Free Business Essays - Is Insider Trading Ever Ethically Justified?
Introduction
The aim of this essay is to answer the question of whether insider trading within the business world is an ethical practice. To do this, an analytical method has been employed to examine both the ethical issues involved in insider trading and how these problems apply to businesses today. There then follows a critique of how useful this method is in achieving this aim.
Literature Review
In researching this subject, several sources were consulted: namely, books, journals and the internet. The objective was to develop a greater understanding of the process of insider trading, the context in which it takes place and in particular the area of ethics and morality.
O’Hara (2001) and the two discussion papers, Cespa (2004) and Medrano & Vives (2002), give a valuable insight into the world of financial trading.
The most informative books and journals were sought concerning different approaches to ethical theory, the most useful being Nantel & Weeks (1996) and Garofalo (2003) as they most readily enabled the conceptualisation of the differences between each approach. A useful general overview of ethics in business is to be found in Zekos (2004).
The internet proved a useful tool for looking at how issues of ethics relate to business in the modern day market: the IBE and FSA websites most notably provide a good overview.
Methodology
The ethical approach used in this essay to analyse the ethical issues emergent from the process of insider trading is a combination of the deontological and teleological or utilitarian philosophies. Deontology is concerned with the duties and behaviours of relevant parties (akin to the subject of ethics in itself) whereas teleology is concerned with the ultimate ends resulting from the actions of those involved.
The reason for this combined approach is that, whilst these philosophies differ from each other in focus, they complement each other when examining the whole problem and provide a balanced view.
Insider Trading
Traders in the stock market exchange company assets; the value of the assets (shares) of a company is determined by certain information, for example, how productive a company is. Cespa (2004) identifies two ways in which traders value a company’s shares: by the information acquired from a specialised provider, such as a stock market analyst, or by information obtained from a source within or related to the company, i.e. they are insiders.
So insider trading refers to the practice of those with privileged or valuable knowledge about a particular company, known as “insiders”, trading on shares of a company where they are looking to gain pecuniary or other benefits.
Being an insider can give a trader an advantage in several ways. One example is if the trader acquired superior knowledge about an impending business merger – which can result in the share price increasing – before that knowledge became public, he or she could sell their shares at a profit.
Stakeholders
Key stakeholders are defined here as those that play a part in or are affected by insider trading.
Within a company they form a broad group comprising directors and managers of a company, their employees, shareholders and traders. Any of these groups could be thought of as potential “insiders” of valuable company information.
Looking at the broader picture, family and friends of those involved in the business, third party business associates and so on will be affected by the effects of insider trading and are therefore stakeholders.
Given recent developments in information and communications technology, stakeholders interact within the context of trans-national networks.
Ethical Issues
The Institute of Business Ethics (IBE), a group established to promote and support companies in business ethics matters, conducted a national survey to explore the views of workers in the UK on ethical practices in the workplace. It found that around 80% of the workforce felt positive about such practices.
However, one can infer from this that a significant 20% of the workforce surveyed do not feel positive about ethical practices in the workplace. Some of these issues are described below.
It is self-evident that the sharing information is necessary to conduct business effectively. The problem with trading insider information occurs when this information is either obtained fraudulently or when a stakeholder has a duty to share information but does for the purposes of financial gain.
It could be reasonably argued that the misuse of insider information for the financial gain of some to the detriment of others is not conducive to organisational unity. Indeed Oketch (2004) advocates the prohibition of the abuse of insider trading due to the fact that the exploitation of investors’ trust constitutes inequitable treatment and is therefore a breach of good corporate practice.
Another matter for consideration is the view of the customers of the business. Their judgement on whether a company is ethical or not and their reaction to this is a serious matter for businesses as they play a crucial role in providing profit. This then raises the question of whether a business is forthcoming and honest about how its financial competitiveness is gained.
Given the inequitable treatment of stakeholders that sometimes arises from insider trading, one can deduce that this may lead to a breakdown of trust between relevant parties and a lessening of employee or customer loyalty to the company.
Analysis of Ethical Issues
There are two philosophical schools of thought that can be applied to questions of ethics: the utilitarian and deontological approaches. The former is concerned with the consequences of actions, for instance, directors of a company attempting to bring about the greatest financial benefits to their shareholders in an unsteady market; the way in which this is achieved is not as important as the fact that beneficial results are borne of their actions. Conversely, the deontological approach places much more importance upon the way actions are carried out rather than their results. Therefore in the same example if shareholders were rewarded with greater dividends as a result of insider knowledge gained by dishonest means, this would be an unethical practice for the directors of the company: the ends would not justify the means.
