Ethical dilemmas and implications of Goldman Sachs insider trading investigation

Ethics Insider Trading

The Ethics of Insider Trading

Economist Henry Manne argues that insider trading is beneficial to insider or outsiders because it allows trading to be based on reliable information instead of rumors.

Stock prices move based on real, factual information, yielding a more accurate reflection of the true value of a stock. Outsiders benefit because they have more accurate information on with which to make decisions.

Werhane criticizes this view as being premised on a perfectly functioning free market.

Werhane believes that a free market can only work when there are equally matched parties. Otherwise, the market is perverted and can no longer allocate resources efficiently. Also Werhane believes that the free market requires "restrained self-interest," that observes the principles of justice and fair play.

Beneath these views is a fundamental disagreement about the ultimate purpose of stock market activities. The narrow function of the stock market is to provide liquidity for shareholders. However, there are now two common understandings of the legitimate purposes of the stock market: 1) to allocate capital to the most optimal economic opportunity available; and 2) to make sure investors get the maximum return on their investment.

Manne approaches the problem from a broad, Kantian ethical perspective, that nobody who is using the stock market properly is harmed. Manne focuses on non-shareholding outsiders and ignores the shareholding outsiders, who cannot dispose of the stock before SH insiders. Thus, Manne suggests that speculators hold shares at their own risk. In a broader sense, insider trading rules are illegitimate because they attempt to protect an inherently unethical, unproductive, and peripheral economic activity, speculation.

Viewed according to the formal principles of the stock market's functions, shareholders cannot expect a fair game when they are buying shares solely for the purpose of selling those shares at a later date. In this sense, shareholders who receive information later and act later are not actually cheated at all. They consent to share in the company's ultimate fate when they buy the share as owners of the company, not owners of the share. The only accurate, timely information they are entitled to is the information they use at the time of purchase to determine the fundamental value of the stock.

Werhane approaches the problem from a practical perspective, where the effects of insider trading are viewed in consideration of the practical function and use of stock markets. Speculating has become such a common practice in the stock market that it is an essential element of a proper stock market. It is doubtful that the stock market values would be anywhere near its current value if not for speculation.

Goldman Sachs Investigation

The Goldman Sachs investigation inquires into whether traders at a number of hedge funds and trading firms, improperly gained nonpublic information from Goldman Sachs (who gained the information from industry informants) about pending health-care, technology and other merger deals.

In the Goldman Sachs situation, certain traders benefited from privileged information of impending mergers by buying stock on those mergers before the merger was officially announced.