Saturday, October 17, 2009

Should Insider Trading be Illegal?

In a case announced yesterday,

federal authorities exposed what they claim is the biggest insider-trading ring in a generation -- a conspiracy in which a hedge-fund kingpin and executives at blue-chip firms including IBM and Intel allegedly connived to profit on Google and other big-name stocks.

I take no stand on whether the individuals accused in this case broke existing law; if so, the feds should prosecute them.

But it is not obvious that insider trading should be illegal.

The main argument for a ban is that it protects outsiders from being taken advantage of by insiders. Perhaps, but in a world with no ban, outsiders would be more careful about trading with insiders, so the net impact on who gains and loses from inside information might be modest.

More importantly, insider trading means that information about a company's prospects become incorporated in its stock price sooner rather than later; this is a good thing.

Insider trading can act as a check on malfeasance within a company; insiders who know the books are being cooked, for example, can start dumping their stock, alerting the market that something is up.

In a world with no ban, small investors might fear to trade individual stocks and would face a greater incentive to diversify; that is also a good thing.

On top of all this, consistent enforcement of the ban is close to impossible. Authorities catch a tiny fraction of violations, so honest insiders obey and dishonest insiders still profit.

So, my strong hunch is that the ban does more harm than good.

9 comments:

Arnie Kriegbaum said...

Amen. Only insiders really want the current level of non-insider trading enforcement. So, I induce that they stand to gain the most from the current system.

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