What explains insider trading laws?

Tom Joo has a very interesting article on insider trading legislation, Legislation and Legitimation: Congress and Insider Trading in the 1980s. Here’s an excerpt from the abstract:

Congress sought political legitimacy: not investor confidence in the markets, but voter confidence in the political-economic system. Our government has a symbiotic relationship with a capitalist system under which the power of business and finance sometimes rivals that of the state. This arrangement is acceptable to most voters during prosperous times, but can undermine the legitimacy of the political-economic system in times of perceived economic crisis. Government crafts its responses to such crises to protect its legitimacy. The process of self-legitimation does not consist merely of responding to exogenous preferences of constituents. It also includes attempts to mold constituents' preferences to be more consistent with the self-interest and problem-solving abilities of Congress.

I like the story, but it has a missing piece, as I explain below the fold.

Joo points out that, rather than face tough political questions about regulating hostile takeovers, the main business issue of the day, Congress focused attention on insider trading, which was “linked in the public imagination” to takeovers. This allowed them to seize on general anti-capitalist populist sentiment and seething resentment of the rich (see also Jeanne L. Schroeder, Envy and Outsider Trading: The Case of Martha Stewart, 26 CARDOZO L. REV. 2023 (2005)). Moreover, by concentrating on insider trading, Congress could leave the politically influential Wall Street establishment alone and concentrate on the brash new money types like Mike Milken and Ivan Boesky who threatened the establishment.

The article has obvious applications to Enron and SOX, and to corporate crime legislation generally.

Joo says (p.2) that “the neoclassical law-and-economics revolution. . . holds that legal change should be, and for the most part is, a matter of business and economic conditions pushing the law in an economically efficient (i.e., liberal and capitalist) direction.” He cites, among others, Easterbrook & Fischel, Romano & Hansmann & Kraakman for this sweeping proposition. This is not exactly an accurate read. Among other things, Joo cites Fischel's book Payback throughout in support of Joo’s version of the story. Romano wrote on the efficiency of state law, decidedly not federal law.

The missing piece that I referred to above is this: In order for Congress’ version of economic reality to fly, the general public had to believe that all of the supposed problems of the 1980s could be blamed on evil insider traders. Congress alone couldn’t put that one across.

As readers of this blog know, I think Congress had help in the form of a consistent anti-capitalist vein in films and mainstream journalism. Most importantly for Joo’s story, all of the elements of the tale are in the film Wall Street, as I discuss in my recent paper, Imagining Wall Street. Oliver Stone gave us the indelible image of the Milken/Boesky-like Gordon Gekko as a bad guy, and Congress ran with it.

Comments

[Robert Schwartz]

"the self-interest and problem-solving abilities of Congress."

The problem solving abilities of Congress? When has Congress ever solved a problem?

[Tom Joo]

Larry:

Thanks for the insightful comments on my paper. You are right that I overgeneralized about neoclassicists' descriptive claims about the efficiency of federal law.

One thing I disagree about, however, is your point that my argument requires that
"the general public had to believe that all of the supposed problems of the 1980s could be blamed on evil insider traders."

I'm trying to offer an explanation of why Congress chose to _try_ to sell that particular bill of goods (as opposed to inaction or some other fairy tale); I don't argue that people actually bought it. In fact, agree with you that Congress failed to "put that one across." I do state in the paper that the public did not think insider trading was such a big danger, but I guess I didn't put this one across sufficiently. Thanks for pointing this out.

One possibility is that the political market rationally opposed IT regulation on efficiency grounds. Another is that the public saw insider traders as folk heroes and role models. In either case, Congress was trying (and probably failing) to snow the electorate into accepting regulation that was mainly based on bogus reasoning.

Thanks again for the comments,

Tom Joo