Smart money has an interesting article on whether insider trading should be legalized. The article mainly presents positive points of legalizing insider trading.
There are two main negative points I can think off
- Management Focus – I wonder if it will change management’s incentive to control the movement of its stock price more than running the company from a longer term perspective. They might choose to run the company in a more volatile way which might increase the chance of making money from stock price movements.
- Raise cost of equity – If investors feel that that they are not on an equal playing field with insiders they may want a higher return for that risk. It might reduce the amount of capital that flows into the stock market and raise the cost of equity financing.
I do know that there are less obvious victims of insider trading. Lets look at an insider trading situation in which a person buys ahead of a big positive announcement. This person might prevent another person from buying stock because he offered a little better price. The other situation is that he bought the stock of a person who was planning to sell but by luck may not have gotten filled before the news. Since the other people who missed out were not basing their decision on insider trading the insider trader prevented them from getting lucky. It is hard to think of a person not getting lucky as a victim or at least they have not been victimized such that someone should go to prison for a few years.