning employees the right to trade on inside information could take the place of more traditional (and expensive) elements in the employee's compensation package. Rather than giving out end of the year bonuses, for example, firms could allow employees to put together their own bonuses by cashing in on inside information, thus saving the company money. In addition, proponents argue, insider trading would improve the efficiency of the market. We will return to these claims below. If inside information really is a form of corporate property, firms may assign employees the right to trade on it if they choose to do so. The only reason for not permitting firms to allow employees to trade on their information would be that doing so causes harm to other investors or to society at large. Although our society values property rights very highly, they are not absolute. We do not hesitate to restrict property rights if their exercise causes significant harm to others. The permissibility of insider trading, then, ultimately seems to depend on whether the practice is harmful. Harm There are two principal harm-based arguments against insider trading. The first claims that the practice is harmful to ordinary investors who engage in trades with insiders; the second claims that insider trading erodes investors' confidence in the market, causing them to pull out of the market and harming the market as a whole. I will address the two arguments in turn. Although proponents of insider trading often refer to it as a "victimless crime," implying that no one is harmed by it, it is not difficult to think of examples of transactions with insiders in which ordinary investors are made worse off. Suppose I have placed an order with my broker to sdl my shares in Megalith Co., currently trading at $50 a share, at $60 or above. An insider knows that Behemoth Inc. is going to announce a tender offer for Megalith shares in two days, and has begun to buy large amounts of stock in anticipation of the gains. Because of his market activity, Megalith stock rises to $65 a share and my order is triggered. If he had refrained from trading, the price would have risen steeply two days later, and I would have been able to sell my shares for $80. Because the insider traded, I failed to realize the gains that I otherwise would have made. But there are other examples of transactions in which ordinary investors benefit from insider trading. Suppose I tell my broker to sell my shares in Acme Corp., currently trading at $45, if the price drops to $40 or lower. An insider knows of an enormous class action suit to be brought against Acme in two days. He sells his shares, lowering the price to $38 and triggering my sale. When the suit is made public two clays later, the share price plunges to $~5. If the insider had abstained from trading, I would have lost far more than I did. Here, the insider has protected me from loss. Not all investors buy or sell through such "trigger" orders. Many of them make their decisions by watching the movement of the stock. The rise in share price might have indicated to an owner of Megalith that a merger was imminent, and she might have held on to her shares for this reason. Similarly, the downward movement of Acme stock caused by the insider might have suggested to an owner that it was time to sell. Proponents of insider What is Really Unethical About Insider Trading? trading argue that large trades by insiders move the price of shares closer to their "real" value, that is, the value that reflects all the relevant information about the stock. This makes the market more efficient and 'provides a valuable service to all investors. 28 The truth about an ordinary investor's gains and losses from trading with insiders seems to be not that insider trading is never harmful, but that it is not systematically or consistently harmful. Insider trading is not a "victimless crime," as its proponents claim, but it is often difficult to tell exactly who the victims are and to what extent they have been victimized. The stipulation of the law to "disclose or abstain" from trading makes determining victims even more complex. While some investors are harmed by the insider's trade, to others the insider's actions make no difference at all; what harms them is simply not having complete information about the stock in question. Forbidding insider trading will not prevent these harms. Investors who neither buy nor sell, or who buy or sell for reasons independent of share price, fall into this category. Permitting insider trading would undoubtedly make the securities market riskier for ordinary investors. Even proponents of the practice seem to agree with this claim. But if insider trading were permitted openly, they argue, investors would compensate for the extra riskiness by demanding a discount in share price: In modern finance theory, shareholders are seen as investors seeking a return proportionate with that degree of systematic or market-related risk which they have chosen to incur. . . . [The individual investor] is "protected" by the price established by the market mechanism, not by his personal bargaining power or position. • . . To return to the gambling analogy, if I know you are using percentage dice, I won't play without an appropriate adjustment of the odds; the game is, after all, voluntary.