Why is Insider Trading Illegal?

The meme of the day, as admirably summed up by Paul Murphy, is the question of why exactly insider trading is illegal, and whether it should be. I seem to recall a trenchant column by Holman Jenkins in the WSJ around the time of the Martha Stewart case arguing that it shouldn’t be, but I can’t find it right now, partly because the WSJ keeps on telling me that "search is momentarily unavailable".

One thing which gets missed in much of the debate is the difference between a civil and a criminal offense. Some companies, and their shareholders, might conceivably want their employees to be able to trade on insider information, goes the argument – and if that’s the case, then who are the authorities to come swooping in and telling them that they can’t? Similarly, if a company doesn’t want its employees behaving in such a manner, it can contractually oblige them not to, and sue them if they do.

But if we were to move in that direction, no one would ever go to jail for insider trading, and the downside would be limited even when such activity were explicitly and contractually banned. Plus, private companies generally don’t have the resources to uncover insider trading, while regulators do.

I do think it’s important for insider traders to go to jail, if the practice is to be discouraged. Should the practice be discouraged? I think so, yes. One of the engines of stock-market liquidity is the pretense that everybody is on a level playing field. Generally speaking, nations of shareholders have reasonably vibrant economies compared to nations of bondholders. If you want a nation of shareholders, you need to give individuals some faith that they won’t get picked off like so many fish at a poker table. And one way to do that is by making insider dealing illegal.

I do appreciate this is a relatively weak argument, and if insider trading wasn’t illegal I’m not sure I’d be agitating for it to be added to the statute books. What’s more, the Brazilian stock market seems to be doing just fine without any level-playing-field fiction. But it would be nice if there were some compelling economic reason to make insider trading illegal; without it, one feels that the law is overreaching just a little.

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1 Response to Why is Insider Trading Illegal?

  1. Pingback: Insider trading makes us richer, better informed, and could prevent corporate scandals. Legalize it.

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