This paper examines the ethics of insider trading from a utilitarian perspective. It begins by defining insider trading as described by the U.S. Securities and Exchange Commission, distinguishing between its legal and illegal forms. The paper then outlines the core principles of utilitarianism as developed by Jeremy Bentham and John Stuart Mill, focusing on the standard of collective happiness as the measure of moral rightness. Using this framework, the paper evaluates competing economic arguments — those that view insider trading as a natural, efficiency-promoting market force, and those that argue it undermines investor trust and market fairness. The paper concludes that utilitarian analysis alone cannot definitively resolve the moral status of insider trading without greater empirical consensus on its market effects.
Insider trading generally refers to the buying or selling of financial instruments — usually in the stock market — on the basis of privileged information that is known only to a restricted group of people. Debate has raged among economists, traders, businesspersons, philosophers, and the general public for many years about the rights and wrongs of insider trading. No consensus seems to have emerged yet. This paper examines the practice of insider trading from a utilitarian ethical point of view and attempts to determine whether the practice is morally justified.
Before discussing the ethics of insider trading, it is helpful to clarify what the term actually means. According to the U.S. Securities and Exchange Commission (SEC), insider trading can be of two types: the legal variety, in which corporate insiders — directors, officers, and employees — buy and sell stocks in their own company and inform the SEC of the trades within a specified time; and the illegal type, in which a person or persons buy or sell securities in breach of a relationship of trust and confidence while in possession of material, non-public information about the security. Such illegal trading also includes the "tipping" of inside information to friends, associates, brokerage firms, and others.
Having established what insider trading consists of, a brief review of utilitarianism is in order, so that the practice may be evaluated from a specific ethical perspective. Utilitarianism is part of normative ethics, developed mainly in the late eighteenth and nineteenth centuries by the English philosophers Jeremy Bentham and John Stuart Mill. In brief, the utility theory holds that any act may be considered right or wrong depending on whether it produces happiness — not only for the person who performs the act, but also for everyone affected by it.
The theory is thus different from the "egoist" ethical theory, which is concerned only with self-interest, and from ethical theories that judge the rightness or wrongness of an action independent of its consequences. It also differs from theories that focus on the motives of the person performing the act; in utilitarianism, it is possible to do right even through bad motives, provided the outcome maximizes overall happiness.
From a utilitarian point of view, the ethics of insider trading reduce to a single question: does the act increase or decrease the happiness of those who practice it and those affected by it? Apart from the insider who engages in the trading, the persons most affected — or likely to be affected — are the shareholders. From a wider perspective, the effect extends to the market as a whole and all the players involved in it. This is where determining whether insider trading is good or bad becomes complex. The insider will almost certainly gain happiness through a quick profit, although this is not guaranteed: having inside knowledge does not eliminate all market risk, and other factors can punish a rash move by the insider.
Whether insider trading diminishes the happiness of other market participants by adversely affecting the market is a controversial question. Some economists hold that an unregulated free market operates automatically and impersonally, much like planets in a solar system. According to this view, acts such as insider trading are simply competitive interactions that are part of natural market forces. The "invisible hand" of the market continues to maintain order — "not just in spite of but precisely by virtue of the selfishness of the players." Other economists have argued that insider trading is beneficial to all stock market participants because "it reduces overall dependence on chance."
"Investor trust, unfairness, and quantification problems"
A second problem a utilitarian faces when assessing insider trading is the difficulty of quantifying the amount of happiness and unhappiness such an act is likely to produce. Despite Bentham's theory of hedonic calculus, which holds that such quantification is theoretically possible, the practical difficulty of doing so is clearly illustrated in this case. A further objection is that insider trading is "morally wrong" and "unfair" to the majority of market participants who lack access to inside information. Since utilitarianism is concerned only with the end result or consequence of an action, the "morally wrong" argument is largely irrelevant within this framework; the "unfairness" argument becomes relevant only insofar as it results in increased unhappiness among market participants.
This examination of insider trading from a utilitarian point of view demonstrates that it is not possible to determine with certainty whether trading on the stock market with inside information is ethically right or wrong. The main reason for this inconclusiveness cannot be attributed to any inherent weakness in utilitarian theory itself, but rather to the inability of economists to agree on whether insider trading is harmful or beneficial to securities markets. There is therefore a clear need for more serious and rigorous research on the behavior of free markets, the mechanics of competition, capitalism, and the economic impact of insider trading.
You’re 85% through this paper. Sign up to read the remaining 1 section.
Sign Up Now — Instant Access Already a member? Log inAlways verify citation format against your institution’s current style guide requirements.