> If insider trading were permitted, in short, we could expect a general drop in share prices, but no net harm to investors would result. Moreover, improved efficiency would result in a bigger pie for everyone. These are empirical claims, and I am not equipped to determine if they are true. If they are, however, they would defuse one of the most important objections to insider trading, and provide a powerful argument 177 for leaving the control of inside information up to individual corporations. The second harm-based argument claims that permitting insider trading would cause ordinary investors to lose confidence in the market and cease to invest there, thus harming the market as a whole. As former SEC Chairman John Shad puts it, "if people get the impression that they're playing against a marked deck, they're simply not going to be willing to invest." 30 Since capital markets play a crucial role in allocating resources in our economy, this objection is a very serious one. The weakness of the argument is that it turns almost exclusively on the feelings or perceptions of ordinary investors, and does not address the question of whether these perceptions are justified. If permitring insider trading really does harm ordinary investors, then this "loss of confidence" argument becomes a compelling reason for outlawing insider trading. But if, as many claim, the practice does not harm ordinary investors, then the sensible course of action is to educate the investors, not to outlaw insider trading. It is irrational to cater to the feelings of ordinary investors if those feelings are not justified. We ought not to outlaw perfectly permissible actions just because some people feel (unjustifiably) disadvantaged by them. More research is needed to determine the actual impact of insider trading on the ordinary investor.31 II. Is there anything wrong with insider trading? My contention has been that the principal ethical arguments against insider trading do not, by themselves, suffice to show that the practice is unethical and should be illegal. The strongest arguments are those that turn on the notion of a fiduciary duty to act in the interest of shareholders, or on the idea of inside information as company "property." But in both arguments, the impermissibility of insider trading depends on a contractual understanding among the company, its shareholders and its employees. In both cases, a modification of this understanding could change the moral status of insider trading. Does this mean that there is nothing wrong with insider trading? No. If insider trading is unethical, it is so in the context of the relationship among the firm, 178 Jennifer Moore its shareholders and its employees. It is possible to change this context in a way that makes the practice permissible. But should the context be changed? I will argue that it should not. Because it threatens the fiduciary relationship that is central to business management, I believe, permitting insider trading is in the interest neither of the firm, its shareholders, nor society at large. Fiduciary relationships are relationships of trust and dependence in which one party acts in the interest of another. They appear in many contexts, but are absolutely essential to conducting business in a complex society. Fiduciary relationships allow parties with different resources, skills and information to cooperate in productive activity. Shareholders who wish to invest in a business, for example, but who cannot or do not wish to run it themselves, hire others to manage it for them. Managers, directors, and to some extent, other employees, become fiduciaries for the firms they manage and for the shareholders of those firms. The fiduciary relationship is one of moral and legal obligation. Fiduciaries, that is, are bound to act in the interests of those who depend on them even if these interests do not coincide with their own. Typically, however, fiduciary relationships are constructed as far as possible so that the interests of the fiduciaries and the parties for whom they act do coincide. Where the interests of the two parties compete or conflict, the fiduciary relationship is threatened. In corporations, the attempt to discourage divergences of interest is exemplified in rules against bribery, usurping corporate opportunities, and so forth. In the past few years, an entire discipline, "agency theory," has developed to deal with such questions. Agency theorists seek ways to align the interests of agents or fiduciaries with the interests of those on behalf of whom they act. Significantly, proponents of insider trading do not dispute the importance of the fiduciary relationship. Rather, they argue that permitting insider trading would increase the likelihood that employees will act in the interest of shareholders and their firms. 