Theories for Prohibiting Insider Trading I
There are economists and legal scholars that are pushing to change the insider trading laws today. They are against prohibiting insider trading and declaring it as unlawful. According to these people it would be more beneficial if insider trading would be declared lawful. On the opposite side of the spectrum there are those scholars that are in favor of declaring insider trading as illegal and completely banning any form of insider trading. This has been the debate that have raged on since the time when the early insider trading laws were enacted. I am here to discuss the arguments that are proposed by those scholars that advocate for the prohibition of insider trading. According to them there are three compelling reasons why insider trading should remain unlawful and prohibited. The first one is called the fraud theory, the second one is the fiduciary-duty theory and the last one is the information-access theories.
You would have probably guessed that the earliest theory or argument that has been concocted to support the prohibition of insider trading is the fraud theory. Much of the language of the Securities and Exchange Act of 1934 was focused on the fraud theory. In fact, the most often cited legal basis of insider trading, which is Section 10(b)-5, still describe insider trading as a form of a deception or manipulation that is used in trading securities. Even the courts back then used the fraud theory in interpreting Section 10(b)-5. According to the fraud theory insider trading should be unlawful because it is a form of exploitation and fraudulent business practice. In insider trading there is a deliberate act or omission that causes intentional damage to another. It is rather interesting to know, however, that before, the common law, or those cases decided by the courts, do not mandate that participants in voluntary or freely entered transactions should disclose all the confidential data that involves material facts in the transaction. What is required by law is that participants in these transactions should not make an intentional narration of false, deceptive and untruthful statements. In other words, parties to a transaction are not required to be completely honest. They are just not allowed to tell a lie. This is why before, insider trading is not seen as illegal because the parties thereto are not telling any untruthful statements of facts. They are therefore not violating any laws. But the enactment of the 1934 Act changed this perception. Jurisprudence or decided cases have interpreted the law to mean that a fraudulent business practice not only involves telling an untruthful statement, it also includes insider trading because the informed insiders use the information that they obtained to be able to enrich themselves at the expense of the uninformed others. They are in effect manipulating and deceiving those that are not informed. The prohibition against insider trading in the 1934 Act was seen as a measure to protect those investors that are not informed from those that are informed. The law focuses more on the disadvantageous effects of insider trading to liquidity traders. Some would even argue that even if insider trading would promote economic efficiency and even if there would be market gain, the ethical considerations that are raised by insider trading through the exploitation of those that are not informed is enough to prohibit insider trading because such gains are obtained through unfair behavior.