The Epistemology of Insider Trading

The “Law Blog” column of the Wall Street Journal had a troubling article last week. Its headline said: “What, Precisely, is Inside Info? Legal Issue Arises in Raj Trial.” This refers, of course, to the current trial of Raj Rajaratnam, the founder of the Galleon Group, a hedge-fund management firm. The article then goes on to ask: “When is a tip inside information? That is, when does information passed along truly constitute information that others don’t have?”

The author is using shorthand here, obviously. A person who receives a tip cannot literally have “information that others don’t have.” Necessarily, the tipster has the same information. Rather, the author’s meaning is this: The world is divided into two sets of people—those who legitimately have certain information, and those who have illegitimately been provided with that information by those who legitimately have it. Those who have illegitimately been tipped possess information that “others don’t have” (except for all those who have the information legitimately). And they are said to possess “inside information” on which they may not trade.

Epistemological philosophers could have a field day with this, and I am surprised that they have not. Consider just two of the many paradoxes that the theory raises: Business information is about real-word facts (unless it concerns the unexpressed beliefs of people). Necessarily, then, any information that exists can be learned directly from an examination of reality as well as by communication from another individual.

Suppose, then, that one individual has been illegitimately provided with information by those who legitimately possess it, but other individuals have acquired the same information by investigating the facts of reality. Does the person who has been tipped possess “inside information,” even though he does not possess “information that others don’t have”?

Or try it the other way around: Suppose that no one has been illegitimately tipped to information by those who legitimately possess it. Suppose instead that one financial Sherlock Holmes has learned facts about the business world through his own investigations of reality. But he is the only person who has done so. Now he is indeed someone who has information “others don’t have.” But surely that does not mean he has “insider information” on which he may not trade.

These are the sorts of contradictioons that are arising in the Rajaratnam case, and that will arise even more acutely in the “expert network” cases that lie ahead. The obvious solution, in the Information Age, is simply to let corporations sue people who violate a corporate trust by leaking information, and get the government out of the “insider trading” business.

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