We got a lot of heat today on our claim that the prosecution of Raj Rajaratnam is a waste of time.
Readers seem convinced that somehow ordinary investors are being hurt by insider trading. We just don’t see it. So maybe you can help us out. In the comments section below, we invite you to propose ways that ordinary investors suffer actual losses because of insider trading. We’ll promote the best answers to their very own post.
Keep in mind that we’ve already refuted quite a few of the arguments people tend to make in favour of criminalizing insider trading.
Buyers are hurt because insider trading buyers push up prices. That’s true but diversified investors are as likely to be sellers as buyers in insider trades, so it ends up breaking even.
Sellers are induced to sell too low because they don’t have the inside scoop. If anything, sellers are helped by insiders willing to buy their shares at the price the sellers are demanding. If the insiders are the only buyers at that price, then the seller would have been forced to sell at a lower price or hold a stock he wanted to sell.
Fewer investors will buy individual stocks if they are worried about insider trading. Ordinary investors tend to lose out when they try to pick stocks. They’re actually benefitting if they avoid stock picking in favour of broad diversification and index funds.
Less money will come into stock markets if people are worried about insider trading. This probably isn’t true. Insider trading leads to better pricing, which means that investors can be more confident in prices rather than less. Surprising quarterly results, for instance, will create less volatility in a market where insiders have been trading the stock.
Insider trading means that ordinary investors are disadvantaged when it comes to the pros. Unfortunately, this is the case regardless of insider trading regulations. People who are professionally dealing with stocks will always have a leg up on the investor who holds down a job and invests his money on the side.
Insider trading damages transparency and trust in the markets. Much of the trust that ordinary investors place in the fairness and transparency of the markets is misplaced. What’s more, whatever costs may come from increased fears and investor caution are likely to be made up for by increased market efficiency.
I would never have sold if I’d known what the other guy knew. So what? This is a claim that you are entitled to all the information everyone else in the market has. But there’s no justification for this claim. The market exists, in part, because different people have different kinds of information and different opinions about what that information means.
Insiders cheat outsiders when they trade on non-public information. Insiders almost never induce outsiders to sell. In a liquid market for securities, sellers typically have no contact with buyers. This means that they are selling without regard to who is buying or what information the buyer might have. No one is lying to anyone else because no one is explaining why they are buying or selling a stock. It’s not like selling a car with a broken chasis and telling the buyer you just decided to walk more often.
Insider trading permits someone to talk down a stock while secretly buying it up in advance of good news. This might be possible but it is very hard to execute. In the first place, actual buying activity is more influential than rumours. More importantly, this is just stock manipulation which is illegal regardless of whether it is done through insider trading.
Based on the furious comments on our earlier posts, however, we assume some of you have much better arguments than the ones put forth above. So go ahead, show us why we’re idiots on this subject.