32 We have already touched on the main argument for this claim. Manne and others contend that assigning employees the right to trade on inside information would provide a powerful incentive for creative and entrepreneurial activity. It would encourage new inventions, creative deals, and efficient new management practices, thus increasing the profits, strength, and overall competitiveness of the firm. Manne goes so far as to argue that permission to trade on insider information is the only appropriate way to compensate entrepreneurial activity, and warns: "[I]f no way to reward the entrepreneur within a corporation exists, he will tend to disappear from the corporate scene."33 The entrepreneur makes an invaluable contribution to the firm and its shareholders, and his disappearance would no doubt cause serious harm. If permitting insider trading is to work in the way proponents suggest, however, there must be a direct and consistent link between the profits reaped by insider traders and the performance that benefits the firm. It is not at all clear that this is the case indeed, there is evidence that the opposite is true. There appear to be many ways to profit from inside information that do not benefit the firm at all. I mention four possibilities below. Two of these (2 and 3) are simply ways in which insider traders can profit without benefiting the firm, suggesting that permitting insider trading is a poor incentive for performance and fails firmly to link the interests of managers, directors and employees to those of the corporation as a whole. The others (1 and 4) are actually harmful to the corporation, setting up conflicts of interest and actively undermining the fiduciary relationship. 34 (1) Proponents of insider trading tend to speak as if all information were positive. "Information," in the proponents' lexicon, always concerns a creative new deal, a new, efficient way of conducting business, or a new product. If this were true, allowing trades on inside information might provide an incentive to work ever harder for the good of the company. But information can also concern bad news - a large lawsuit, an unsafe or poor quality product, or lowerthan-expected performance. Such negative information can be just as valuable to the insider trader as positive information. If the freedom to trade on positive information encourages acts that are beneficial to the firm, then by the same reasoning the freedom to trade on negative information would encourage harmful acts. At the very least, permitting employees to profit from harms to the company decreases the incentive to avoid such harms. Permission to trade on negative inside information gives What is Really UnethicaIAbout Insider Trading? rise to inevitable conflicts of interest. Proponents of insider trading have not satisfactorily answered this objection. 35 (2) Proponents of insider trading also assume that the easiest way to profit on inside information is to "create" it. But it is not at all clear that this is true. Putting together a deal, inventing a new product, and other productive activities that add value to the firm usually require a significant investment of time and energy. For the well-placed employee, it would be far easier to start a rumor that the company has a new product or is about to announce a deal than to sit down and produce either one - and it would be just as profitable for the employee. If permitting insider trading provides an incentive for the productive "creation" of information, it seems to provide an even greater incentive for the non-productive "invention" of information, or stock manipulation. The invention of information is in the interest neither of the firm nor of society at large. (3) Even if negative or false information did not pose problems, the incentive argument for insider trading overlooks the difficulties posed by "free riders" - those who do not actually contribute to the creation of the information, but who are nevertheless aware of it and can profit by trading on it. It is a commonplace of economic theory that if persons can benefit from a good without paying for it, they will generally do so. If there is no way to exclude those who do not "pay" from enjoying a benefit, no one will have an incentive to pay for it, there will be no incentive to produce it, and the good will not be supplied. In the case of insider trading, an employee's contribution to the creation of positive information constitutes the "payment." Unless those who do not contribute can be excluded from trading on it, there will be no incentive to produce the desired information; it will not get created at all. (4) Finally, allowing trading on inside information would tend to deflect employees' attention from the day-to-day business of running the company and focus it on major changes, positive or negative, that lead to large insider trading profits. This might not be true if one could profit by inside information about the day-to-day efficiency of the operation, a continuous tradition of product quality, or a consistently lean operating budget. But these things do not generate the kind of information on which insider 179 traders can reap large profits. Insider profits come from dramatic changes, from "news" - not from steady, long-term performance. If the firm and its shareholders have a genuine interest in such performance, then permitting insider trading creates a conflict of interest for insiders. The ability to trade on inside information is also likely to influence the types of information officers announce to the public, and the timing of such announcements, making it less likely that the information and its timing is optimal for the firm. And the problems of false or negative information remain. 