Insider trading, as defined on The Bob Zadek Show, describes the crime in which a person who works for a publicly traded corporation acquires material non-public information about that company and uses it to buy or sell the stock. Bob Zadek introduced the topic by noting that it is a crime in the United States and much of the civilized world, and that a company called Galleon—whose president had just been indicted on an alleged $2 billion insider trading scam—had put the subject in the news. Legalize Insider Trading (2009)
The economic rationale
Zadek framed the episode’s central question: why should anyone care if an insider with secret information uses it to buy or sell a stock? Don Boudreaux, identified as a professor of economics at George Mason University and a former chair of its economics department, answered that the main reason most people object is that they think it is simply unfair—they imagine the stock market as something like a casino, where a player with information you lack makes the game unfair. Boudreaux rejected that framing on the ground that the point of a stock market is not to make money for stock traders but to make sure capital goes to where it is most productive as quickly as possible. For that to happen, he said, asset prices including share prices have to be priced as accurately as possible, and one benefit of insider trading is that when insiders trade on their inside knowledge it enables prices to include that information. Legalize Insider Trading (2009)
Zadek pressed the fairness question directly to listeners, asking how they would feel about someone buying or selling alongside them while holding information they did not have. Boudreaux argued that what a stock trader should want is for the stock price to be as honest as possible, and that the real unfairness runs the other way: an insider who knows a company is failing but cannot trade leaves other buyers to purchase the stock at a price that turns out to have been too high, so that they lose money when the information becomes public. Had insiders been allowed to trade, those buyers would have been saved from being misled by an inflated price. Zadek attributed the same position to Milton Friedman, quoting him as saying that more insider trading is needed, not less. Legalize Insider Trading (2009)
The legal history of the prohibition
Boudreaux stated that insider trading was not even illegal in the United States until about 1961, and that Congress has never said insider trading is illegal. He traced the prohibition to William Cary, a Columbia University professor of law whom John Kennedy appointed to head the Securities and Exchange Commission, and to something called the Cady, Roberts memorandum. During the 1930s debates over the Securities Act and the Securities Exchange Act of 1933 and 1934, Boudreaux said, there were proposals to make insider trading illegal, and even that highly interventionist Congress under Franklin Roosevelt did not do it. What the 1934 Act did contain was Clause 10b, a prohibition of securities fraud—a distinction Zadek emphasized. Cary’s theory, in Boudreaux’s account, was that this broad prohibition of securities fraud could be interpreted as a prohibition on insider trading. Zadek characterized the result as the SEC creating a new product, and Boudreaux as a bureaucrat at the SEC creating a new product. Legalize Insider Trading (2009)
Boudreaux added that although the prohibition was then almost fifty years old and Congress could have overturned it had it wished, it did not, and the courts have largely accepted it. He stressed that within his own lifetime insider trading had been perfectly legal in the United States and only became illegal in the early 1960s. Legalize Insider Trading (2009)
Insider non-trading and vagueness
Zadek raised what he called a deliciously fascinating point from Boudreaux’s article “Learning to Love Insider Trading”: insider non-trading, which is not against the law because, as Zadek put it, we do not have electrodes plugged into people’s brains yet. Boudreaux explained that a person can actively buy or sell a stock, but can also change his mind—planning to buy and choosing not to, or planning to sell and choosing not to. An employee who intended to buy 100 more shares and then learns from inside information that the company is in worse financial shape than most people believe can cancel the purchase and thereby profit by being saved from a bad investment. Only active trades can even conceivably be prosecuted, Boudreaux said, yet inside information affects decisions not to trade no less than decisions to trade. Zadek observed that such conduct cannot be criminalized because the government cannot prove you intended to do something and did not. Boudreaux called this a fundamental unfairness about the law itself: the person who actively trades on inside information is prosecuted and punished, while the person who uses the same information to refrain from trading cannot be punished. In his view none of it should be illegal. Legalize Insider Trading (2009)
Zadek also posed a hypothetical he called synthetic insider trading: an employee of a drug company about to introduce a competing product, knowing that the rival’s fortunes will decline, shorting the rival company rather than trading in his own employer’s stock. Boudreaux said he did not know the legal answer because Section 10b-5 is so vague that perhaps some bureaucrat could decide to try it, and that this vagueness is itself part of the problem. Zadek argued that society is not benefited by a body of law so vague that it is subject solely to the arbitrary and capricious whim of a bureaucrat—the SEC, which he described as not even a law enforcement body but a bureaucratic body deciding whom to beat up based on a somewhat random interpretation of the statute. Legalize Insider Trading (2009)
Fraud, fiduciary duty and Enron
Boudreaux distinguished insider trading from fraud, stating that no one is advocating that company executives engage in fraud or violate their fiduciary duties. He named Henry Manne as the theorist who in the 1960s first began thinking along these lines and who wrote the seminal book Insider Trading and the Stock Market. Boudreaux’s position, as he stated it, is that companies themselves should be allowed to say what information is and is not off-limits to inside traders, and that if a company does not impose such a rule the government should not do it; where a company does impose one, it should be allowed to sue violators of its bylaws in court. Legalize Insider Trading (2009)
On the harm to the public, Boudreaux offered the example of Enron: a buyer who purchased Enron stock in the summer of 2000 or January of 2001 watched it go kerplunk a year later, and had insiders been allowed to trade—they knew what was going on—they would have sold the stock short, so the buyer would either not have bought it or would have bought it at a much lower price and would not have been harmed as much. He suggested that insider trading prohibitions likely scared off insiders at Enron, or people who knew the information, from making trades that would have benefited everyone except the bad guys at Enron. Legalize Insider Trading (2009)
Zadek closed the hour by quoting Ron Tempas, described as an Associate Deputy Attorney General in 2006 testifying before Congress, who called insider trading a variation of corporate fraud and said it smacks of secret backroom exchanges between insiders every small investor fears. Zadek called this class warfare and evidence of the intellectual bankruptcy of the SEC. Boudreaux replied that insider trading in fact helps expose backroom deals, and that people with political power moralize and speechify because they have a platform, with little of it related to reality. Legalize Insider Trading (2009)
Across episodes
The topic appears in two episodes, and the excerpts show no development between them. In the 2009 episode Don Boudreaux supplied the economic and legal argument, and in the 2020 episode Bob Zadek referred back to that earlier show, recalling that his guest had been Don Boudreaux and that he had wished insider trading were mandatory rather than a crime, adding that criminalizing it harms the market, investors and everybody. Populism 201: Advanced Topics in American Democracy (2020) In the same 2020 passage Zadek restated the libertarian view that a valid role of government is to protect individuals against theft, physical harm and fraud, which he offered as common ground with his guest. Populism 201: Advanced Topics in American Democracy (2020)
What the sources do not cover
The excerpts do not report the outcome of the Galleon prosecution, the holding or citation of any insider trading case, or the text of Section 10b or Rule 10b-5. They do not state the current state of the law, any penalty or sentencing practice, or any empirical study of price accuracy. Martha Stewart is mentioned only as someone accused of a cover-up rather than of insider trading, and the excerpt does not say what became of her case.