Is there a lot more insider trading than most people think?

I’ve long thought so, here are some new results supporting that view:

… a groundbreaking new study finally puts what we’ve instinctively thought into hard numbers — and the truth is worse than we imagined.

A quarter of all public company deals may involve some kind of insider trading, according to the study by two professors at the Stern School of Business at New York University and one professor from McGill University. The study, perhaps the most detailed and exhaustive of its kind, examined hundreds of transactions from 1996 through the end of 2012.

The professors examined stock option movements — when an investor buys an option to acquire a stock in the future at a set price — as a way of determining whether unusual activity took place in the 30 days before a deal’s announcement.

The results are persuasive and disturbing, suggesting that law enforcement is woefully behind — or perhaps is so overwhelmed that it simply looks for the most egregious examples of insider trading, or for prominent targets who can attract headlines.

The professors are so confident in their findings of pervasive insider trading that they determined statistically that the odds of the trading “arising out of chance” were “about three in a trillion.” (It’s easier, in other words, to hit the lottery.)

There is more here, via Ray Fisman.


I'm less likely to believe them because of their "3 out of a trillion" number. The chance of the California lottery drawing 42 20 05 29 16 are remote, yet, it happened, just last week.

What's the null hypothesis? No buying of options by anyone before the official announcement of good news comes out? Sometimes entire sectors are being lifted, and people will anticipate the good news of company B because of good news of company A a month prior.

BTW, I suspect there is a large amount of insider trading. If you can't spot the sucker at the table, assume you are the sucker.

Hm, the paper is better than I first thought.

We further show that no such patterns exist for any randomly chosen announcement dates, neither in the volume, nor in the prices or liquidity. Thus, if there is no (privately) expected increase in the target’s stock price, we do not generally observe abnormal options activity that would be consistent with trading by privately informed investors

So 1/4 of M&A deals had suspicious activity. I wonder if those 1/4 had anything in common.

There are bankers involved. There are reputations to be upheld.

It's a very interesting paper, but it would have been stronger if the authors started with the set of abnormal volatility low price options, and used that to predict M & A announcements.

"I’m less likely to believe them because of their “3 out of a trillion” number. The chance of the California lottery drawing 42 20 05 29 16 are remote, yet, it happened, just last week."

Well, yes, things with a remote probability do indeed happen sometimes. To be more specific (in frequentist terms), if an outcome has a 3 in 1 trillion chance of obtaining, that means you expect to observe the outcome 3 times in a set of 1,000,000,000,000 i.i.d. trials.

I suspect they took their 95% confidence interval and multiplied it a bunch of times to arrive at 3 out of a trillion, ignoring the fact that their confidence intervals could all be related.

I really like Levine's take on all this:


This is only disturbing is you think insider trading is really bad. Lest we forget that everyone is voluntarily entering into these transactions and the people without inside information would have bought or sold regardless of whether the inside trader had entered the market. Most people who trade believe that they possess some sort of insight that the market does not. I fail to see a huge distinction between someone that incorrectly believes he possesses an informational edge taking advantage of someone in the stock market and someone who actually possesses an edge. If one act is morally reprehensible, they both are, IMHO.

Id say the exception to that rule is when the insider has a responsibility to keep some information private. By trading based on that knowledge, they are broadcasting their privileged insight to the world in violation to their duty to the company.

I completely agree! Usually people get upset because insider trading isn't "fair" though.

If it's true insider trading (ie someone with fiduciary responsibilities passing information along) I agree with sanctions.

The sanctions should be between the companies involved and the individuals violating that trust. The SEC/FBI should stay out.

I don't understand why you say "people without inside information would have bought or sold regardless of whether the inside trader had entered the market."

I mean, if every shareholder in the process of placing a sell order on some of their shares in XYZ corp were to first receive a text message with the following valid information from the SEC -- "John Smith, whose brother in law is a golf partner with the CEO of XYZ corp, bought 29,000 shares of XYZ after having coffee with his brother-in-law this morning" -- would all of those shareholders still place those sell orders? Would they set the same limit price on those orders as they would have before?

