Views on improving the integrity of global capital markets
21 June 2012

Nature versus Nurture: the Culture of Insider Trading

Bob Dannhauser, CFA

The Financial Times’ John Gapper raises the very interesting question in a recent article of whether otherwise good people can justify unethical activity when “norms and expectations of the corporate elite are corrupt.” This is a rather important question for those concerned with ethics and standards of conduct in the capital markets, for it suggests that the deterrents of enforcement mechanisms aimed at catching bad actors with bad intents may be no match for cultural influences that wink at bad conduct.  

Gapper compares psychopathic behavior of what are fundamentally crooks in the business to sociopathic behavior of fundamentally sound individuals who develop a warped sense of right and wrong based on the norms of those around them, comparing Allen Stanford’s outright Ponzi scheme to the (surprising to some) behavior of Rajat Gupta in passing on insider information about Goldman Sachs.

Insider trading is an interesting point of focus, for it meets with shrugs in some jurisdictions around the world. Take, for example, the Economist’s recent profile of insider trading in Japan with little practical consequence, and the Financial Times’ Mumbai correspondent reporting on “rampant” insider trading in India and lack of serious enforcement actions.

U.S. officials take a hard stance against insider trading and its negative effects on market integrity, and have begun employing prosecutorial techniques (including wiretaps) more at home in organized crime investigations to press for high visibility convictions. CFA Institute supports prohibitions on insider trading, and indeed, Standard II.A of the Standards of Professional Conduct to which all CFA charterholders must abide prohibits acting upon or causing others to act upon material, nonpublic information. But this view isn’t necessarily universal, with prominent figures such as the economist Milton Friedman having argued that insider trading introduces relevant information to the marketplace quickly. Never mind the investor on the other side of those trades!

Beyond insider trading, practitioners should give thought to what potential inadvertent signals their own corporate cultures give to those inclined to cheat at the margins, either breaking laws outright or compromising their clients’ interests. “Tone at the top” is one of those clichés that gets used a lot because there is strong underlying truth: If firm leaders demonstrate visible commitments to ethical conduct, chances are better that the corporate culture and norms will support ethical behavior. For asset managers, that means weaving ethics into the value proposition of the firm, rewarding behavior that affirms client interests, and dealing swiftly and decisively with contrary behavior, even before the regulators catch on. It means treating codes of conduct as more than necessary evils for compliance purposes and relating the provisions of those codes to supporting enduring client relationships that are profitable. And it means looking for ways to bolster investor confidence in fair capital markets rather than letting traditions dominate what’s right from what’s wrong.

Because after all, being called sociopathic isn’t exactly a compliment.

About the Author(s)
Bob Dannhauser, CFA

Bob Dannhauser, CFA, is head of global private wealth management at CFA Institute.

2 thoughts on “Nature versus Nurture: the Culture of Insider Trading”

  1. John asking a such really interesting and important one.. normally peoples don’t think about that..

  2. Ben Tremblay says:

    It always worries me when I see “sociopath” thrown around in a manner that only serves to obscure the significant role played by the psychopaths among us, those who “carry catastrophe lightly in both hands”. And I’m quite often worried me.
    So I’m gratified to see this intelligent treatment of this complex.


    p.s. I’ve used school yard bully dynamics as analogous: there are the bullies (the psychopahs) and there is the circle of socopaths who guard and protect them. Then there are the rings of sycophants. What is a simply honest person to do except strive merely to survive?! Understandable that most duck and cover. “The nail that sticks out gets hammered.”

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