It is not often that football players and Congressmen are indicted for the same wrongdoing, but last month NFL linebacker Mychal Kendricks and Representative Chris Collins from New York were both indicted for insider trading. Kendricks has pled guilty; Collins denies the charges. Both also face civil charges.
The federal government alleges that Representative Collins was a tipper. As a director of a small Australian drug company, Collins received confidential news that the firm’s promising experimental drug failed a big test. In violation of company policy and federal law, he immediately called his son who began frantically selling his stock in the firm and telling other relatives and friends to do the same (and they did). When the news was publicly announced, the stock price of the drug plummeted and the son alone avoided losses of $570,000.
Kendricks was a tippee. His friend Damilare Sonoiki worked at Goldman Sachs and tipped Kendricks regarding upcoming (but still secret) mergers involving Goldman clients. Kendricks bought stock of the target companies and profited $1.2 million by selling the stock after public announcement of the deals drove the prices up.
Was this activity illegal? Clearly. Insider trading is the trading of stock on the basis of material, non-public information by people who owe a legal duty not to trade before public disclosure of the information. There are some areas of insider trading law that are still a little murky, but these two cases involve activity that has been clearly illegal under federal law for nigh on to fifty years. Collins was a classic corporate insider (a director) who is not allowed to do indirectly (through his son) that which he cannot do directly. He is criminally responsible for his son’s trading.
Sonoiki was what the law calls a “misappropriator” who stole information from his employer’s clients and used it for his own purposes. He tipped Kendricks who traded and profited and then compensated Sonoiki with NFL tickets, tens of thousands of dollars in cash, and the chance to hang with Kendricks’s glamourous contacts.
Insider trading is illegal. Is it unethical? Yes. First, the fact that an action violates the law is usually, though not always, a sign that the action is unethical.
Second, actions are often unethical because they are unfair. Insider trading is clearly unfair. Both Collins and Kendricks profited by taking property (nonpublic corporate information) that belonged to the shareholders of an Australian drug company (Collins) and Goldman Sachs clients (Kendricks) and exploiting it for their own personal profit. Additionally, Collins and Kendricks both profited from trading on information that regular investors could not learn no matter how carefully they monitored the market and no matter how much time they spent researching stocks. Insider trading unlevels the playing field and rigs the market.
Third, actions are often unethical because they cause harm to others. Insider trading does this. It undermines confidence in the markets and causes potential investors to stay on the sidelines rather than play in a crooked game. Diligent enforcement of insider trading laws in countries around the world is correlated with both development of stock markets and economic growth. Unchecked insider trading tends to retard market development as well as economic growth.
Arguments in favor of insider trading as a policy matter are generally unconvincing. Professor Henry Manne argued for 40 years that insider trading could be an efficient means of compensating insiders for their good work on a firm’s behalf. Did Colllins do any good work for his company that should have been rewarded? Did Kendricks? Manne eventually gave up “insider trading as compensation” as an unworkable idea. Others argue that insider trading signals the market of new developments, but what signal does the market get when a linebacker buys some shares of Company A? If it is any signal at all, it is very indistinct. Insiders who cannot trade have no incentive to delay announcement of inside information other than for a corporate purpose. But insiders who can engage in insider trading are incentivized to keep material information from the markets as long as possible so that they can maximize their profits.
Behavioral ethicists are always interested in the “why”? Why did Kendricks trade? It looks like greed. He was an NFL player making NFL money, but somehow it wasn’t enough. He has apologized, but generally tried to place the blame on Sonoiki. Why did Collins break the law? Greed also played a role, no doubt, especially as magnified by Loss Aversion. Collins had put a lot of money into the drug firm’s stock, mostly by buying shares for his son. Because his son and other relatives were facing significant losses, Collins might well have taken risks to help avoid those losses that he would never have taken to make a profit in the first place. Check out our two Ethics Unwrapped videos on loss aversion. Why did Sonoiki jeopardize his job at Goldman Sachs (as well as his freedom) by tipping Kendricks? Again, it appears that greed was involved, and the excitement of knowing and spending time with celebrities. Furthermore, there is quite a bit of insider trading going on around Wall Street (unfortunately), and due to Incrementalismit can come to seem like the norm to Wall Street insiders whose constant exposure to the practice makes insider trading seem not as bad as it seems to the rest of us. Additionally, the victims of insider trading generally have no identifiable names or faces at the time of the wrongdoing, so they seem too abstract to worry about harming. Check out our Tangible & Abstractvideos, too.
Shame on Kendricks and Sonoiki. Shame on Collins, if the allegations against him are true.
References
Frank Cross & Robert Prentice, Law and Corporate Finance(2007).
Josh Barro, “Indicted Rep. Chris Collins Shows Why Members of Congress Should Not Trade Stocks,» Business Insider,Aug. 8, 2018.
Alan Feuer & Shane Goldmacher, “New York Congressman Chris Collins Is Charged With Insider Trading,” New York Times, Aug. 8, 2018.
Michael McCann, “Explaining the Insider Trading Case Against Mychal Kendricks,” Sports Illustrated, Aug. 29, 2018.
Eric Orts & Alan Strudler, “Moral Principle in the Law of Insider Trading,” 78 Texas Law Review375 (1999).
Robert Prentice, “Permanently Reviving the Temporary Insider,” 36 Journal of Corporation Law 343 (2011).
Robert Prentice & Dain Donelson, “Insider Trading as a Signaling Device,” 47 American Business Law Journal1 (2010)
Eugene Soltes, “Teaching Versus Living: Managerial Decision Making in the Gray,” 41 Journal of Management Education455 (2017).
Emily Stewart, “The Insider Trading Case Against an NFL Linebacker and a former Black-ish Writer, Explained,” Vox.com, Aug. 29, 2018.