“Gossip boys”: insider trading and regulatory ambiguity

Author:Laura L. Hansen
Position:Western New England University, Springfield, Massachusetts, USA
SUMMARY

Purpose – The purpose of this viewpoint, case study analysis paper is to assist in understanding how history repeats itself in the case of insider trading, even with regulatory intervention. Design/methodology/approach – Qualitative methodology approach, using interviews of some of the watchdogs of Wall Street (SEC, US Attorney's Office) during the insider trading scandals of the... (see full summary)

 
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Introduction

Insider trading has once again emerged, abate quietly, as a debatably ambiguous crime, demonstrated by recent attempts to prohibit members of the US Congress from capitalizing on finance and industry information that they have privy to, in advance of public notice. Since the trial and subsequent conviction of Raj Rajaratnam (Galleon Hedge Fund Manager) for making approximately $45 million on tips from corporate elites, plus the arraignment of Rajaratnam's younger brother Rengan more recently for similar charges ( Bray and Rothfeld, 2013 ). This type of malfeasance is infrequently pursued through criminal justice avenues, but rather generally handled through legislative and civil court routes, as demonstrated by the whispers of alleged insider trading on Capital Hill in Washington, DC ( Mullins et al., 2010 ). It is timely to seriously think about the relationship between insider trading, opportunity, and regulatory practices. This was best demonstrated by the insider trading networks that formed during the 1980s on Wall Street, a period of time when there was an increase in mergers and acquisition activity ( Hansen, 2004 ). Though decisively occurring during a different economic climate, comparisons can be made with today's scandals from a standpoint of mechanisms, including corporate culture and regulatory agencies, which have contributed to these types of crimes.

This case study concludes that the regulatory system is faulty, where some are prosecuted and others get away with civil actions (e.g. Rajat Gupta at Goldman Sachs) much as the regulatory systems that are expected to control all types of underground, black market activities. Understaffed and held hostage by politics, the Securities and Exchange Commission has inconsistency monitored financial markets ( Hansen, 2009 ; Hansen and Movahedi, 2010 ). Though the white collar criminals discussed in this essay are clearly well-compensated in their legitimate occupations, they have one thing in common with all workers within informal and underground economies: there is unreported/underreported income resulting in unrecorded productivity (e.g. IRS W-2s).

If any lesson has been learned from the era of greed in the 1980s, or the present era of malfeasance for that matter, is that no lesson has been learned. As Larry Summers (Former Economic Advisor, Obama administration; Harvard Professor) has recently been quoted as saying, “the four most dangerous words in finance are ‘it's different this time’” (Jacobs, 2011, p. 34) It is not.

We have to be clear on the definition of insider traders, since there are legitimate and quasi-legitimate stock trades by industry insiders and shareholders including board members and family members. The subjects of this discussion are the illegitimate insider traders, who have been charged with violating their fiduciary responsibilities and Security and Exchange Commission (SEC) regulations.

Three key issues
1. Anonymity of money

Money, as an abstraction, makes insider trading seemingly harmless. Money translated into a figure on a spreadsheet does not possess the same properties as currency that is physically stacked in a vault. In other words, whereas 18 characters of type represent $1 million, within this text, the same $1 million in real currency stacked on a table represents something else cognitively. Even with a single form of currency, money has properties that land, due to its visibility, will never possess. In the words of Simmel (1978, p. 377) :

Money, more than any form of value, make possible the secrecy, invisibility and silence of exchange […] money's formlessness and abstractness makes it possible to invest in it in the most varied and remote values […]. Its anonymity and colourlessness does not reveal the source from which it came.

It is the very invisibility of money that would spawn a different type of crime from mere theft.

A less nefarious function of money was proposed by Max Weber, who believed that the ability to convert goods and services into monetary dimensions allowed for the growth of bureaucratic management and accounting ( Mizruchi and Stearns, 1994 ). Further argument for proposing that money is an abstraction is the invention of the bitcoin, virtual currency that is backed by no government, no other security than the faith of its owners that it is worth something in the course of managing exchanges online. In some ways this feels ominously like the tulip bubble (“Tulipmania”) in the seventeenth century The Netherlands.

