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The Attack on Martha

Tags Financial MarketsLegal System

06/21/2002William L. Anderson

While the view that all society must be egalitarian is evident nearly everywhere, perhaps it is no more prevalent in the business world than in how we regulate capital markets. As Ilana Mercer has written, the law requires information to be socialized. If one party knows more than others regarding information about a particular firm or industry, then the SEC is perfectly able to rule that possessing--and acting upon--that knowledge is a crime.

Such is the apparent fate of the indicted former head of the biotech firm ImClone, Sam Waksal, as well as members of his family and his most famous friend, Martha Stewart. In its typical outburst of egalitarian envy, the mainstream news media from the Washington Post to CNBC has already pronounced Waksal and Stewart guilty and worthy of lengthy prison sentences.

Congress is also "investigating" this incident, and its investigators already have declared that Stewart may have given "false statements" to congressional staff members--yet another crime. With the media and Congress, not to mention federal agencies, in a mood to "bring down" Martha Stewart and her "empire," it is doubtful that she stands a chance in the current frenzy.

Much of the story is already familiar to readers of this page. Waksal headed ImClone, which was seeking Food and Drug Administration approval for Erbitux, a drug ImClone claimed would be effective in combating cancer. When apprised that the FDA was turning down the drug's approval application, Waksal allegedly contacted family members and Stewart, who then sold their stock in the company just before the price plummeted.

This sharing of and acting upon such "inside" information, the SEC and Congress solemnly declare, is a crime, since the general public was not aware of it at the same time. Somehow, the government does not consider it to be a breach of the law when its own officials act upon "inside" information to protect themselves. For example, after receiving warnings that terrorists might hijack U.S. airliners, U.S. Attorney General John Ashcroft began to fly on private aircraft. Some members of Congress grumbled, but no one was sent to Ashcroft's office to place him in handcuffs and chains.

Perhaps if President George Bush were to make Rudy Giuliani the head of the new Department of Homeland Security (or whatever Bush and Congress will call it), a federal raiding party might appear at Ashcroft's door. When he was U.S. attorney in Manhattan two decades ago, the power-hungry Giuliani began the current war against securities markets with a number of high-profile insider trading prosecutions.

Giuliani fired his first salvo by hauling two officers of the New York Stock Exchange from the trading floor, placing handcuffs and chains on them, then parading them before the news cameras. The media and political classes loved it, and so did the general public.

The message from Giuliani and his supporters was this: Envy is good. There are people out there who are better off than we are, and we must do what we can to "cut them down to size." Although those particular market officials were not convicted of anything, others in Giuliani's sights, including Michael Milken and Leona Helmsley, did not fare so well, taking new addresses in federal prisons for a while.

The issue of insider trading seems to be straightforward, but it is not. First, as Paul Craig Roberts has pointed out, the law is purposely vague, something the SEC says is needed since a specific law would then rob prosecutors of their ability to pursue such charges. In other words, when acting upon information in the securities markets, one cannot be sure if one is committing a crime or not. However, the local U.S. attorney--and the courts, which have upheld this legal abomination--will be happy to inform you afterward that such activity is indeed criminal.

Second, this is a law aimed at a certain group of people. Since people like myself do not deal in large amounts of money, it is doubtful that government prosecutors are likely to care if I buy a hundred shares of Acme because someone "in the know" gave me a good tip. The folks that prosecutors love to go after are those who are wealthy and high profile, such as Martha Stewart. No doubt, Stewart's scalp would look mighty fine on the pole of a career prosecutor seeking political fame or future legal fortune.

Fanning flames of envy, prosecutors are able to go after people who are rich and often unpopular. When Guiliani first went after Leona Helmsley and her husband, Newsweek ran an unflattering picture of Leona on its cover, with the headline, "Rhymes with Rich." The gist of the article was this: Helmsley was mean to some of her employees and could be an unlikable person at times. She also was supposed to have declared, "Only little people pay taxes." Therefore, she was guilty of tax evasion and must go to prison.

Even when the Wall Street Journal pointed out that Helmsley and her husband paid an enormous amount of income taxes, other mainstream journalists did not see fit to use that information. After all, they were on a righteous crusade in the name of envy, and they didn't want anything upsetting their worldview.

One can see the same principle at work here. Stewart is hard-working, ambitious, and often unpleasant. She is also very successful, and she became so by giving people goods and information on how to make their homes nicer places. In other words, she came by her fortune honestly, not by shaking down businesses and individuals as is the case with most members of the political classes. Furthermore, she has not been a permanent fixture in Washington, D.C., which demands that anyone who makes a private fortune contribute large portions to political candidates of both parties.

