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What's Wrong With Insider Trading?

Updated: Feb 2, 2021

The Martha Stewart Case

In 2002, American TV personality Martha Stewart’s image of domestic perfection was tarnished by an investment scandal. The previous December, Stewart had received a call from her stockbroker at Merrill Lynch, who told her that the CEO of ImClone was desperately trying to sell his shares in the company. Stewart quickly decided to sell her nearly 4,000 shares in ImClone as well. The next day, ImClone announced that the FDA had rejected one of their cancer drugs, and their share prices slumped.

By acting on the advance knowledge that ImClone was in trouble, Martha Stewart avoided a loss of about $45,000. However, she paid dearly for it when she was later indicted for insider trading. Not only did she break the law by trading on private information, but she lied to investigators about her reasons for the sale, claiming that she had an agreement to sell her ImClone shares whenever the price dropped below $60.

Ultimately, Stewart was convicted of insider trading and obstructing the investigation into her trading activities. She served five months in prison and five months under house arrest, and she was on probation for the next two years. In the settlement for the related civil case, Stewart agreed to pay the maximum penalty of three times the losses she avoided (around $195,000) and give up her role as CEO of Martha Stewart Living Omnimedia for five years.

A Systems of Exchange Perspective

One of the interesting aspects of investment scandals like this one is that they reveal shared assumptions about the system of exchange in which they occur. As sociologists often say, social norms are most evident when they are broken.

The dominant system of exchange in America (and the context for this scandal) is the price system of exchange. Actors enter price-based exchanges assuming that all other actors are autonomous and motivated to get the lowest possible price for a desired good. Actors are assumed to be unaffected by social relations or moral concerns. Many believe that the self-interested exchanges of independent actors will result in the greatest good for the greatest number of people. Regulators such as the Securities and Exchange Commission ensure that economic actors don’t form social ties that would give them economic advantages.

Martha Stewart violated the assumption in price systems of autonomous exchange. She used her social connections to gain private information that gave her an advantage over other actors in the stock market.

In other words, the social ties between Stewart, her stockbroker, and the CEO of ImClone constituted particularistic social relations when the norm in price systems is to maintain a universalistic orientation toward other actors. Economic actions that rely on significant social relations and information that is not publicly available are a breach of the norms in price-based systems.

It is noteworthy that Stewart’s behavior would have been normal -- even expected -- in a communal system of exchange, where social relationships and shared identity are the basis for economic activity. For a deeper look at how the social norms of one system can be deviant in another, see the case study on Corruption in Systems of Exchange.

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