I would refer you this article by Jeff Matthews explaining why.

http://jeffmatthewsisnotmakingthisup.blogspot.com/2009/10/how-to-solve-crime-let-criminals-decide.html

While I agree with Don that it is impossible to police insider trading, legalizing insider trading would create a very large loophole for a management teams to benefit greatly at the expense of their employees and company shareholders.

What do you suppose the economic waste would be if a CEO “earns” a 500m dollars from investors by manipulating non-public market information, consequently letting go 40% of their workforce or bankrupting the company?

I find the economic argument compelling, but there’s a moral element that I don’t think economists can address.

Naturally this was bad. It was bad for the stock holders, bad for the companies, bad for the states who held the charters to the companies, and it was only good for corrupt managers, CEOs and boards. The Modern Corporation and Private Property by Adolph Berle explained how stock holders no longer have any control over their own corporations, way back in 1932, and things indeed have changed, CEO’s have much more power now.

So what was the point of the rule against insider trading, I mean historically? The point is that current regulations back in 1935 had no way to punish corrupt managers. None. A CEO could pump and dump his corporate stock, buy and sell until he personally had all the wealth that the company used to have, and then it’s all IBG, “I’ll Be Gone” and there wasn’t a law that could touch him. The reasons for this is that when insider trading is legal it’s impossible to tell the difference between a bad manager and a corrupt manager.

That is why the insider trading laws were passed. Without the ability to nail corrupt CEO’s due to insider trading corrupt CEO’s will never ever be caught. Is that what we want? For CEO’s to destroy their very companies in order to make quick buck and leave a ruined husk, and never be punished?

You can’t count on the good nature of mankind for them to be decent human beings. We do need laws for that you know.

In the fantasy world that boudreaux seems to live in, the shareholders have the ability to fire corrupt managers. In the real world, where I live, we only find out that a CEO is corrupt after a company has been bankrupted, and even then the CEO leaves with all the money.

There is one reason and one reason only that CEO’s do not do this all the time, and that is because of the insider trading laws, which would put them in jail. Without that, the entire system would come crumbling down as CEO’s sucked dry the husks of our corporation in the pursuit of personal profits.

“At bottom all insider trading robs information from the rightful owners for the personal gain of the employee insider.”

“Professor Boudreaux’s failure to protect the ownership rights of shareholders is a significant and substantive failure on the part of one who otherwise champions individual rights and freedoms.”

A more detailed post is at: http://redst8r.wordpress.com/2009/10/25/insider-trading-hooey/

But you want to ignore this fact. It is you who is lacking coherence of thought preferring ideology over reality. If communism failed over the course of a century we just saw free market capitalism self destruct in less then 30 year. Yet the true believers push on.

I speak of Congressional insider trading done with impunity and perfectly legal for them, but criminal for you, me and Raj, et. al.

It is a bad joke to talk about insider trading in any form without making an issue of that.

“All of which seems perfectly plausible, but for the inconvenient fact that a given security represents only a particular combination of expected return and systematic risk, for which there is a vast number of substitutes. The correct measure for the supply of securities thus is not simply the total of the firm’s outstanding securities, but the vastly larger number of securities with a similar combination of risk and return. Accordingly, the supply/demand effect of a relatively small number of insider trades should not have a significant price effect. Over the portion of the curve observed by individual traders, the demand curve should be flat rather than downward sloping.”

————-

An interesting opposing view. I think the core difference of opinion b/w Profs. Boudreau and Bainbridge come down to whether individual stocks are close substitutes — i.e., Prof. Bainbridge suggests that I might be just as happy with stock in ACME, Inc. as Zenith, Inc.

Maybe I’m an odd duck of an investor, but my preference in stock is very idiosyncratic. I don’t buy a share unless I understand the business very well and feel comfortable with that specific company’s business model and ability to execute. For example, I don’t see DO and RIG (two oil drillers that are often discussed as competitors), as being close substitutes.

I suppose Prof. Bainbridge would say that my voice is drowned out by the millions of day traders, but I don’t think so. They’re a constant baseline of noise –albeit liquidity-providing noise — spread across the spectrum of stocks. Just as many sales as buys (tautology intended). The marginal difference in demand over a long enough run (i.e., weeks, not seconds or minutes) are professional investors and individuals like me. Or so I think.

As Don points out, for a frequent trader, deciding not to trade right now based on private information is as important as deciding to trade, and yet is impossible to detect.

But even more ridiculous, if information wasn’t distributed unevenly, the stock market would have no function at all. Its very purpose is the buying and selling of information. If the only information that could be traded was that which was already available to everyone, all prices would be permanently zero, and no one would show up to trade.

In reality, there would still be fluctuations because there are some things that no one can predict; so some people would still win more due to pure dumb, ignorant luck. Perhaps that would be “fairer”!

Compare with laws regulating pure gambling – it’s illegal to know too much about which horse is going to win, but the ideal is that everyone knows nothing, so it’s pure luck and everyone has fun.

But investment isn’t a game; it’s important. Does the government really want it to only be about gambling on the unknown?

Therefore I would go further: the only useful, meaningful, functional kind of trading is trading on information with restricted availability, and hence is a form of insider trading.

It’d be akin to young Bert driving a quality secondhand car he bought at a private sale. If Bert shows it offs to Phil and Phil complains:

“No fair! I didn’t hear about! If I had have heard of the deal I would have jumped at the chance but I didn’t see the car being advertised in the local classifieds.”

“Yeah well it wasn’t exactly an open sale – the seller was my uncle Kurt. He wanted to sell this perfectly roadworthy car basically as a trade-in because he wants to buy a new car. The deal was struck at my cousin’s Gert birthday party.”

“That’s bullcrap! He should been obliged to put an ad in the classifieds so everyone gets a chance at such a deal.”

“I beg to differ – it was inside family deal.”

“That’s unfair! Inside trading sucks!”

“Whatever.”

However will companies be better off private? It is said that since public companies have disinterested shareholders they risk long-term growth failure by pandering to the short-term interests of the shareholders. Doesn’t that sound similar to Hoppe’s criticism of Democracy?

Yeah, I concur – be hardcore, use the term ‘legalise’!

I’ts good to see the best writer on political economy today get his due, even if only once in a while.