3G If the arguments given above are correct, permitring insider trading does not increase the likelihood that insiders will act in the interest of the firm and its shareholders. In some cases, it actually causes conflicts of interest, undermining the fiduciary relationship essential to managing the corporation. This claim, in turn, gives corporations good reason to prohibit the practice. But insider trading remains primarily a private matter among corporations, shareholders, and employees. It is appropriate to ask why, given this fact about insider trading, the practice should be illegal. If it is primarily corporate and shareholder interests that are threatened by insider trading, why not let corporations themselves bear the burden of enforcement? Why involve the SEC? There are two possible reasons for continuing to support laws against insider trading. The first is that even if they wish to prohibit insider trading, individual corporations do not have the resources to do so effectively. The second is that society itself has a stake in the fiduciary relationship. Proponents of insider trading frequendy point out that until 1961, when the SEC began to prosecute insider traders, few firms took steps to prevent the practice. 37 They argue that this fact indicates that insider trading is not truly harmful to corporations; if it were, corporations would have prohibited it long ago. But there is another plausible reason for corporations' failure to oudaw insider trading: they did not have the resources to do so, and did not wish to waste resources in the attempt to achieve an impossible task. 38 There is strong evidence that the second explanation is the correct one. Preventing insider trading requires continuous and extensive monitoring of transactions and the ability to compel disclosure, and privately imposed penalties do not 180 Jennifer Moore seem sufficient to discourage insider trading. 39 The SEC is not hampered by these limitations. Moreover, suggests Frank Easterbrook, if even a few companies allow insider trading, this could make it difficult for other companies to prohibit it. Firms that did not permit insider trading would find themselves at a competitive disadvantage, at the mercy of "free riders" who announce to the public that they prohibit insider trading but incur none of the enforcement costs. 4° Oudawing the practice might be worth doing simply because it enables corporations to do what is in all of their interests anyway - prohibit trading on inside information. Finally, the claim that the fiduciary relationship is purely a "private" matter is misleading. The erosion of fiduciary duty caused by permitting insider trading has social costs as well as costs to the corporation and its shareholders. We have already noted a few of these. Frequent incidents of stock manipulation would cause a serious crisis in the market, reducing both its stability and efficiency. An increase in the circulation of false information would cause a general decline in the reliability of information and a corresponding decrease in investor trust. This would make the market less, not more efficient (as proponents of the practice claim). Deflecting interests away from the task of day-to-day management and toward the manipulation of information could also have serious negative social consequences. American business has already sustained much criticism for its failure to keep its mind on producing goods and services, and for its pursuit of "paper profits." The notion of the fiduciary duty owed by managers and other employees to the firm and its shareholders has a long and venerable history in our society. Nearly all of our important activities require some sort of cooperation, trust, or reliance on others, and the ability of one person to act in the interest of another - as a fiduciary - is central to this cooperation. The role of managers as fiduciaries for firms and shareholders is grounded in the property rights of shareholders. They are the owners of the firm, and bear the residual risks, and hence have a right to have it managed in their interest. The fiduciary relationship also contributes to efficiency, since it encourages those who are willing to take risks to place their resources in the hands of those who have the expertise to maximize their usefulness. While this "shareholder theory" of the firm has often been challenged in recent years, this has been primarily by people who argue that the fiduciary concept should be widened to include other "stakeholders" in the firm. 41 I have heard no one argue that the notion of managers' fiduciary duties should be eliminated entirely, and that managers should begin