2. Wall Street professionals and financial markets

The abstraction of currency itself is far from being the only issue in the crime of insider trading. According to finance theorists ( Prodhan, 1994 ), the modern market does not necessarily require a working knowledge of its idiosyncrasies. Prodhan (1994, p. 5) further notes that “financial analysis is irrelevant in an efficient capital market because prices always fully reflect all information; hence superior analysis will not result in superior returns.” The market itself is never clearly defined1. From the standpoint of sociologists and criminologists, this is a recipe for disaster. It is the very naiveté of the average investor and trust in financial professionals that creates a situation ripe for fraud and dishonesty on the part of financial “experts” ( Rosoff et al., 1998 ). Among the more devastating to investors and employees is any form of securities fraud. If not financially destructive, as in the case of Enron, and now possibly Goldman Sachs, it is morally destructive, as pubic disclosure of fraud can tear at the basic trust and social fiber of society. Unfortunately the policy debate about the ethics of insider trading has been going on for over a century, since some believe that insider trading allows the market to reach its natural levels, economic Darwinism so to speak2.

3. Environment, regulation and opportunity

The environment plays a key role in providing both opportunities to create illegal informal economic structures and constraint on individuals in the banking industry. There are two means by which the environment plays a part in shaping the way that investment bankers interact with one another. The first instinct is to place importance on the regulatory system. It appears that the competitive environment, in this case increased mergers and acquisition activity, may play a greater role in offering opportunities. In such an unpredictable environment, individuals resorted to mimic isomorphism, as predicted by DiMaggio and Powell (1983) . This mimicry was both legitimate and illegitimate in the 1980s and involved the formation of networks predicated on similar goals.

Case study: insider trading on Wall Street 1979-1986

The dates used in this study were chosen because they coincide with the beginning of Dennis Levine's insider trading activities and end with his arrest in 1986, when the networks of other conspirators was uncovered by the SEC and prosecutors, including Ivan Boesky. Though there is no evidence that Levine and others were participating in insider trading prior to this period, it is unknown as to how long this particular illegitimate network operated, except what has been revealed within court documents and journalists reports ( Stewart, 1992 ).

The focus of this case study is the way by which definitions are transmitted by opportunities. Opportunity is formally defined as “a potential course of action, made possible by a particular set of social conditions, which has been symbolically incorporated into an actor's repertoire of behavioral possibilities” ( Coleman, 2001, p. 341 ), opportunities are defined here by the regulatory system as a social condition, which determines what financial transactions are legal and which are not. There are three types of opportunity definitions, moving from micro to macro environments.

The first environment is the institution itself. Each corporation has an institutional environment, which imparts the normative expectations of that particular economic entity. Simon and Hagan (1999) noted that the social structure of elite institutions dominates American society, with the pursuit of the “American Dream.” All American businesses are, in reality, constrained by the demand to increase profit and decrease costs. With regulatory ambiguity in the 1980s, corporations did not necessarily have clear guidelines as to what could be definitively defined as malfeasance or criminal behavior.

The second environment is the industrial environment. For each type of industry, there is a separate code of ethics, language, and role expectations. Investment banking, though not distinctly different in its pursuit of profit from other types of businesses, requires that there be not only an aura of success, but also an apparent decorum of trustworthiness. This requires professionalism and licensing. At the very least, there needs to be the appearance of legitimacy.

The third environment is the regulatory environment. As previously emphasized, the regulatory environment is of greatest concern in this case study as a deterrent against insider trading networks. The link between business and government is inevitable in a capitalist society. Of great importance to this study is the way by which the government defines a societal value system in favor of business ( Simon and Hagan, 1999 ).

In the 1980s under the Reagan administration, there was...

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