The point is that the people would not have gotten that information if the law had been followed either - they would be trading in the dark both times.

And I agree with that point. I have never been able to grasp the idea that delaying price corrections to build in reality is better for the general public.

If I have some positive inside information about XYZ corp and I need to buy the stock before 11 AM today (because that's when that info goes public), I am willing to pay more than market for those shares. My purchase has an (albeit small) impact on prices and this affects other traders who are, as you say, in the dark.

Market makers set spreads for the general market. They are as tight as they can offer without getting killed by informed investors. Give informed investors better tools to make money, market makers widen spreads and tax the general public to pay the informed investors. The question is whether insider trading leads to bigger advantages for informed investors. I would imagine it does because they can make bigger leveraged bets with confidence they will pay off. But high speed traders playing the role of market makers can perhaps do a better job of identifying informed investors trading on non-public information and so this is now less of a problem. Perhaps.

I agree with you in that I don't think the people would trade the same if they knew the non-public information, but that's not an option. Either the insiders trade, or they don't, but in neither case is the non-public information disclosed.

But, what about the fact that, as an inside trader, I have moved the market a little bit by purchasing some shares at an above market price? I would argue that some aspect of my insider information is disclosed at the moment my trade is executed, through share price. Once my trade is executed, the market is aware of something new: someone out there is willing to pay more than market for some shares.

Now, I agree that the detailed information about _why_ I am willing to pay more than market is not disclosed in the execution price of my trade, but, still, _something_ is disclosed and it moves the market. It's even possible that my trade moved the market to a price above some other (uninformed) trader's limit price so that she misses out on buying some shares in XYZ corp. And, if that uninformed trader, analyzing XYZ company "in the dark," misses her opportunity to buy at a reasonable price (based on her analysis of public information only), then I would argue that she's been hurt by the inside trade I have executed.

We also do not know how much more said individual would have been willing to pay, or how much money he would risk in a vacuum. So the signal that we get from an insider trade is dampened a whole lot

>>Either the insiders trade, or they don’t, but in neither case is the non-public information disclosed.

This statement is categorically false.

As Matt Levine over at Bloomberg View often explains very eloquently, insider information is a very poorly understood concept by most people. If I'm driving by a company's headquarters and the building suddenly collapses, that is material nonpublic information for sure, but it is perfectly legal for me to trade on that information before it hits the market, because I was not entrusted with such information by the company and agreed to keep it secret. Compare that to an investor relations employee who trades pre-release earnings info for Rolexes.

Bans on insider information are best thought of as taking the civil case of wrongful disclosure (or some such legal term) and turning it into a criminal offense.

Yes, Levine probably probably has the clearest and most concise writing on modern insider trading laws. For example it's not insider trading for me to place a magnetometer outside a power plant to measure how much electricity they're generating. But using that information I'll be able to confidently predict whether they'll hit their third quarter earnings. I might go out and buy a whole bunch of out-of-of the money options to leverage such information and make a huge one-day return.

From the standpoint of this paper someone would call this insider trading, but from a legal standpoint it's perfectly within the law.

I think you may be wrong about that. The example I heard was your plane is about to land, you look out the window and see a factory on fire, you land and short the stock in the company that owns the factory. I have heard that is insider trading because you are trading on non-public information, even though you did not acquire it improperly from an employee or other insider in the company.

Your magnetometer may be outside the plant, but it's your magnetometer. It is producing non-public information, even though anybody else could also place a magnetometer outside the plant.

"Illegal insider trading refers generally to buying or selling a security, *in breach of a fiduciary duty or other relationship of trust and confidence*, while in possession of material, nonpublic information about the security."

If I have no economic relationship to the power plant or its owners than I am perfectly free to generate material non-public information. Without a breach of fiduciary duty there's no fraud, and hence no insider trading.

