Insider trading was first outlawed in the United States by the Securities and Exchange Act of 1934. The major motivation for the ban was to increase the public'

Insider trading was first outlawed in the United States by the Securities and Exchange Act of 1934. The major motivation for the ban was to increase the public's confidence that they could invest in financial securities without being taken to the cleaners by insiders who had a major informational advantage. [0] Economic theory does lend some support for the idea that markets will perform better when the public is confident enough to participate in them broadly, and broad participation should drive valuations higher. (The latter is a dubious benefit.) But there is likewise plenty of theoretical justification for the harm done to markets by insider-trading laws. Markets are basically mechanisms for aggregating and analyzing information, and insider trading laws restrict the supply of basic facts. Mispricing ensues. There are other justifications for banning insider trading, albeit all rationalizations post facto, as far as the legal history goes. Allowing a manager to trade her company's shares (particularly to short them) can put her incentives out of step with those of the company's other shareholders. But the managerial misbehavior that could provoke is already illegal under various other regimes. And the principal-agent problem is no argument at all for setting up a system like we have, one which bans trading by knowledgeable people who are in no position to influence corporate decisions. But the economics are almost beside the point. The promise made by insider trading laws is that any Joe Schmoe can trade on the same footing as sophisticated professional investors, and that promise is a farce. It's a farce not only because the incentives will always drive some people to break insider trading laws, but because ordinary people do not have ready access to all of the legally "public" facts anyway; many of them are locked up in obscure or expensive databases. And if Joe Schmoe did have all the public facts, he would still lack the other big piece of the informational puzzle, which is the ability to interpret the facts properly. That more than anything requires real expertise. In my opinion, the public-confidence angle is the strongest component of the case for outlawing insider trading, but I think it's a rather weak case in the end. The perverse truth is that if insider trading laws inspire the public to think they can play the markets on equal footing with sophisticated investors, then insider trading laws have succeeded in installing a false confidence; they have hoodwinked the public. ---- 0. This has remained a main justification (at least rhetorically) for maintaining and strengthening insider trader laws over the past eight decades. For example, an act amending the rules in 1984 has this preamble: "Insider trading threatens ... markets by undermining the public’s expectations of honest and fair securities markets where all participants play by the same rules."