Insider Trading: Why It Should Be Legalized

We should go after real frauds like Madoff and Enron.

The rampant insider trading of the past several years has finally and tragically claimed its first victim. Ephraim Karpel, an informant for the FBI in the sting operation against several traders who profited from inside information, killed himself. He was 50 years old.

I say he was the “first” victim because insider trading is a victimless crime. In fact, one step further: The use of insider information actually benefits all participants in a market.

Example: Let’s take the case of Galleon buying shares of Hilton because they knew Blackstone was preparing to buy it. Let’s further say you were planning on selling shares of Hilton that day no matter what (as many people did). With Galleon buying millions of shares, the price of Hilton stock moved up that day much more than it would have otherwise. So you sold your shares for a higher amount than you would have if there was no insider trading. OK, so the next day Hilton jumped another 15 percent. That’s OK. You were going out of the stock regardless. So it’s better for you that there was a more smooth price action thanks to the inside information.

Let’s save the witch hunts for the people who are truly bringing down the markets: the Madoffs and the Enrons.

In general, the more information is in a market, the more accurate asset classes in that market should be valued. The laws regarding inside information should be changed—either relaxed or completely eliminated. Why?

Allocation of resources

Tens of millions were spent on these insider-trading cases where, as mentioned above, there were no known victims (until now). Meanwhile, Madoff stole tens of billions from his clients. Enron cost tens of thousands of people their pensions and retirement savings. Better to use resources to track down crimes where the victims are easy to identify and still in great pain to this day. I know people who killed themselves because they were victims of these horrible crimes. And these were crimes that were not horribly difficult to spot. It’s the reason why Madoff had almost zero institutional investors despite such steady returns.

Faith in our markets.

Exposing more public frauds and hedge-fund frauds will more quickly restore faith in the U.S. markets. One might say, “Well, insider trading takes away faith in the U.S. markets.” But this is not clear at all. Every day countless websites, for instance, keep track of “unusual option activity.” The implication is that “someone knows something” when an unusual amount of calls are bought on a stock. That attracts investment into that stock as more information gets converted into a fairer value of that particular company. The flipside: If you don’t know whether or not companies are frauds, you’ll just stay away from the market.

More transparency from corporate America.

If it becomes legal for information to be traded, then companies will be more forthright about material events that are happening in their company: the loss of a major customer, acquisition talks, profits spiking, etc. The more transparency, the better the market.

Indirect way of compensating executives.

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If the CEO of a company knows that the company is about to announce great profits, then I’d rather the market compensate him (by his buying of shares) rather than the shareholders. Better for shareholders (they spend less money on compensation), better for the CEO (he benefits from bringing higher profits to shareholders), and better for the market in general (a more accurate price for that stock as information gets transferred from the mind of the CEO into the actual price of the stock). Now, does this mean people should not be indicted for insider trading right now? Of course not. It’s against the law. Furthermore, if someone (a board member) has a fiduciary responsibility not to release information and he does, then he should be fired and suffer the consequences to his career and finances. So let’s avoid the tragedy we witnessed today with Karpel and save the witch hunts for the people who are truly bringing down the markets: the Madoffs and the Enrons.

James Altucher is managing director of Formula Capital and author of How to Be the Luckiest Person Alive and five other books.