A story in yesterday’s Wall Street Journal throws light on the suspicious business history of Lev Parnas, one of Rudolph Giuliani’s helpers in the Ukrainian affair (“Giuliani Associate Left Trail of Troubled Businesses Before Ukraine Probe Push,” October 31, 2019). Mr. Parnas has been charged by federal prosecutors and Mr. Giuliani himself may be under investigation. In an article titled “The Unravelling of Rudy Giuliani (October 17), The Economist wondered how the former adulated mayor of New York City has come to be embroiled in the Ukrainian scandal with shady figures:
One answer—popular in New York—is that his mayoral successes were significant but exaggerated, and weighed by character flaws that have worsened over time. … In truth it is hard to find any altogether convincing explanation for Mr Giuliani’s behaviour. He was once a serious politician prone to indiscipline; now he is wild. Yet a former colleague of his, who knows both men, suggests resentful envy of his old co-star Mr Trump—whom he must secretly disdain—may be eating him alive. If so, Mr Giuliani is going to really hate it when the president and his entire party flatly disown him. That looks like the inevitable next stage in his disgrace.
Everybody seems to forget the Rudolph Giuliani of the 1980s, who may help understand the character and values of today’s Giuliani. As the U.S. Attorney for the Southern District of New York, he mounted a legal and very mediatized witch-hunt against Wall Street financiers. Some like Ivan Boesky were probably crooks, but Michael Milken, Robert Freeman, and others were certainly not. Milken was charged with 98 crimes of racketeering and fraud, including so called “insider trading,” that is, buying or selling, or abstaining from it, on the basis of information not available to everybody. Like old witches, his will to defend himself was broken and he ended up pleading guilty to six rather regulatory offenses (but felonies nonetheless) other than insider trading. He was imprisoned for nearly two years.
In this witch-hunt, Giuliani used the Racketeer Influenced and Corrupt Organizations Act (RICO), which was never intended for ordinary white-collar crimes. As for insider trading laws, they are legally and morally shaky and highly controversial from an economic viewpoint. The main economic and legal arguments against criminalizing insider trading had been explained in a 1966 book by Henry Manne of George Mason University, Insider Trading in the Stock Market. Insider trading that is not stolen and does not violate any contractual agreement disseminates information that contributes to the correct pricing of stocks. Moreover, laws against insider trading give investors a misleading sense of security. And when revealing inside information does violate contractual agreements, it is better dealt with through civil litigation. In 1980, most Western European states had no law against insider trading, virtually none criminalized it.
It is safe to say that these arguments weighed nothing in the mind of Giuliani, who was pursuing personal publicity and political ambitions. In a little book I published in Paris in 1991, Apologie des sorcières modernes (In Defense of Modern Witches), a “pamphlet” in the French sense of the word, I compared creative financiers like Milken to witches hunted by self-righteous and obscurantist inquisitor Giuliani.
The fact that Giuliani recently tried to obtain a presidential pardon for Milken may be a rare redeeming factor in a life devoted to authoritarian pursuits (on his deep authoritarianism, see “Liberty, Authority, and Giulani,” EconLog, November 19, 2018).
It would be ironic if the former witch-hunter found himself on the wrong side of the law, after contributing so much to undermine the rule of law.
READER COMMENTS
daniel
Nov 1 2019 at 11:12am
I wouldn’t think so, so I assume that’s a typo.
Pierre Lemieux
Nov 1 2019 at 11:31am
Thanks, @Daniel. Horrible typo, now corrected. This sort of error illustrates wishful thinking: the writer reads what he wishes he had written. Please make sure you read my posts first in order to alert me to that kind of thing!
Craig
Nov 1 2019 at 1:56pm
Naturally I enjoyed your article on Rudy Giuliani and for the most part I think the focus of the article remains Giuliani’s prosecutions for violating 10(b)(5) and of course your general disdain for criminalizing trading based on inside information. Now, whether its subject to a criminal sanction or a civil sanction is a material difference in real life, but its not a difference that impacts the moral underpinnings of the practice. In other words, if we make trading on inside information a fraud subject to a private lawsuit or a crime, the underlying activity would be immoral in either case. So we could debate the finer points, but I would suggest that trading based on inside information is, generally, morally wrong. How the law then treats with that conduct becomes a separate issue.