In other words, while Stewart is well known and has made contributions to social betterment through her goods and services, she is not universally popular. Furthermore, she is wealthy. Therefore, she is guilty of a felony and should go to jail.

Third, the principle of "insider trading" is in itself fundamentally flawed. Information that is worth anything in a market setting at all by definition must come from "the inside." There is no way to make information public in the way that the government wants it to be done without making all relevant information useless for the purpose of economic decision making.

In the neo-classical model of "perfect competition," all producers and consumers have instantaneous possession of all relevant knowledge, and no one has an economic advantage on anyone else. When such a system is in "equilibrium," there are no economic profits to be made. While many neo-classical economists and their academic and political allies call such a state of affairs "ideal," Austrian economists point out that such an "equilibrium" presents, not a picture of bliss, but rather of stagnation, since by definition it eliminates the entrepreneur from the picture.

That "perfect competition" is both unattainable and undesirable, and one would think people would leave it alone. Instead, the government wishes to create this imaginary state by force, no matter what the costs may be. Therefore, we have insider-trading laws which, if taken to their logical conclusion, would make all entrepreneurial activity illegal, since entrepreneurs always act upon information that either is not known or not properly interpreted by the general public.

Let me further examine the ImClone situation. The government alleges that after Waksal found out the FDA had rejected the Erbitux application, the then-ImClone CEO called family members and friends, who then sold their stock at prices higher than what would later be the case when news of the FDA's action hit the streets. This action, the SEC says, was criminal because other shareholders did not have the same information, so they had to take losses when the stock price plummeted.

Government officials conveniently forget that the other stockholders were going to take losses anyway, thanks to the government's own actions. For all the accusations directed at Waksal, he did not harm his company or any of his shareholders if he did what the feds have alleged. Instead, the real crime, according to the government, was that family and friends who held ImClone stock did not take the same bath that others took. In other words, because they were not harmed as badly as other shareholders, they are now criminals.

I am not praising all acts of insider trading, but I do think that such actions are civil, not criminal, matters. For example, if I am an attorney working for Acme, and I am helping to put together a merger with ABC Corporation, I have a fiduciary responsibility to my company not to make that information public until the proper time.

Should I violate those principles in a way that helps leak information into the market (like secretly purchasing 10,000 shares of ABC), then Acme can pursue a civil claim against me for dereliction of duty. That is a civil matter between Acme and me, and is not something that should land in criminal court.

Do the ImClone shareholders who saw prices of the company stock plunge have a case against Waksal? That question is much more difficult to answer than the government would like for us to believe. First, as noted earlier, it was the government's action against ImClone that drove down the firm's stock price, not Waksal's alleged warnings to friends and family. That these people--no doubt, the majority shareholders in the company--did not take the losses that other stockholders would later take does not change things.

Second, if his actions induced some shareholders to sell "early," then that deed provided a signal to others in the market that perhaps they should sell as well. Had he waited until the information had hit the street, he could not have provided any service to anyone. That may sound harsh, but people who decide to get into the stock market also should understand that they are bearing the appropriate risk.

At best, other shareholders might have a dubious case against Waksal (although in this litigious age, what once was dubious now results in some people being able to plunder others). Even if he did the things the government alleges, he is no criminal, if one uses the historical and universal definitions of what a crime is.

Such moral niceties, unfortunately, will not deter the ambitious career prosecutors who are now on the case. Just as Michael Milken and Leona Helmsley were wonderful trophies in the case of the wickedly ambitious Rudy Guiliani, no doubt the present set of U.S. attorneys pursuing this case want Waksal--and maybe Martha Stewart--in their trophy cases as well.

Giuliani was able to parlay his "innovative" prosecutions of Milken and Helmsley into fame and fortune, and Joel Klein, who led the government's case against Microsoft, was able to parlay his acts of destruction against the NASDAQ companies into an antitrust attorney's job that pays him millions of dollars a year. Janet Reno might be able to turn the Waco massacre into a job as governor of Florida.

Unfortunately, there is no check upon the behavior of rogue prosecutors like Giuliani. The mainstream news media always respond positively to stories that permit them to demonize some people on the basis of sheer envy. Congress passes inane laws like insider-trading statutes, and the president signs these monstrosities into law, then sends his own goon squads to enforce them. No one sees that, in the final analysis, envy not only is bad; it is downright destructive.


Contact William L. Anderson

William L. Anderson is a professor of economics at Frostburg State University in Frostburg, Maryland.

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