working primarily for themselves. Ill. C o n c l u s i o n I have argued that the real reason for prohibiting insider trading is that it erodes the fiduciary relationship that lies at the heart of our business organizations. The more frequently heard moral arguments based on fairness, property rights in information, and harm to ordinary investors, are not compelling. Of these, the fairness arguments seem to me the least persuasive. The claim that a trader must reveal everything that it is in the interest of another party to know, seems to hold up only when the other is someone to whom he owes a fiduciary duty. But this is not really a "fairness" argument at all Similarly, the "misappropriation" theory is only persuasive if we can offer reasons for corporations not to assign the right to trade on inside information to their employees. I have found these in the fact that permitting insider trading threatens the fiduciary relationship. I do believe that lifting the ban against insider trading would cause harms to shareholders, corporations, and society at large. But again, these harms stem primarily from the cracks in the fiduciary relationship caused by permitting insider trading, rather than from actual trades with insiders. Violation of fiduciary duty, in short, is at the center of insider trading offenses, and it is with good reason that the Supreme Court has kept the fiduciary relationship at the forefront of its deliberations on insider trading. Notes I See, for example, Douglas Frantz, Levine & Co. (Avon Books, NY, 1987). 2 This is certainly true of former SEC chair John Shad, one of the leaders of the crusade against insider trading, who recently donated millions of dollars to Harvard University to establish a program in business ethics. Also see Felix Rohatyn What is Really Unethical About Insider Trading? of the investment banking house Lazard Fr~res: " . . . [A] cancer has been spreading in our industry . . . . Too much money is coming together with too many young people who have little or no institutional memory, or sense of tradition, and who are under enormous economic pressure to perform in the glare of Hollywood-like publicity. The combination makes for speculative excesses at best, illegality at worst. Insider trading is only one result." The New York Review of Books, March 12, 1987. 3 An important exception is Lawson, 'The Ethics of Insider Trading', 11 Harvard Journal of Law and Public Policy 727 (1988). Henry Manne, for example, whose book Insider Trading and the Stock Market stimulated the modern controversy over insider trading, has nothing but contempt for ethical arguments. See Insider Trading and the Law Professors,23 Vanderbilt Law Review 549 (1969): "Morals, someone once said, are a private luxury. Carried into the area of serious debate on public policy, moral arguments are frequently either a sham or a refuge for the intellectually bankrupt." Or see Jonathan R.Macey, Ethics, Economics and Insider Trading: Ayn Rand Meets the Theory of the Firm, 11 Harvard Journal of Law and Public Policy 787 (1988): "[I]n my view the attempt to critique insider trading using ethical philosophy - divorced from economic analysis - is something of a non-starter, because ethical theory does not have much to add to the work that has already been done by economists." s In re Cad),,Roberts, 40 SEC 907 (1961). On tippees, see Dirks v. SEC, 463 US 646 (1983) at 659; on 'temporary insiders', see Dirks v. SEC, 103 S. Ct. 3255 (1983) at 3261 n. 14, and SECv. Musella 578 F. Supp. 425. 7 See Materia v. SEC, 725 F. 2d 197, involving a financial printer and the Winans case, involving the author of the Wall StreetJournal's 'Heard on the Street' column, Carpenterv. US, 56 LW 4007; U.S.v. l/Vinans, 612 F. Supp. 827. It should be noted that the Supreme Court has not wholeheartedly endorsed these further extensions of the rule against insider trading. 8 See Kaplan, 'Wolfv. Weinstein: Another Chapter on Insider Trading', 1963 Supreme Court Review 273. For numerous other references, see Brudney, 'Insiders, Outsiders and Informational Advantages Under the Federal Securities Laws', 93 HarvardLaw Review 339, n. 63. 9 See Mitchell v. Texas Gulf Sulphur Co., 446 F. 2d. 90 (1968) at 101; SEC v. Great American Industries, 407 F. 2d. 453 (1968) at 462; Birdman v. Electro-Catheter Corp., 352 F. Supp. 1271 (1973) at 1274. 10 Saul Levmore, 'Securities and Secrets: Insider Trading and the Law of Contracts', 68 VirginiaLaw Review 117. 11 See Anthony Kronman, 'Mistake, Disclosure, Information, and the Law of Contracts', 7 Journal of Legal Studies 1 (1978). The Restatement (Second) of Torts ~ 551(2)e (Tent. Draft No. 11, 1965) gives an example which is very similar 181 example to the one above, involving a violin expert who buys a Stradivarius (worth $50 000) in a second-hand instrument shop for only $100. 