Legalize Insider Trading

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Wednesday, July 22, 2020


The foundational characteristic of the American equities market, the stock market, is asymmetric information: being able to see the long term or greater value in something that is not presently included in its valuation by the calculation of the analytical beholder. Pursuing the prospect of finding an investment strategy that is undervalued, either long or short, is what drives investors to purchase equities on American stock exchanges. They do not buy stocks because they think they are getting something of exactly equal value to the cash they pay. After all, that would be the pointless sacrifice of liquidity and, likely, a percentage of capital.

Investors buy stocks because they believe they have an augmentation in their analytical process that enables them to see the value that others do not at a given instance. They will go to great lengths to do this. Many investors spend thousands of hours reading financials and news about different companies and their affiliates, searching for valuable information regarding the financial opportunity. More employ experts to find these opportunities for them. Finally, individuals even pay hundreds of thousands of dollars to academic institutions that carefully curate admittance and subsequently provide specialized kinds of asymmetric information to customers over time, educating them regarding the best ways to find value in equities. These opportunities for exposure to this valuable information are not universal; mostly they are reserved for those with either the intellect to merit exposure or the financial means to acquire that exposure.

Financial education, combined with the tools to employ that education, is the best advantage anyone could get in the market. Generally, few individuals pursue pecuniary pedagogy to the point where they can be maximally effective. Those possessing financial education have access to information that few individuals have access to, and they use it to influence their investing. This particular kind of scarce information has been arbitrarily declared permissible for use by the United States federal government. 

It is only illegal to use information about significant confidential corporate developments because disproportionate exposure is inevitable. The foundations of equities markets are rooted in the prediction of profitability based on asymmetric information distributions. Informational asymmetry both legal and non-legal can be and often is the result of chance. So why punish profiteering from chance asymmetrically?

 For instance, take two traders, one of whom comes from humble means and the other does not, both hardworking and well-intentioned. The individual with greater means uses his money to procure a Bloomberg terminal and services subscription for a year. With his education and his Bloomberg subscription, the rich guy sees above-market returns. Say the other individual is matching market returns until overhearing inside information from executives in a coffee shop, subsequently uses the inside information to clear an equivalent return to the first individual. Why should one individual be punished for capitalizing upon his windfall gain?

 The argument for the illegality of insider trading is that it gives the insider an unfair advantage over other investors and does a disservice to their employer by putting their interests above the firm’s (and their investors’). 

Every individual puts their interest above their employer’s. If an employer wants to structure their firm to prevent steering it for the sole purpose of employee enrichment, they are free to do so, but it should not be legally mandated. Insiders instantly inputting the information into the market indirectly through trading does not do any disservice to investors. Not trading on material information to prevent the flow of information to investors is manipulative of investor behaviors and therefore of the market itself.

Unfair advantage is not sufficient reason to forbid insider trading either, given it is not sufficient regarding the prevention of capitalization upon a whole slew of other advantages that are “unfair” in terms of their distribution. Regulators cannot adequately police the fairness of windfall gains or losses, and aspiring to do so exposes the belief that these instances are always zero-sum, that there is an equal amount of corresponding loss wherever there is windfall gain. This is unreasonable since the adaptation to the skills and weaknesses of an individual or firm is what permits specialization and trade, the main catalyst for all western progress and innovation, beyond western enlightenment philosophy of course. This progress has objectively improved the quality of life of everyone living today. 

Arbitrarily inhibiting the use of a specific kind of asymmetric information only reduces the efficiency with which the market allocates capital in the short run, which generates an unknown deadweight loss in the long run regarding prosperity and innovation. This deadweight loss, like any, is disproportionately burdensome to the less fortunate.

The views expressed in this article are the opinion of the author and do not necessarily reflect those of Lone Conservative staff.


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