Insider Trading in Jewish Ethics

Insider trading--using privileged knowledge for profit in the stock market--violates many Jewish principles.

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Some acts are clearly forms of theft, but what about the borderline cases? An expert applies Jewish law on theft to some workplace scenarios and shows its theological underpinnings. "Insider trading" refers to the practice of taking unfair advantage of knowledge about a company's inner workings not available to the general public by trading in the company's shares or in bonds it has issued. Reprinted with permission from The Challenge of Wealth: A Jewish Perspective on Earning and Spending Money (Jason Aronson).

What is commonly known as insider trading is in effect the use of information regarding the present or future prospects of activities of a corporation. Business information falls, broadly speaking, into two groups. One is perfectly legitimate, but legislation prevents the use of the other. There is no argument, legal or moral, against entrepreneurs gathering information regarding economic trends in the market or in regard to a specific corporation and then operating in accordance with such information. All business activity requires the collection of data, and all decisions will be made in the light of such data.

insider tradingThe problem arises only when such information is gathered from sources only available to some, either on the basis of their positions or as a result of their special relationships with the source of the information. This insider information places all the other participants in the market at a disadvantage, which they cannot overcome by their own efficiency or efforts.

Regulating Insider Trading

In order to provide protection against such unfair practices, some countries have legislated against the use of insider trading. Others, in view of the difficulties involved in distinguishing between insider information and legitimate forms of information, have ignored the issue. Implied in such a policy is the assumption that anyone engaged in the stock market should be able to discern the use of such information and protect himself against its misuse. "If you cannot stand the heat, keep out of the kitchen"or "let the buyer beware" would seem to be the basis for this assumption.

In those countries where legislation exists forbidding the use of insider trading, its use becomes halakhically [in the eyes of Jewish law] illegal. This flows from the rule of dina d’malkhuta dina -- literally, "the law of the land is the law"--through which halakhic sanction is given to legislation in economic and financial matters, provided it does not contradict Jewish law. Such legislation becomes binding and can be used in litigation before a rabbinic court. The injured party can claim that he assumed that the law of the land was observed, and therefore is entitled to restitution for any loss suffered as a result of an act made illegal by the secular or non-Jewish legislator.

Applying Jewish Law

The Jewish issue of the use of privileged information only becomes acute in those countries in which preventative legislation does not exist or in the case of Israel, if one wanted to conduct a stock exchange on the basis of halakhah. Halakhically, insider trading has to be viewed from a number of perspectives. It is important in all of these to remember that the share being bought or sold represents, after all, ownership of part of the assets of the corporation. All the concepts regarding truth in trading [discussed elsewhere in the book from which this is excerpted--sanctifying God’s name by dealing honestly, going beyond the letter of the law to be fair, and not "placing a stumbling block before the blind"] apply therefore to the share, just as they would if all the assets were being sold.

1. Halakhic sources do not recognize the Roman concept of "let the buyer beware" and place the onus, both legal and moral, on the seller to make sure that the buyer has full information regarding the nature and quality of the goods sold. If this is not done, he is guilty of genevat da'at [direct deception]; the transaction is a mekah ta'ut -- an erroneous sale--and may be canceled. On these grounds it may be argued that the sale or purchase of stock that is not what it appears to be, in view of the information available to all the participants in the market, would be geneivat da'at and a mekah ta'ut.

2. Alternatively, since the price of the stock with public knowledge of the information held by the insider trader would be higher than that of the market price prevailing, the seller could claim protection of ona'ah, the Jewish just-price concept. Since full disclosure is an integral part of the concept of ona'ah, it seems that the use of insider trading, which prevents the market from [gaining] access to [knowledge of] the real value of the stock, would not be permitted in halakhah even if there were no external legislation.

3. An important principle in Jewish law is the notion of custom, determining the rights and the obligations of the parties to market transactions. For example, if it is the local custom for the employer to provide workers with certain benefits, then all workers in that area are automatically entitled to these benefits even if their contracts do not specify them. It is assumed that both parties understood this obligation and accepted it unless there exists proof of the contrary.

In those countries in which legislation prevents the use of insider trading, one who suffered a financial loss from such use [i.e., as a result of insider trading by others] could claim compensation in a rabbinic court on the grounds that he assumed the law or even the customary rules of trading were being observed. Since it became clear that this was not so, he could have redress in the bet din [rabbinic court], over and above any action initiated by the regulatory authorities for breach of the stock-exchange regulations.

4. There are cases where insider information is bought from somebody else who had access to data as part of his employment. For example, a lawyer working for a firm of brokers, a bank official involved in the financing of a takeover through the issuing of bonds, or a government official privy to decisions regarding future zoning regulations, instead of using the information himself, sells it to somebody else. This sale introduces a new element into the use of insider trading, namely the receiving of stolen goods.

The halakhic codes forbid the buying of stolen goods, seeing the buyer, in the words of Maimonides, “strengthening the hand of evildoers since if he wouldn’t be able to sell the goods, the thief would not steal.” In other words, the buyer is creating a market, thus making the theft profitable and so shares in the immoral act. A user of insider information obtained in this manner is therefore not only faced with problems of genevat da‘at or ona’ah but also of being a mesayea  li-dvar averah -- an accomplice to a forbidden act-theft.

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Dr. Meir Tamari

Dr. Meir Tamari, former chief economist in the office of the Governor of the Bank of Israel, is director of the Center for Business Ethics at the Jerusalem College of Technology. His books include Al Chet: Sins in the Marketplace (Jason Aronson) and Jewish Values in Our Open Society: A Weekly Torah Commentary (Jason Aronson).