You may recall from the high-profile Martoma case of SAC, that the prosecution hinged on the doctor in the drug trial having signed a confidentiality agreement with Elan. In the absence of that confidentiality agreement there would not have been a breach of duty in the chain of information and Martoma would have not broken securities law.

Without the breach requirement, insider trading law would become absurd. All informed traders are in possession of material non-public information by definition. For example if Warren Buffet wants to buy a stock, the very fact that Warren Buffet thinks it's a good buy is by itself material non-public info. (Certainly the stock would rise if Buffet publicly announced that he believed it was a strong investment). Does that imply that Buffet, or any famous and well-respected investor, must publicly announce all his options before buying any shares?

In 1988, a friend of mine was invited by Bill Gates to go skydiving with him. I asked him to call me the moment he gets his boots on the ground in case Gates' chute didn't open, but he felt that would be insider trading.

Probably would not fall under American insider trading law. Although one could make the case that as a guest of Gates in a dangerous activity your friend had a sort of duty to him, which could constitute a breach. But if someone overhead that Gates was skydiving and waited on the ground with binoculars to see if he crashes, then that would be legal.

The idea isn't even that outlandish. Hedge funds regularly hire channel checking firms that do things like stand on the docks of Taipei and count how many Nvidia containers get loaded on the cargo ships.

The issue with insider trading is that it's essentially fraud. By analogy, let's say the fair market price for an apple is 50 cents. Buy an apple for 50 cents, sell it for the same, no problem. On the other hand, let's say you have an apple laying around and you find out it's full of worms. Clearly it is wrong to keep this bit of info secret, and turn around and fraudulently sell your apple for 50 cents on the market.

Take instead some apple stock you happen to have. You work at an apple assembly factory and find out all the ipads sold in the last 6 months were assembled with a defectively short lifetimed screen and a massive expensive recall will be needed. Turning around and selling your rotten apple stock is no different than selling your wormy apple. Taking advantage of options just allows you to profit off of rotten apples you don't even own.

The fact that selling a wormy apple as a fresh one at a market for 50 cents slightly increases supply and therefore informs the market that the average apple at market is worth less than 50 cents in no way erases or compensates for the wrong of fraudulently selling a bad apple as a good one.

The fraud angle doesn't work. Knowingly selling a bad apple is not fraud, unless you make some affirmative misstatement of fact regarding the apple. Instead, you've only breached your contract for sale, not committed any kind of fraud.

Taking the analogy to the stock market, selling Apple stock with knowledge of non-public bad news that will negatively impact the future stock price is not fraud - you have made no misrepresentation of fact to the buyer. Instead, the buyer receives exactly what she paid for - the shares of Apple stock. If the buyer wants a warranty as to "no adverse information known by seller," it's the buyer's responsibility to get that warranty into the contract. Having such a warranty as a default rule would likely raise transactional costs and be the basis for endless litigation (as if we didn't have enough of those already).

I was using the term fraud in its general understanding, not in any legal sense. The issue raised was the morality of trades rather than legality. If it makes you feel better, replace the word fraud with bad. I'd like to think you don't oppose car lemon laws or attempts to misleadingly sell wormy apples, mad-cow laden beef, et cetera, whether you call "fraud", "breach of contract" or anything else.

Regardless of the added costs, such regulations exist in many areas. Buyer beware is the general rule, but as is the case with used cars if it's unfeasible for the buyer to completely test a product prior to purchase, fault can be found with the seller. Again regardless of the costs, the morality of selling wormy apples as fresh ones is unchanged.

Note this regulation can reduce transaction costs and promote trades rather than increase costs or stifle them. For instance, comprehensively checking a car is expensive, by leaving some burden of responsibility with the seller, buyers are spared the costs of doing so. Without such assurances, a low-end used car market might become impossible -- it would be prohibitively expensively to check out the car, but too risky to buy otherwise in a market saturated by lemons.

