The Ethics of Insider Trading

Global Tides Volume 19 Article 12 May 2025 The Ethics of Insider Trading Miles Morgan Pepperdine University, Follow this and additional works at: https://digitalcommons.pepperdine.edu/globaltides Part of the Business Law, Public Responsibility, and Ethics Commons, Economics Commons, Ethics and Political Philosophy Commons, and the Law Commons Recommended Citation Morgan, Miles (2025) "The Ethics of Insider Trading," Global Tides: Vol. 19, Article 12. Available at: https://digitalcommons.pepperdine.edu/globaltides/vol19/iss1/12 This Religion and Philosophy is brought to you for free and open access by the Seaver College at Pepperdine Digital Commons. It has been accepted for inclusion in Global Tides by an authorized editor of Pepperdine Digital Commons. For more information, please contact . Morgan: The Ethics of Insider Trading 1 The Ethics of Insider Trading Introduction In business ethics, insider trading has gone untouched by scholars, as the consensus is that insider trading is morally indefensible, however, questions have emerged regarding the moral responsibility of insiders. This paper engages with Analyzing Insider Trading from the Perspectives of Utilitarian Ethics and Rights Theory by Robert McGee to evaluate the relationship between applied ethics and insider trading. A satisfactory anti-insider trading account must be able to economically or philosophically explain why insider trading is morally wrong. The assumption that this is impossible may be due to a misunderstanding of how we decide what morality is or how economic morality is defined. However, even when these differences are reconciled, anti-insider trading individuals must be able to confront what it is exactly that makes insider trading unethical. In this paper, I will provide an account of what makes insider trading morally impermissible by summarizing McGee’s claims, then countering these claims. In this paragraph, I will define what insider trading is to provide context to readers who are not familiar with its practice, in addition to giving a brief overview of McGee’s two main arguments. Insider trading occurs when “insiders trade company stock while in possession of material, nonpublic information about the company” (SEC, 2015). The Securities and Exchange Commission (SEC), the institution responsible for investigating matters of insider trading, defines an insider as “anyone who possesses inside information because of his or her relationship with the Company or with a person within the Company” (SEC, 2015). The commission also classifies material information as “information which, if known, could reasonably affect the investment judgment of a person making a decision to buy or sell the stock” (SEC, 2015). Clarifying these definitions is necessary, as understanding the relationship between insiders and the material information they possess is crucial to deconstructing McGee’s arguments. To start, McGee references a utilitarian account of ethics. He suggests that the stock market and people benefit from an increase in efficiency resulting from insider trading, noting that in economics, efficiency equates to ethical behavior. Along with his utilitarian approach, McGee applies rights theory to defend his claim. In the rights-based account, McGee argues that material information is the intellectual property of Published by Pepperdine Digital Commons, 2025 1 Global Tides, Vol. 19 [2025], Art. 12 2 insiders; therefore, whoever is the owner of that information may act on or do whatever they want with the information as long as what they do doesn’t infringe upon the rights of others. While McGee’s reasoning appears comprehensive, I contend that both his utilitarian and rights-based defenses are flawed. Summary of Utilitarian Argument The first of McGee’s ethical frameworks for evaluating insider trading is classical utilitarianism, a moral theory that ascribes to the notion that an action is right if it results in the greatest good for the greatest number of people. Though McGee does make an effort to differentiate between classic and more eclectic versions of utilitarianism, he relays that more eclectic versions, in context, will take some factors outside of net societal benefit into account, specifically, fiduciary duty (McGee, 2009). He illustrates this point with a flow chart: under classical utilitarianism, insider trading is ethical if it generates more societal gains than losses; in contrast, eclectic approaches may deem insider trading unethical if fiduciary duty is violated, regardless of the net benefit. This is an important point to distinguish between, as the argument differs based on the approach that is used, but McGee adopts a classical position, which will be the basis of this paper. In his defense of utilitarianism, McGee references the efficiency argument, a variant of economic philosophy led by Richard Posner that connects ethics to market efficiency. Within his framework, insider trading is ethical if it leads to more accurate stock pricing. He explains that theoretically, this would occur by speeding up the dissemination of relevant information (McGee, 2009). Specifically, McGee supports this claim by suggesting that trades based on insider knowledge often act as early signals that move market prices in the right direction before public disclosure occurs. As a result, this correction, he argues, makes markets more responsive and ultimately benefits society at large. Additionally, McGee references Henry Manne’s well-known argument that insider trading improves the accuracy of market pricing by allowing insiders with material information to move the market. Furthermore, McGee claims that once insiders trade, others in the market may infer that new information exists, prompting financial analysts and other market participants to react. This mechanism would accelerate the process by which stock https://digitalcommons.pepperdine.edu/globaltides/vol19/iss1/12 2 Morgan: The Ethics of Insider Trading 3 prices move, arguably making the market more informationally efficient. Following this, McGee claims that allowing insiders to trade on privileged information gives them an incentive to uncover financial information, which he argues benefits society. To conclude his thoughts that efficiency is the economic equivalent of utilitarianism, McGee makes his boldest claim that insider trading should be permissible even if it is immoral, as long as there are no victims in the trade or no one’s rights are being violated. Though Mcgee supports the utilitarian model, he recognizes its limitations. He notes that calculating gains and losses from insider trading is imprecise and highly context-dependent, as utility is inherently subjective and not easily quantified. Additionally, McGee emphasizes that insider trading might still appear beneficial from a utilitarian lens even if it involves a breach of fiduciary duty, meaning that as long as the aggregate gains outweigh the losses, (...truncated)