NCPA - National Center for Policy Analysis

In Defense of Insider Stock Trading

March 17, 2003

In 1961, the Securities and Exchange Commission decreed that corporate insiders either disclose information they were privy to or abstain from trading in their corporation's stock. That directive received judicial sanction in 1968 and Congress subsequently fell into line.

But now some economists and scholars have begun to question this prohibition and even find value in the forbidden practice. They argue:

  • Insider trading does little or no direct harm to any individual trading in the market -- even when an insider is on the other side of the trades.
  • Aside from cases of fraud, insider trading helps move the price of a corporation's shares to its "correct" level -- thereby making for an "efficient" stock market.
  • That it is an efficient and highly desirable form of incentive compensation -- especially for corporations dependent on innovation and new developments.

The last argument has come to the fore recently with the spate of scandals involving stock options -- which are the closest substitute for insider trading, but which suffer many disadvantages.

Managers and shareholders of large, publicly-held corporations have a strong common interest in the accurate pricing of the company's shares. If that is not reliable, investors will demand a higher return in order to be compensated for assuming this added risk. So the shares of a company with reliable pricing of its shares will sell for more than otherwise identical shares.

Source: Henry G. Manne (George Mason University), "The Case for Insider Trading," Wall Street Journal, March 17, 2003.


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