Stocks can face a similar problem. The more widespread insider trading is, the more risk an average trade intended as a simple investment will instead be the wrong side of a insider trade. If insider trading becomes known to be prevalent, the stock market as an investment vehicle risks breaking down entirely. Why would anyone seeking a return in investment buy stock if it's known many or most sellers are passing off damaged goods?

If you consider the equilibrium alternative to laws against insider trading to be a complete breakdown of the market, you can see that regardless of nominal costs the law actually reduces costs by facilitating the existence of a market at all.

This is still not correct. Me selling you 100 tons of iron ore because I think the price of iron will go down is different from me selling you 100 tons of low-quality ore and saying it's high-quality. In any case it proves too much. What if I'm selling a stock because I am just a really good analyst and made a great model of it but only using public information? In either case I'm selling you the stock but we both have the understanding that I'm doing it because I think it will go down in value.

You are also confused about what insider trading is. See my comment above.

"Insider trading" is a legal term, and semantics matter when you're discussing the law. Now that you're changing the analogy from a legal one to a moral one, let's discuss morality. In your example, Person A sells Apple stock to Person B with knowledge of nonpublic information that will both become public, and will negatively effect the stock price. You posit that the sale is immoral because Person A is getting a "better deal" than he should have received, and therefore the sale is immoral without disclosure of the nonpublic information. But, if that were the case, any sale of anything by a person with more knowledge to a person with lesser knowledge is immoral.

Let's say I know that the blue book value of my car is 10k, and that most people would pay no more than book value. If I find someone to buy my car for 20k, am I doing something immoral? What if I buy a bottle of wine from a store for $10, and sell it to someone else for $50? If I haven't lied about the wine, have I done something immoral? I'd say no - that's just how markets work. I don't see a moral difference between those examples and the Apple employee hypothetical.

Finally, you referenced lemon laws, and that those are similar to insider trading laws. I don't think that's accurate. Lemon laws increase the penalties for selling defective cars. They take a typical breach of contract claim, and add attorneys' fees provisions and increased damages provision in order to make litigating those kinds of typically small value cases worthwhile. But, in the end, it's still a breach of contract claim at its heart - you sole me something that turns out to be different than warranted. With insider trading, the good sold is exactly as warranted, it's simply the value of that good that's at issue. I think there's a fundamental moral difference between a dispute over the nature of the good itself, and a dispute over it's value.

J: Yes, the difference in selling the ore is exactly what is important. Selling a cart of ore that goes down in value because the value of iron goes down is very different than selling a cart of ore that goes down in value because you saw someone fished out the higher grade half of it. As an employee with privileged information selling stock, I am arguing you are in the latter case:

Most people selling apple stock are selling because it is a company with U asking price, V book value, X sales, Y brand value, Z business model, etc. People are buying the same stock with the same knowledge in spite of future risks of decreasing sales, recalls, bad business plan, et cetera, but perhaps different models. When you buy a bunch of iron ore, there is some expected variance in the quality or quantity of ore, provided you cannot exactly measure these attributes up front. However, the employee with non-public knowledge of an upcoming bid of U + 2 billion$ or disastrous recall causing V book value to decrease by 2 billion$ is instead selling or shorting stock as though it still had price U or book value V.

You don't have to explicitly say any of these values while selling a stock to mislead because the stock sales are indistinguishable. In the fruit example, it's like turning the good side up packaging it so you can't see any flaw and selling it next to good apples for the same price.

Misrepresentation doesn't have to be explicit -- say you bought a wedding band for 700$ from a jeweler selling both solid and plated bands. Most of the plated bands have a dramatically lower price, and the solid have a higher price. You might ask about the quality of some higher priced bands and the jeweler could say truthfully they were solid gold. The one you happen to select in the end happens to be priced like a solid band, but is actually plated. Would you feel cheated here? I would imagine so, even if the jeweler never explicitly lied to you about the quality and simply priced an object disproportionate to its quality.

