Capitalism and Financial Scandal

July 23, 2002 -- The recent furor over accusations of insider trading by high-profile shareholders of ImClone Systems has been touted as yet another example of corporate fraud, heralded by the collapse of Enron in December last year. These allegations led to the arrest of ImClone’s ex-CEO Sam Waksal and have shrouded Martha Stewart’s activities in doubt. They have also elicited the usual demand for stricter government regulation of corporate functioning.

It is another rallying point for the voices that routinely decry big business and capitalism and clamor for the government’s protection from them. President Bush has already acquiesced to such demands for action and has promised steps to strengthen the Securities and Exchange Commission. There is also talk of creating an accounting industry Oversight Board (effectively expanding government regulation of the accounting industry).

But while outright fraud does require investigation, the present situation does not demonstrate the failure of the free market, nor is it a reason to enact more laws. Today’s corporate scandals, whether insider trading or auditing irregularities, are not caused by a lack of regulatory laws, or by the capitalist features of the economic system. They are caused by irresponsible individuals who should be tried under criminal laws that already exist.

Methods of self-regulation in the stock exchange are already in place, and it is because of them that these scandals have come to light as fast as they have. ImClone’s supposedly questionable activities were detected as early as January, barely a few weeks after they occurred. There are mechanisms that check for suspicious activity by tracking price and volume movements in the stock exchange. Most brokerage firms are careful when dealing with clients that buy or sell their own stock because they cannot afford to have their reputations tarnished by suspicious deals.

As more and more cases of accounting fraud have come to light, the market has begun to place a high premium on the accuracy of auditing and financial records. Ultimately, as long as the market is free to exercise its judgment, the onus will lie on firms to make their accounts transparent, and convince a skeptical public of their honesty. As transparency becomes a valued asset, companies will automatically rush to show that their activities are above-board. Already some firms have taken the initiative of assuring their shareholders of the accuracy of their records. The problem is being solved, as usually happens when private initiative is allowed to chart its way without government interference.

This type of self-regulation is more effective than government imposed-regulation. Governmental regulations only serve to downplay the importance of reputation as an asset in the market. They establish minimum rules that could well be circumvented by corrupt alternatives that are inevitable when government monitors business. There are always ways for dishonest individuals to find loopholes in laws.

America is not a fully capitalist country, but elements of free enterprise are still strong. Free markets remain the only truly just and progressive economic organization as they are based on trade, individual liberty, and initiative. Capitalism honors individual rights and recognizes the rationale behind them. By keeping government out of private business, free markets ensure competitiveness, innovation, integrity, and justice. There is more effective tracking of suspicious activities in a capitalist economy—by competitors, by the media, and by the market. Justice is delivered by the market instead of government threats—watch how difficult it will be for any of the disgraced companies to regain credibility after this blow. Stockholders will make them pay dearly for their dishonesty.

Capitalism does not breed corruption. Errant individuals become corrupt; “the system” does not make them so. There is nothing the government can do to prevent corruption that the market cannot do. The problem does not lie with the capitalist aspects of the economy—but the solution does.

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