The Problems with Bans on Insider Trading
By David Henderson
It is startling to note that at least five-sixths of all insider trading scenarios (it would be practically impossible to measure actual cases) could never be prosecuted, even with a policeman shadowing each and every insider. Why? Consider how inside information can affect the behavior of an insider. He or she can think the stock will appreciate and buy shares or think the stock will decline and sell shares. The insider can also decide not to sell or buy shares. Next, after this action or inaction, the share price can rise, fall, or stay the same. Even if the price rises or falls, it may match the market as a whole, complicating the picture.
This is from Charles L. Hooper, “Insider Trading Turned Inside Out,” one of the two Econlib Feature Articles for June.
After this paragraph, Charley goes on to explain how he gets his five-sixths number.
Not that this was planned, because the lead time for such articles is weeks or months, but the article comes at an opportune time. Late last week, the news was about a potential insider trading case involving golfer Phil Mickelson and investor Carl Icahn.
Consider the case where an insider trades ahead of a public news release. Before the insider buys, investors happily buy and sell at $100 per share. After the insider buys, investors happily buy and sell at the new higher price, say $101. When the news finally becomes public, the lucky ones realize they made $9 per share and the unlucky ones lost $9. The gains and losses were $9 per share instead of $10 without the insider.
The insider did not create the lottery and did not cause anyone to make or lose money. The insider merely took the existing lottery and reduced the magnitude of the losses and gains to the other participants. Those who blame the insider for causing some to lose money ignore two important points: (1) there are those who gain and their gains exactly offset the losses suffered by others; (2) people would have made more or lost more had the insider not acted. In effect, those who blame the insider find fault in the fact that the insider didn’t do more to dampen the stock market lottery. To be consistent, they should blame the insider for not shouting the information from rooftops.
Read the whole thing.