An article in the latest edition of the Undercurrent analyzes the moral arguments underlying insider trading laws. In this post, we recount a specific insider trading case from the early 1980s that revealed that it is indeed the profit motive that insider trading laws exist to penalize.
Here’s the story:
Ron Secrist, an employee at an insurance company, learned that his company was engaged in a massive financial fraud. The company had been making up imaginary insurance policies that existed only on paper, then selling those policies to re-insurers for cash. Learning of this situation, Secrist decided to do the right thing: he quit his job, and reported the fraud to a securities analyst named Ray Dirks.
Dirks immediately went to the Wall Street Journal with the details. To his surprise, the Journal refused to believe that the insurance company, one of the hottest stocks of the time, could be engaging in fraud. Dirks also went to the Securities and Exchange Commission (SEC), but the officers there ignored him for the same reason. Dirks, not dissuaded, used the investigative skills he had developed as a securities analyst to gather more evidence about the fraud, confirm it in a number of ways, and make it public. While he was at it, he told his clients, the only people who would listen to him, to sell their stock in the company.
Dirks should have received a medal, or at least a thank you, for making public one of the most audacious frauds Wall Street has ever seen. Instead, he got a lawsuit. The SEC censured him for “insider trading,” because he had provided his clients with non-public information. Only after a protracted ten-year battle, staggering lawyer fees, and a trip to the Supreme Court did he finally clear his name.
The Supreme Court found Dirks not guilty, so justice was ultimately served in this case. But the Court’s reasoning did not bode well for future insider traders. The Court argued that even though Dirks’ clients had profited from his actions, Dirks was not guilty because profit had not been his intent in uncovering the fraud. The implication of the court’s decision was obvious: Since Dirks would have been criminally liable had he been motivated by profit, it is the profit motive that makes insider trades criminal. It is the intention to make money that renders such trades illegal.
Just imagine if Dirks had done everything he had done, but the Supreme Court had found that his reason for doing it was to protect his clients’ investments. Imagine he had been investigating companies on their behalf, to evaluate whether they were worth investing in. According to the law, such a profit motive would constitute an admission of guilt.
Each year, the government prosecutes hundreds of investors who take the same types of actions that Raymond Dirks took, but whose intent happens to be to make money (or prevent loss), rather than to expose a fraud. In a nation where money-makers were once exalted as heroes for their honest achievements, they are now prosecuted for the crime of profiting from them.