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Insider Trading: How Fair Is It?

The Securities And Exchange Commission (SEC) has sued Goldman Sachs as it sold mortgage securities without disclosing, John Paulson, a hedge fund manager was betting against the same securities. Sebastian Mallaby writes in The Washington Post : “The securities in question, so-called synthetic collateralized debt obligations, cannot exist unless somebody is betting that they will lose value. The firms that bought Goldman’s securities knew perfectly well that some other investor must be taking the opposite position. It was their job to evaluate the Goldman offer and make up their own minds.” And: “An investor who wants to bet against a bundle of mortgages is entitled to suggest what should go into the bundle. The buyer is equally entitled to make counter-suggestions. As the SEC’s complaint states clearly, the lead buyer in this deal, a boutique called ACA that specialized in mortgage securities, did precisely that.”

The merit of the case is hard to judge as full information on the case is not available at present. It goes without saying that if Goldman Sachs is guilty of fraud, they should be punished. As this is an alleged case of insider trading, this brings us to the question of the morality of insider trading. There is nothing wrong at all with insider trading, even in the case of shorting stocks, provided that insiders haven’t done anything wrong for the stocks to perform badly. More importantly, insider trading has beneficial effects on the economy, as wealth reaches the hands of efficient knowledgeable people rather than those who have simply turned lucky. Insider trading is a victimless “crime”. Insider traders do nothing other than using their superior knowledge to make money on stocks. It should be obvious that it is a healthy market activity which should be lauded.

Insider trading, in fact benefits everyone. Even those who wish to sell the stocks will find the price of the stocks rising as of the demand from insider. Some might even decide to hold the stocks as the demand for the stocks are rising. It is true that some of them who lack any solid understanding of the future prospects might sell those stocks. But, their complaints are not justified. The arguments that insiders should work for the interests of these stockholders is fallacious? These are the stockholders who were willing to sell these stocks at the first opportunity. In case the insider sells a stock, expecting that it might fall in price, it helps those who buy it to buy it at a lower price. It also prods people to sell it, and the fall in the price of the stock would be gradual not causing much harm to other stockholders.

The attitude of the state towards such criminals was well expressed by the economist Murray Rothbard: “Armed robbers are usually coddled by our judicial system. Columnists and social workers worry about their deprived backgrounds as youths, the friction between their parents, their lack of supervised playgrounds as children, and all the rest. And they are let off with a few months’ probation to rob or mug again. But no one worries about the broken homes that may have spawned investment bankers and inside traders, and no social workers are there to hold their hands. They receive the full might of the law, and are sent straight to jail without stopping at Go.”

Four years back, Batni, an executive director of the company, sold 10,000 equity shares of Infosys during an open trading window. He notified the intent to sell shares, but failed to notify it within one working day of the transaction. He did it 3 days later. He was made to shell out five lakhs as fine, which he donated to charity. Infosys raised its public image, but what happened to that person? Wasn’t he being victimized for his ability? The purpose of the law is clear: The able must be punished. Are we forgetting the fact not only the investor, but the society as the whole benefits when more knowledgeable investors are rewarded and the ill informed ones punished? Proponents of such regressive policies evade impossibility of equality.

No matter the nature of laws and no matter what Government does, inside information can’t be completely wiped out from deal. People will be forced to keep away from such deals out of the fear the Government and regulatory bodies will crack the whip. It is not only preposterous, but disastrous. Let’s not see Life as a competition, a horse race in which the weights on horses are to be equaled.

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