The ethical approach used to analyse the ethical issues and dilemmas that emerge from the process of insider trading can be said to be dependent upon the particular business environment in question. For instance, the world of marketing, the underlying goal of which is to deliver customer needs, lends itself to an entirely utilitarian approach.
It could be said that while both approaches have their benefits, it is perhaps more sensible to adopt an approach that incorporates both ways of thinking. Directors and senior managers with a great amount of responsibility and a greater sphere of influence have perhaps a duty to consider both the way in which they behave along with the consequences arising from their actions.
Garofalo (2003) goes one step further in propounding a unified ethical framework incorporating three different approaches within a global context. These three elements are deontology, teleology (where actions are judged to be good or bad by the ultimate end or consequence, akin to utilitarianism) and virtue theory (actions are judged by the character of the actor rather than their behaviour or the actions’ consequences).
From the issues mentioned above it could be said that insider trading is an unethical practice. If traders have knowledge that they know that by its sharing could bring about benefits for others, they perhaps have a duty to declare it. Truth telling, whilst meaning something different according to the particular situation one is in, can be thought of as something that ideally each of us would like to see followed by all humans.
However, an alternative view is put forward by Machan and Chesher (2003) when they argue that there is nothing morally wrong with learning of business opportunities ahead of others and instead shows good business acumen rather than the violation of the other party’s rights.
Businesses can cope with such inappropriate behaviour and its subsequent disparities in financial or social gain by creating and implementing a code of ethics: a definitive guide to the duties and responsibilities of the organisation to its customers and the management to its employees. This can become a benchmark for corporate behaviour and attitude and should be adopted by managers who want to portray an ethical company to the wider community.
The IBE advises that this Ethical Code of Practice adopted by businesses should include the following key areas: the purpose and values of the business, employees, customer relations, shareholders (or other financial providers), suppliers, society (or wider community) and the implementation of their values.
A case example of such a code of practice used in reality is that developed by the Respect Project, an organisation funded by the Information Society Technologies (IST) Programme to create ethical guidelines for the conduct of socio-economic research. Their code of practice is based on the principles of upholding the best standards in terms of their scientific research with the fundamental goal of working to benefit society as a whole.
Some consideration is given to the implications of introducing regulatory policies on insider trading by Medrano & Vives (2002) . They discuss how regulating insider trading can help achieve a more equitable environment. The Financial Services Authority is a regulatory body set up by the UK government to monitor standards and exchanges within the financial industry and goes some way to ensuring ethical standards are upheld.
Evaluation
The development of an ethical code of conduct was put forward which might help an organisation determine some solutions to ethical problems they face. It may not be easy to formulate blanket rules on this but could be used by an organisation as a set of guidelines for good practice.
Having explored ethical duties and responsibilities of businesses, it would be interesting to explore the subject of human virtue and its relevance to this conundrum. Aristotle observed the virtues of the human character and how these affected human relationships, and would further inform the reader on this topic since the connections we form and information that we share as a result of these connections is such an important consideration.
Further insight into some of the issues raised here could be gained by studying how ethical and moral philosophy has changed through the ages as this would unify the various schools of thought on approaches to ethics and lead to greater understanding of the subject.
Conclusion
The philosophies of ethics could be summarised here as being those concerned with what is right (deontology) and what is good (utilitarian theories). Determining what is right or good with insider trading could be said to be dependent on the viewpoint of the individual – whether they see it as maximising a business opportunity or depriving others of what is theirs. However businesses can refer to a code of conduct that, if developed with the aim of improving the welfare of all stakeholders concerned, can be deemed ethically sound.
Bibliography
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2. Giovanni Cespa (2004), Discussion Paper No. 4667: Information Sales and Insider Trading, Centre for Economic Policy Research
3. Philip O’Hara (2001), ‘Insider Trading in Financial Markets: Legality, Ethics, Efficiency’, International Journal of Social Economics, Vol 28, Issue 10/11/12, p1046-1063
4. Georgios Zekos, ‘Ethics Versus Corruption in Globalization’, Journal of Management Development; Vol: 23, Issue 7 pp631-647, Aug 2004
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6. Moses Oketch, ‘The Corporate Stake in Social Cohesion’, Corporate Governance; Vol 4, No 3, pp 5-19, 2004
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15. Institute of Business Ethics website, http://www.ibe.org.uk
16. Respect Project website, http://www.respectproject.org
17. Luis Medrano and Xavier Vives (2002), Discussion Paper No. 3292: Regulation Insider Trading When Investment Matters, Centre for Economic Policy Research
18. FSA website, http://www.fsa.gov.uk
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