12 It seems clear that sometimes failure to disclose can be a form of misrepresentation. Such could be the case, for example, when the seller makes a true statement about a product but fails to reveal a later change in circumstances which makes the earlier statement false. Or if a buyer indicates that he has a false impression of the product, and the seller fails to correct the impression. A plausible argument against insider trading would be that failure to reveal the information to the other party to the transaction allows a false impression of this kind to continue, and thus constitutes a form of deception. It is not clear to me, however, that insider trading is a situation of this kind. J3 An important question is whether trades involving the violation of another kind of fiduciary duty, constitute a violation of 10b-5. I address this second type of violation below. 14 Chiarella v. US, 445 U.S. 222, at 227-8; 232-233. Italics mine. 1~ 445 US at 233. Italics mine. 16 The equal access argument is perhaps best stated by Victor Brudney in his influential article, 'Insiders, Outsiders and Informational Advantages Under the Federal Securities Laws', 93 HarvardLaw Review 322. 17 Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information, 1981 Supreme Court Review 350. 18 Robert Frederick brought this point to my attention. iv Manne, Insider Trading and the Stock Market (Free Press, New York, 1966), p. 75. 20 Bill Shaw, 'Should Insider Trading Be Outside The Law', Business and Society Review 66, p. 34. See also Macey, 'From Fairness to Contract: The New Direction of the Rules Against Insider Trading', 13 Hofitra Law Review 9 (1984). 21 Easterbrook points out the striking similarity between insider trading cases and cases involving trade secrets, and cites Perrin v. US, 444 US 37 (1979), in which the court held that it was a federal crime to sell confidential corporate information. 22 Brudney, 'Insiders, Outsiders, and Informational Advantages', 344. 23 U.S. v. Newman, 664 F. 2d 17. 24 U.S.v. Winans, 612 F. Supp. 827. The Supreme Court upheld Winans' conviction, but was evenly split on the misappropriation theory. As a consequence, the Supreme Court has still not truly endorsed the theory, although several lower court decisions have been based on it. Carpenter v. US, 56 LW 4007. 25 Unless there is some other reason for forbidding it, such as that it harms others. See p. 176 first column below. -~0 Easterbrook, 'Insider Trading As An Agency Problem', 182 Jennifer Moore Principals and Agents: The Structure of Business (Harvard University Press, Cambridge, MA, 1985). 27 Carlton and Fischel, 'The Regulation of Insider Trading', 35 Stanford Law Review 857. See also Manne, Insider Trading and the Stock Market. 2~ Manne, Insider Trading and the Stock Market; Carlton and Fischel, 'The Regulation of Insider Trading'. 29 Kenneth Scott, 'Insider Trading: Rule 10b-5, Disclosure and Corporate Privacy', 9Journal ofLegal Studies 808. 3o 'Disputes Arise Over Value of Laws on Insider Trading', The Wall StreetJournal, November 17, 1986, p. 28. 31 One area that needs more attention is the impact of insider trading on the markets (and ordinary investors) of countries that permit the practice. Proponents of insider trading are fond of pointing out that insider trading has been legal in many overseas markets for years, without the dire effects predicted by opponents of the practice. Proponents reply that these markets are not as fair or efficient as U.S. markets, or that they do not play as important a role in the allocation of capital. 32 See Frank Easterbrook, 'Insider Trading as an Agency Problem'. I speak here as if the interests of the firm and its shareholders are identical, even though this is sometimes not the case. 33 Manne, Insider Trading and the Stock Market, p. 129. 34 For a more detailed discussion of the ineffectiveness of permitting insider trading as an incentive, see Roy Schotland, 'Unsafe at any Price: A Reply to Manne, Insider Trading and the Stock Market', 53 VirginiaLaw Review 1425. 35 Manne is aware of the "bad news" objection, but he glosses over it by claiming that bad news is not as likely as good news to be provide large gains for insider traders. Insider Trading and the Stock Market, p. 102. 36 There are ways to avoid many of these objections. For example, Manne has suggested "isolating" non-contributors so that they cannot trade on the information produced by others. Companies could also forbid trading on "negative" information. The problem is that these piecemeal restrictions seem very costly - more costly than simply prohibiting insider trading as we do now. In addition, each restriction brings us farther and farther away from what proponents of the practice actually want: unrestricted insider trading. 37 Frank Easterbrook, 'Insider Trading as an Agency Problem.' 38 Ibid. 39 Penalties did not begin to become sufficient to discourage insider trading until the passage of the Insider Trading Sanctions Act in 1984. Some argue that they are still not sufficient, and that that is a good reason for abandoning the effort entirely. 40 Easterbrook, 'Insider Trading as an Agency Problem.' 4~ See Freeman and Gilbert, CorporateStrategy and the Search for Ethics (Prentice-Hall, Englewood Cliffs, NJ, 1988). Department of Philosophy, College of Arts and Sciences, University of Delaware, Newark, DE 19716, U.S.A.

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