Let’s assume that you and I are business partners operating a deli. On a daily basis we operate the business, we see the customers, we see the cash flow and we see the expenses. There are no secrets. So if you want to buy me out or vice versa, we can negotiate at arms length about the purchase price of the business. Now, let’s say that I am temporarily disabled and in the hospital for the equivalent of a business quarter. While in the hospital I ask you about the status of the business. You would have an affirmative duty of candor and a duty of loyalty to your business partner to report the state of the business accurately. If you misreported the financial condition of the business, that would be a breach of that duty and if I relied on that misrepresentation it could be a fraud if it induced me to sell to you at a price lower than I would have had I been in possession of the actual accurate information.
Of course all of that is at the partnership level. At the corporate level, the concept of the separate personhood of corporations from their shareholders exists. But I would suggest that this doesn’t change the moral equation one iota. Sure, shareholders and the corporate entities are considered ‘separate’ but let’s not forget that this is a LEGAL FICTION. Its the LEGAL FICTION of separate personhood and the person buying or selling shares based on inside information stands with you as a co-shareholder or as a future co-shareholder (usually the inside seller retains some position in the company being sold).
Of course a shareholder can only make a buying or selling decision based on the previously disclosed information. That information is typically given to shareholders on a quarterly basis though obviously corporations will often give shareholders guidance, update and other news impacting the company will impact whether people want to buy or sell stock.
However, the pertinent information is mostly the information that would ordinarily be disclosed after a reporting period but before that information is disclosed in the next reporting period giving the inside seller an advantage. He knows something that his co-shareholders, or future co-shareholders, don’t know.
But there’s the rub, as we can see in our previous example, the inside shareholder stands in the same position as a ‘partner’ with an affirmative duty to disclose pertinent business information to his business partners. The only thing muddying those waters is the fact that they are now ‘shareholders’ in a position where disclosing information to an ever-changing group of owners would be wholly impractical. So, the rule is that they don’t disclose the information ‘on demand’ because those demands would be happening daily and that would completely bog down the corporation from engaging in its business activities.
Morally, as a current shareholder, I can simply demand that my co-shareholders and the agents hired by them to control the corporation fully disclose the relevant financial conditions. I have a right to this information. Now, if I am buying into the corporation, I might not yet own shares, but that’s neither here nor there because I could buy one share to get my toe into the water, triggering the fiduciary duty to disclose.
Of course, statutory law creates brightline statutory duties to disclose which, if violated, can lead to criminal sanction. I would suggest the common law duties mirror the statutory duties are based on long standing contractual principles.
Pierre Lemieux
Nov 2 2019 at 9:11pm
@Craig: Thanks for the comments, which cover many of the standard objections to insider trading. Just a few points that seem crucial to me:
(1) It is not because something is immoral–or because somebody thinks something is immoral–that it should be illegal. Suppose you bought a Deli in the middle of nowhere on the rumor (or on your entrepreneur’s intuition) that a train station would be built nearby. Suppose you now decide to sell it, do you have to warn buyers that “I now think that there is going to be no development in the area until hell freezes over”? Suppose that you think that a reproduction of Monet owned by X is, in fact, the original, do you have to tell this to X from whom you are trying to buy it? An admittedly more difficult case: If you own a Monet but have come to think it is not an original, do you have to emphasize this when trying to sell it? Perhaps. Or nay you just remain silent as participants in financial markets, which are impersonal markets (outside of Leviathan’s intervention)? (Do you have to tell a woman you are courting of all your faults?) Perhaps the morality of remaining silent is more questionable in a personal transaction; but on impersonal markets, you should not be obliged to speak—indeed, you do not have to speak at all and, in many cases, there is nobody to listen anyway. Deep markets are impersonal and liquid: it’s a feature, not a bug.
(2) Morality often, if not always, depends on consent, that is, on agreement or contract (implicit or not). That is, by the way, the basis of economic philosophy and of most classical-liberal philosophy. Suppose that some businesses do not prohibit insider trading by their employees or executives. Everybody in the firm consents, because nobody is obliged to work there. Assume that investors are willing to pay a premium for the shares of companies that allow insider trading. (Of course, we can’t know if this assumption is correct until insider trading is decriminalized.) What’s wrong in having different prices for different sorts of shares? Liberty and the resulting diversity is the source of all innovation and progress.
(3) Not all information can ever be disclosed at the same second, not even “material” information, because it’s only with hindsight that it can be known what was material.
(4) Statutory law is not the same as the common law. Insider trading was a creation of statutory law, that is, lawmakers-made law.
Thaomas
Nov 3 2019 at 9:33am
Your thought experiments in I) depend on how the information about the non-original Manet or non-infrastructure were obtained.
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