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I can't see any economic argument for banning insider trading. In general, the point of allowing financial securities to be traded is to ensure that they are properly valued. "Insiders" seem better informed about the proper value of these securities than "outsiders". In few other realms do we ban people who are knowledgeable about a subject from trading items relating to that subject.

Apparently the primary motivation for the ban is a sense that it's "unfair" for insiders to profit from information that other people don't have access to, but I don't understand this normative argument. We don't think that it's unfair for doctors to profit from their specialized medical knowledge - or for that matter, for successful CEOs to profit from their industry expertise by receiving high salaries (as opposed to making well-timed stock trades). A potential investment advantage from access to "inside" information seems like just another form of indirect compensation, which will be priced into the wage market and (all else equal) lower the nominal salary just like all non-cash benefits.

I'm not trying to make some point of libertarian principle or start a philosophical argument. Nor am I assuming that there's some heavy onus on the government to justify any economic regulation. I'm simply looking for a value-neutral summary of the argument for banning insider trading, since I've never heard such an argument.

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  • $\begingroup$ You cannot make the comparison between the insider and a doctor, because the circumstances are not the same. All insider information about a company is proprietary information owned by the shareholders, which is not his (the insiders) to sell - which is basically what he does if he buys stocks based on that information. Also you have the whole issue around agent/principal problem. $\endgroup$ – ssn Aug 15 '18 at 15:36
  • $\begingroup$ @ssn What if the insider is a shareholder, which is almost always the case? Then he owns the information according to your argument. Also, isn't the entire point of firms' keeping certain information from publicly availability in the first place that the "insiders" can profit off it? $\endgroup$ – tparker Aug 15 '18 at 16:30
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    $\begingroup$ Yes he owns part of that information - but not alone, he shares the ownership with all other shareholders. Because of his employment he has been empowered with the “privilege” of knowing insider information, and he is being paid to keep those to himself (through his salary); his employment is not a ticket to profit further for himself, but for the shareholders as a group. And no, it is never for the insiders to profit for it, it is for the shareholders (owners). The only profit the insider should make is is salary/compensation. $\endgroup$ – ssn Aug 15 '18 at 18:45
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One argument is that it creates a sort of moral hazard: An insider may take (potentially harmful) actions so as to create fluctuations in the share price and profit from such fluctuations.

  • His actions may be harmful to the firm and to society.

Example. Suppose a scientist working at a pharmaceutical company on a cure for cancer. All indications are that the cure is likely to work and so the company's share price is very high. The scientist could then deliberately sabotage the work and short-sell the firm's stock.

  • If the share price fluctuations serve no purpose other than to enrich the insider, then these fluctuations are harmful insofar as volatility and uncertainty are harmful.

But you are not alone in your doubts. See e.g. EconLib for more arguments both for and against regulating insider trading.

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