Is insider trading really a crime?
Insider trading is in the spotlight again, following Raj Rajaratnam's conviction last week. Is the government crackdown on insider trading an interference with beneficial economic activity?
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The $5,000 wasn't taken from the people who sold the shares to the trader. They were trying to sell anyway, and would have sold it to somebody else had the trader not entered the market. In fact, by snatching the 1,000 shares at the current price of $10, the trader's demand may have held the price higher than it otherwise would have been. In other words, had the trader not entered the market, the people trying to sell 1,000 shares may have had to settle for, say, $9.75 per share rather than the $10.00 they actually received. So we see that the people dumping their stock either were not hurt or actually benefited from the action of the trader.
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The people who held the stock beforehand, and retained it throughout the trader's speculative activities, were not directly affected either. Once the news became public, the stock went to its new level. Their wealth wasn't influenced by the inside trader.
In fact, the only people who demonstrably lost out were those who were trying to buy shares of the stock just when the trader did so, before the news became public. By entering the market and acquiring 1,000 shares (temporarily), the trader either reduced the number of Acme shares other potential buyers acquired, or he forced them to pay a higher price than they otherwise would have. When the news then hit and the share prices jumped, this meant that this select group (who also acquired new shares of Acme in the short interval in question) made less total profit than they otherwise would have.
Once we cast things in this light, it's not so obvious that our trader has committed a horrible deed. He didn't bilk "the public"; he merely used his superior knowledge to wrest some of the potential gains that otherwise would have accrued as dumb luck to a small group of other investors.
To repeat, stock-market speculation is not a zero-sum activity. Even though we can look at any particular transaction and tally up the "winners" and "losers," the presence of speculators enhances the overall functioning of the stock market. For example, the market for any particular security is more liquid when there are rich speculators who will quickly pounce on a perceived mistake in pricing. If an institutional investor (such as a firm managing pensions) suddenly has a cash crunch and needs to dump its holdings, speculators will swoop in and put a floor under the fire-sale price. This is good for the beleaguered pension fund, and for the stock market in general.
Laws against Insider Trading Give the Government Arbitrary Power
Crackdowns on insider trading are harmful because they chill the cultivation of superior knowledge and speculative correction of market prices. Beyond this loss of general economic efficiency, insider-trading laws are insidious because of the arbitrary power they give to government officials.
In the specific case of Rajaratnam, prosecutors for the first time relied extensively on wiretaps to prove their allegations of insider trading. Legal experts predict that the government will expand its eavesdropping on the financial community in light of this courtroom "success."
More generally, Murray Rothbard argued that every firm on Wall Street is technically engaging in "insider trading." If they literally relied only on information that was available to the public, how could they make any money? Thus, the government has the statutory authority to harass or even shut down anybody in the financial sector who doesn't play ball. In Making Economic Sense, Rothbard declared,
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