Insider trading.25 On November 17, 2008, the SEC filed charges against Mark Cuban for insider trading.

The SEC complaint said that Momma.com, an Internet search engine firm, gave Cuban advance notice

of a stock offering at below-market price, on the condition that he would keep this information confidential.

Cuban already held a good deal of stock in the company and predicted that the new offering

would bring down the market price. As a result, he sold all of his stock. The market price in fact fell the

day after the offering was announced to the public. Cuban’s early sale allowed him to avoid losses of

$750,000. An SEC official stated,“Mamma.com entrusted Mr. Cuban with nonpublic information after

he promised to keep the information confidential. Less than four hours later, Mr. Cuban betrayed that

trust by placing an order to sell all his shares. It is fundamentally unfair for someone to use access to

nonpublic information to improperly gain an edge on the market.”

Mark Cuban (allegedly) broke the insider trading law, which is unethical because breaking the law

is normally ungeneralizable. But is there anything inherently wrong with insider trading? Would it be

ethical if it were legal?

Hints. Several arguments, summarized below, have been advanced against insider trading. Do valid

applications of the conditions for rational choice underlie any of these arguments?

• It reduces utility. If the trade affects the stock price, a major stockholder can dump his holdings just

before bad news is released to the public. This could depress the stock price even more and harm the

company. Yet some economists argue that insider trades make everyone better off in the long run

because the market has more and earlier information about the company, which leads to more

rational investment. If an insider trade has no effect on the stock price, then the trade benefits the

trader and presumably hurts no one. (Remember that the utilitarian test is not whether a general

practice of insider trading maximizes utility, but whether a particular investor’s trade does so.)

• It results in an “unlevel playing field” or, to quote the SEC official, is “fundamentally unfair.” Should

we treat investment as a competition or sports event that has to be “fair” in some sense? Some argue

that if inside trading were standard practice, fewer ordinary investors would buy stocks, because

insiders would reap a greater share of the rewards of investing, and less capital would be raised.

(Note that the generalization test doesn’t ask whether the market would be less efficient, but whether

one can rationally believe that inside traders would still be able to achieve their purpose of making

more money.)

• It is misappropriation of company information, which is shareholder property, and is therefore essentially

theft. Can information about company plans be viewed as property?

• It violates fiduciary duty when the insider is a company officer, because insider trading can harm the

company more than it benefits the trader. This doesn’t apply to Mark Cuban, but is it a valid argument

for company officers?

• It redistributes wealth unjustly because it benefits wealthy inside traders at the expense of small

investors.