The Concise Guide To Economics
by Jim Cox
15. Heroic Insider Trading
Insider trading--making profits in financial markets from knowledge not available to the general public--has been a universally scorned activity of late. But what is the nature of this alleged crime? Making financial gain on superior knowledge is exactly what the stock market is all about.
In fact, this is what all business activity is about. Doesn't Delta make a success of its airline business because it knows better than others how to run an airline? Doesn't Coca-Cola make a success of its soft drink business because it knows the ins and outs of production, distribution, marketing and consumer demand better than other establishments? Certainly, Delta and Coca-Cola don't reveal to competitors their insider's knowledge of their businesses.
But beyond the universal nature of insider trading what are its effects on the stock market?
Let's say Investor A has knowledge that Acme is about to be bought by Ajax and therefore buys Investor B's stock at the current price of $20. The takeover occurs, and the price shoots up to $40. Investor B would have sold the stock anyway, whether Investor A had his knowledge or not. But, somehow in inside-trader-hater logic, ignorant but lucky Investor C, the one who would have made the purchase from Investor B if Investor A had no superior knowledge to act on, could have legitimately been the one to make the quick $20 profit.
But we must ask: Why is C's ignorance a legitimate means of earning profits but A's knowledge an illegitimate one? This boils down to scorning the knowledgeable for being knowledgeable and elevating the ignorant for being ignorant--hardly a desirable trait for social well-being.
Besides, the very act of making stock purchases on insider trading helps to reveal to the world, through the higher stock prices, that these stocks are currently undervalued. Thus, economic information is actually spread through markets more quickly when insider trading occurs than when it is effectively outlawed. And every economic theory I'm aware of says more information sooner is better than less information later.
There's a rule of thumb popular among investment advisors which says the amateur investor should not buy individual stocks because individual stock investing is a full-time job; likewise one should realize when undertaking stock investments that there are bound to be people with more knowledge than he has about the prospects of future stock values.
Insider trading is a victimless crime, and its prohibition should be viewed as nothing more than a welfare program for S.E.C. lawyers. This becomes all the more obvious when it is realized that "insider trading" is not even defined in the laws. It is in fact so vague that it could be used against virtually any investor.
The one legitimately-wrong kind of inside trading is where someone uses "inside" knowledge in violation of a contract or explicit trust. In such cases, civil law ought to apply, with damages to those wronged, rather than criminal law with fines to the U.S. Treasury.
"OK," you may be thinking "there really isn't anything so evil about insider trading, and all of the recent legal activity is no better than a witch hunt, but why call them heroes?"
Well as stated (in regard to other alleged scoundrels) in Walter Block's, Defending the Undefendable:
...others are generally allowed to go about their business unmolested, and indeed earn respect and prestige, but not so these scapegoats; for not only are their economic services unrecognized, but they face the universal bile and wrath of virtually all, plus the additional restrictions and prohibitions of governments. They are heroes indeed; made so by their unjust treatment at the hands of society." Foreword
Further, since they act on a legitimate, but unacknowledged right, they help secure the liberties of all, while more timid souls shrink from the battle. Inside traders should be granted the respect they truly do deserve.