The key here is measurability. If people can actually measure the quality of the gold, fruit, car or stock they trade for, there is no need for buyer protections. Trades occur normally in spite of mutually agreed upon qualities because people place different values on those qualities. To bring it back to stocks, people can value book value, business model, profits, sales, and so forth differently and decide to trade based on differing preferences. Note this differs from trading because you know (for instance) profits of Enron are actually substantially negative rather than positive due to non-public information about accounting irregularities.

What's missing overall in your analysis is that it is expected people buy and sell for marginal reasons rather than absolute price movements. Typically someone will sell apple stock not because they expect disastrous recalls to plunge the stock 30%, but because they expect that apple stock will net them only a 6% going forward and would rather have more amazon stock they expect will yield 6.1% going forward. Other people will sell because they are retiring and need cash rather than investments, and buyers can enter for the same reasons.

Re: Ken The difference between selling your wine or stock is in the representation. Whatever public qualities your bottle of wine has, such as napa valley grapes, are accurate or at least as known to you as it is to your buyer. You can sell it profitably for many reasons (none immoral), desirability, location, etc. Meanwhile there are public records stating a company has a certain accounting value or a certain asking price for shares. With inside knowledge you know this company being bought and sold with this publicly represented accounting value actually have a far different value, but you are selling it as though it does not.

To get an apt wine metaphor, you'd need some knowledge about the wine that couldn't be guessed by the buyer and was contrary to the publicly understood representation. For instance, maybe the wine was watered by half at some point, although all the packaging makes it look identical to the original bottle. In this case, to morally sell the wine, you should disclose your private information that it's watered. If they still want to buy for 50$ afterwards that's fine.


What if the insider is *buying* stock because he expects it to go up?

That's immoral too?


I'm getting on a plane so we'll have to agree to disagree. I would just say that in the Apple employee example, that is clearly illegal insider trading due to the breach of trust with the employer-employee relation, but as a general rule, I think this whole conversation just illustrates that no matter what, stock-picking is a rough game, and people who are not willing to acknowledge that their counterparty may know something they don't should stick to index funds.

You know, it's funny, I just took the CFA Level 3 exam the weekend before last and part of their code of ethics is that you never trade on material nonpublic info regardless of how it's acquired. I guess I just don't agree with that.


"I guess I just don’t agree with that."

How ever do we end up with financial scandals?

The nature of any transaction is that the buyer and seller disagree on the value of the items being traded. One of them is always correct. Insider trading as a trade between a party with privileged information and the market at large differs from academic, professional, or simply well-informed traders against the market, only by the degree of certainty and impact of the information held. It seems to me that insider trading is clearly morally or ethically wrong only when it meets the definition of fraud: "deception deliberately practiced in order to secure unfair or unlawful gain". Trading a commodity through an intermediary in a market traditionally based on publicly available information (meaning that disclosures party to party, ala selling real estate, do not occur), could only meet a weak definition of fraud by omission. Mandatory all-inclusive disclosure would be prohibitive and stupid: "I'm trading this because Mad Money's Jim Cramer said so", "I'm trading this because it's price is my lucky number", and "I'm trading this because I'm pretty sure that the company will do X because someone told someone who told me, that it might."

Options are zero sum and leveraged by their very nature. If someone gets screwed, it's not a few pennies here or there like with HFT. It's likely 25% or more (that's where many options traders set their stops).

It is not just active traders who think they posses some insight that lose, Most people have money in mutual funds or ETFs that trade every day and expect to get average return and when some people get higher than average returns it means others must get less than average. It does not make it less morally reprehensiible if the loss are spread out over a large number of people,

Not quite sure what to make of this. It could be that more individuals just need more local investment options than they presently have.

