It seems perfectly natural and innocuous that those with the most information would want to profit from it, and doing so isn’t illegal anywhere else. So why is it prohibited to make trades based on information not everyone has? What undesirable thing does this prevent?
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Insider trading makes the stock market unfair. Those with insider knowledge will always be able to take advantage of those without insider knowledge.
Imagine if you could play poker against someone and the rules were that they could see your cards but you could not see their cards. You would know you could not win and would not play.
So if insider trading were legal, no outside investors would invest in the stock market because it would be rigged against them. So there would be no stock market.
Not a lawyer…
Insiders have fiduciary duty to the company. This means they are required to put the company’s interest above their personal interest in various matters, including trading. Trading on insider information violates this, as it profits the insider above the other shareholders without this information.
Note they are still allowed to trade, but they are subject to some rules (including reporting).
Note also insider trading isn’t just limited to insiders, so based on these grounds the law covers scenarios where material non public information is held by non-insiders.
it gives individuals with access to confidential information an unfair financial advantage over other market participants. By using inside information they profit from trades that would not be profitable for ordinary investors without such access. This creates an uneven playing field and can have a detrimental effect on market integrity, which adversely impacts all investors.
So as others have said, insider trading does do harm to people. Profittinh off inside information is generally considered unethical, and we DO make it illegal in a lot of other cases.
Cars for one. Almost all states have lemon laws, and generally, if I sell you a car without disclosing something thag I known is an issue, I will be liable.
Proper disclosures are also required in house sales, and even labellong on packages has standards and cannot be knowingly false.
BUT allowing all insider trading would actually be WORSE than what most people are saying. What we have now are markets where very few people have good inside information, but most people have relatively little secret information.
This means that the biggest problem is that someone loses when an insider trades.
But, if you make insider trading legal, we can imagine a situation where almost all traders are people with inside information. Luckily, there is A LOT of research and quite a few models that predict what this would look like, but here is the ELI5:
Imagine you and I are betting on coin flips. I get to flip a coin and observe the outcome. You do not get to see whether it is heads or tails.
Once the coin is flipped (and after I know the result), I will bet you that it is heads or tails.
Would you ever take the bet? OF COURSE NOT! It is not a fair bet. You will never win. So what happens?
We just don’t bet.
The same thing happens in stock markets when they are all insiders trading. No one actually trades, because chances are the other party knows more than you do. If you are not an insider, the best strategy is not to play.
This is fine if we are gambling on coinflips, but it is an issue for a company that is trying to raise money. If the insiders already had enough money, they would not need to sell stock publically. But allowing rampant insider trading means that you wont be able to sell your stock at all.
Insider trading pretty rampantly breaks down markets in a lot of different ways.
it gives individuals with access to confidential information an unfair financial advantage over other market participants. By using inside information they profit from trades that would not be profitable for ordinary investors without such access. This creates an uneven playing field and can have a detrimental effect on market integrity, which adversely impacts all investors.
it gives individuals with access to confidential information an unfair financial advantage over other market participants. By using inside information they profit from trades that would not be profitable for ordinary investors without such access. This creates an uneven playing field and can have a detrimental effect on market integrity, which adversely impacts all investors.
When you buy a stock, you are literally buying it, from someone else. When you sell it, you are selling it to someone else.
Insiders have knowledge and are often involved in the decisions that make a stock worth more or less. Using that knowledge they can take advantage of people.
An analogy should make it easier to understand. Imagine, for instance, that a politician knew he was going to order a railroad to go through a specific neighborhood – but he owns a house there that is going to become worthless. So one day, he goes to your sweet retired grandmother and sells her the house for $100k. Then the next day he announces the railway and your grandmother now owns a worthless house. For all intents and purposes, he stole $100k from your granny. Does that seem honest and fair?
It is not however, only the unfairness which is at issue. Our politician could, on day three, realize he just made $100k, and decide to do it again – and eventually, instead of trying to run things well and efficiently, he is trying to run things to milk little old ladies out of their savings.
The point is – for the economy to work, we need business to try to make profits by being more efficient, more productive or more creative. We don’t want all their energy spent trying to trick stockholders into paying too much for stock – that will just make us all poorer.
So as others have said, insider trading does do harm to people. Profittinh off inside information is generally considered unethical, and we DO make it illegal in a lot of other cases.
Cars for one. Almost all states have lemon laws, and generally, if I sell you a car without disclosing something thag I known is an issue, I will be liable.
Proper disclosures are also required in house sales, and even labellong on packages has standards and cannot be knowingly false.
BUT allowing all insider trading would actually be WORSE than what most people are saying. What we have now are markets where very few people have good inside information, but most people have relatively little secret information.
This means that the biggest problem is that someone loses when an insider trades.
But, if you make insider trading legal, we can imagine a situation where almost all traders are people with inside information. Luckily, there is A LOT of research and quite a few models that predict what this would look like, but here is the ELI5:
Imagine you and I are betting on coin flips. I get to flip a coin and observe the outcome. You do not get to see whether it is heads or tails.
Once the coin is flipped (and after I know the result), I will bet you that it is heads or tails.
Would you ever take the bet? OF COURSE NOT! It is not a fair bet. You will never win. So what happens?
We just don’t bet.
The same thing happens in stock markets when they are all insiders trading. No one actually trades, because chances are the other party knows more than you do. If you are not an insider, the best strategy is not to play.
This is fine if we are gambling on coinflips, but it is an issue for a company that is trying to raise money. If the insiders already had enough money, they would not need to sell stock publically. But allowing rampant insider trading means that you wont be able to sell your stock at all.
Insider trading pretty rampantly breaks down markets in a lot of different ways.
So as others have said, insider trading does do harm to people. Profittinh off inside information is generally considered unethical, and we DO make it illegal in a lot of other cases.
Cars for one. Almost all states have lemon laws, and generally, if I sell you a car without disclosing something thag I known is an issue, I will be liable.
Proper disclosures are also required in house sales, and even labellong on packages has standards and cannot be knowingly false.
BUT allowing all insider trading would actually be WORSE than what most people are saying. What we have now are markets where very few people have good inside information, but most people have relatively little secret information.
This means that the biggest problem is that someone loses when an insider trades.
But, if you make insider trading legal, we can imagine a situation where almost all traders are people with inside information. Luckily, there is A LOT of research and quite a few models that predict what this would look like, but here is the ELI5:
Imagine you and I are betting on coin flips. I get to flip a coin and observe the outcome. You do not get to see whether it is heads or tails.
Once the coin is flipped (and after I know the result), I will bet you that it is heads or tails.
Would you ever take the bet? OF COURSE NOT! It is not a fair bet. You will never win. So what happens?
We just don’t bet.
The same thing happens in stock markets when they are all insiders trading. No one actually trades, because chances are the other party knows more than you do. If you are not an insider, the best strategy is not to play.
This is fine if we are gambling on coinflips, but it is an issue for a company that is trying to raise money. If the insiders already had enough money, they would not need to sell stock publically. But allowing rampant insider trading means that you wont be able to sell your stock at all.
Insider trading pretty rampantly breaks down markets in a lot of different ways.
You have some specific knowledge available to you that is not published or available to the masses. Because of some privileged relationship, you have access to knowledge resulting in future gains or losses that give yourself a financial advantage.
This cheats the invested company and fellow shareholders.
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