Why is insider trading illegal?

According to a TIME magazine article the answer is simple: if insider trading were legal the market would be inefficient. How so?  Two ways:

  1. Professional investors (mutual funds, pension funds, hedge funds) would no longer conduct research and produce information about companies.  Why not?  Because they won’t be able to compete with those few that have inside information.  Rather, the professional investors might wind up bribing and paying insiders for information.  Thus, lack of research -> lack of information -> less efficient market.
  2. Nonprofessional investors (us) won’t participate in a market where we are clearly at a disadvantage.  Lack of participation -> less liquidity -> large spreads for market makers -> less efficient allocation of capital.

I will leave it to the reader to mediate on the tradeoff between information content available with insider trades vs. likely market inefficiencies that would result.

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