January 14, 2004

The Fraud of Insider-Trading Law

A couple of articles on Insider Trading by Sheldon Richman : first part is an analysis of the Martha Stewart case . Second part is a broader look at the concept of Insider Trading .

Is Insider Trading good? Or bad? Here's some personal comments...

It's a tricky question. On the face of it, Insider Trading is a straight out-and-out fraud. An insider has internal information that will - in the insider's opinion - cause the stock price to move. So, she buys or sells ahead of the move, and takes the profits.

This is a straight fraud because it takes money from the shareholder base. The shareholders are poorer because they did not enjoy the benefits of the change in price. Of course, this assumes that an insider cannot also be a shareholder, and therein lies the conflict of interest: an insider has a fiduciary duty to shareholders, which may be breached if acting on the basis of own shareholdings.

However, the real issue that is at the heart of this fraud is that, economically, it's pretty nigh on impossible to detect and prosecute. In practical terms, the information is a) in the heads of the insiders, b) subject to misinformation constraints as much as any market noise, and c) hard to determine as being "inside" or "outside" some magic circle.

Thus in purely transaction cost terms, making Insider Trading illegal is a very difficult sell. It's a bit like the Music intellectual property debate: songs became property when records were invented, because it was now possible to control their sales by following the shellac and the pianola rolls and sheet music. Of course it took a few decades for this to shake out.

Songs lost their property characteristics with the invention of the personal MP3 player, and we are into the first decade of shaking out right now....

Posted by iang at January 14, 2004 02:00 PM | TrackBack