Outside of a "local is better" paradigm I'm not sure how "local investment options" could possibly increase the quality of investment opportunities or decrease the frequency or impact of insider trading. Local, previously unavailable investments, almost invariably means smaller, less established businesses, with larger relative and absolute shares of ownership as the overhead of ~$10 shares is likely prohibitive. Am I missing your point?

How much insider trading is just mimicking somebody else? If a big buyer is seen to be buying shares in a rumored takeover target, it's not surprising that others jump on the bandwagon. Martha Stewart sold because she assumed someone else had inside info and was selling, not because she had any inside info. It could be hard to distinguish bandwagon from info traders.

GMU's Dean Emeritus Manne fully approves of however much insider trading is going on -

'The much-hyped modern insider-trading prosecutions and their results are reminiscent of nothing so much as Prohibition-era government attacks on bootleggers. There is about as much chance of stopping trading on undisclosed financial information as there ever was of stopping the consumption of booze. There is simply too much money sloshing around the world's stock exchanges waiting for an "edge." Information is more mercurial than mercury and will seep into some crevice in the system no matter how many channels are closed.'

And Dean Emeritus Manne is the proud owner of the following - 'Among his notable educational innovations were the Law and Economics Center (LEC), the first academic center devoted to the development of the field of Law and Economics (presently part of the George Mason University School of Law); the Economics Institutes for Law Professors; the Law Institutes for Economists; the Economics Institutes for Federal Judges; the first specialized law degree program for Ph.D.'s in economics; and the first law school (George Mason) whose curriculum was built around the use of economics in law.'

Of course, Dean Emeritus Manne has a solution to this issue - 'Legalize Insider Trading' - piublished at the following aptly named address -

But then, Dean Emeritus Manne is also the author of 'Insider Trading and the Stock Market'.

I'm sure that Prof. Cowen is at least passingly familiar with the scholarly work of Dean Emeritus Manne, and Prof. Cowen's shock at the extent of insider trading is the banal equivalent of Capt. Renualt's.

Unless one is willing to believe that the director of the Mercatus Center is that naive, of course.

prior_approval: "Prof. Cowen’s shock at the extent of insider trading is the banal equivalent of Capt. Renualt’s."

Shock? Huh?

TC: "Is there a lot more insider trading than most people think? I’ve long thought so, here are some new results supporting that view:"

You seem to be harboring some anger toward the Mercatus Center and GMU.

Heh. Ya think?

Is "insider trading" correlated with M&A activity?

Of course.

there is a service called Option Monster that looks for such patters. needless today, if it were possible to make excess returns looking fr abnormal option activity before big news, he would not need to sell subscriptions. Eve if something is statistically significant doesn't mean it's significant.

"The results are persuasive and disturbing, suggesting that law enforcement is woefully behind..."

By policy, law enforcement has had its budget and staff cut, based on the conservative argument that fraud is impossible in a market. Greenspan stated that and purposely did not write the regulations on lending that Congress required the Fed to write, The SEC and CFTC efforts to regulate were opposed and Congress explicitly prohibited it, again based on fraud is not possible in a market.

So, to all those who say that those bad mortgages were obtained fraudulently by individuals, sir you are wrong. Fraud is impossible in a market. Conservative economists say so. Bernie Madoff is a political prisoner, a scapegoat, because fraud is impossible in a market.

Yes, of course, the billions upon billions spent on all regulating and law enforcement agencies just hasn't been enough* to discover what these (2) academics did when a budget smaller by a likely three orders of magnitude. Fat chance.

*note that the primary issuer of regulations, Congress, has been notable for the amount of insider trading for years.

SEC budget, 1995-2013

Facts are meaningless. You can use facts to prove anything that's even remotely true.

Haven't we had a raft of articles on MR pointing out how the government generally exempts itself from Insider Trading laws? They do not apply to members of Congress. Who have all sorts of useful insider knowledge. And invariably retire very rich.

Also people who work for organizations like the IRS are told to sell shares in companies that are about to come under investigation. So there is no suspicion of impropriety. Which is very useful insider information.

I am surprised it is as low as one quarter.

Henry Manne, the godfather of Law and Economics at George Mason, Emory & Miami, had this right from the beginning. Insider trading is part of what makes markets efficient, and quite unavoidable. Criminalizing information just permits random persecution, notably of Martha Stewart (who was jailed with no evidence of insider trading, just for saying the wrong things).

Having imprisoned Martha Stewart, the feds are now after fellow Wall Street Insider Phil Mickelson. Hopefully, they'll soon hunt down other threats to the public like Richard Simmons, Bill Nye the Science Guy, and Tracey Morgan if he ever gets out of the hospital.

One issue with prosecuting true Wall Street insiders is that they're pretty sophisticated about knowing exactly where the legal line of insider trading is and toeing right up to it without crossing it. For example take the insider trading convictions of high-profile hedge fund SAC Capital. Yes the government got convictions on certain trades, but the convictions it obtained covered well less than 1% of its trading activity. That's why even though they paid fines that were ten times or more of the trading profits it was convicted on, Steve Cohen still has in excess of ten billion dollars and no personal criminal conviction.

If you're not a seasoned pro and do something that looks and feels like insider trading, you're much more likely to be stupid about it and do something that both gets you caught and pushes you into the legal definition of insider trading. Prosecutors are ambitious people, and generally want to try cases where they have a sure shot of winning. Trying sophisticated hedge fund managers who are doing something that looks pretty close to insider trading but is legally ambiguous is a good way to waste a lot of time and effort for something that is likely to get thrown out of court.

SAC Capital trader Mathew Martoma is facing years in federal prison for his role in SAC Capital's illegal activities. That's one pretty big toe over the line.

An article in the New York Review of Books recently talked about the trend toward criminally prosecuting firms instead of their individual officers for criminal misconduct. If I remember, the point of the article is that federal prosecutors can rake in huge fines and still get to call it a win on their resumes in return for the full cooperation of the corporation's own officers in the investigation who may have actually committed federal crimes. Corporate liability under criminal law almost always implies that at least one officer of the corporation committed a crime. It may simply be prosecutorial discretion, a weird set of incentives and plausible deniability that keep Steve Cohen a free man. If you have a trader looking at 7-10 years in prison, I wouldn't call the underlying conduct "sophisticated" from a legal or compliance perspective.

Isn't the real problem with insider trading that it makes it far less likely that non-involved traders can make a profit? And once that is well-known, doesn't that mean a collapse in outside investment?

Trying to clamp down on insider trading isn't done because of the moral harm - it's done because the whole investment economy is in deep trouble once investors believe that they can no longer profit without insider knowledge.

The purpose of the stock market is to provide information.

No, the purpose of the stock market is to allow firms to raise capital and to allow existing owners to sell their ownership with relatively low transaction costs. If insider trading is legal, non-insiders are more likely to assume that people selling shares are selling lemons and this means honest sellers will be penalized by information asymmetries. See Akerlof, Spence and Stiglitz.

No, if insider trading is legal then non-insiders are more likely to assume that the shares are priced to accurately reflect the *actual* expected future performance of the company - not just what information is publicly available.

Insider trading *helps* non-insiders by incorporating the private information into prices.

This is like saying that the purpose of a grocery store is to provide information about the value of oranges.

No: It's like saying that the purpose of the traded wheat market is to provide information about the value of wheat.

Which is true.

I believe Dr. Christophe at GMU has published on sales prior to earning announcements.

If insider trading is legal, the equity risk premium will be higher and the cost of capital will rise.

And to the Level III candidate out there, what part of the Mosaic Theory did you not understand? Didn't you study *Dirks*? *Bausch & Lomb*? Trading on material nonpublic information is prohibited when a fiduciary breach is involved. The guy skydiving with Bill Gates had no such fiduciary duty. Although Bill Gates' recreational habits hardly rise to the level of materiality. Seriously.

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