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Is insider trading really a crime?

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For example, in 2008, Rajat Gupta, a board member at Goldman Sachs, apparently told Rajaratnam that Warren Buffet was about to invest $5 billion in Goldman. Rajaratnam bought millions of dollars worth of the stock before the market closed, and then he profited handsomely when the news broke and the stock jumped the next day. Later in the year, after a board meeting, Gupta apparently told Rajaratnam that Goldman would report earnings well below expectations. Rajaratnam dumped the stock, getting out before the earnings news became public and pushed down Goldman's share price.

Now this type of activity — let alone the breaking and entering that Charlie Sheen's character performed for Gordon Gekko in the movie Wall Street — would probably be criminal even in a purely laissez-faire world. Specifically, when the shareholders of a corporation appointed board members, they would presumably have standard confidentiality clauses in the contracts prohibiting this type of behavior. The same thing would hold for a law firm; it's not good business if clients know that their lawyers can phone tips to their buddies on Wall Street while working on a sensitive case, and so a major law firm would insist that its employees sign contracts prohibiting such things.

We Want People Trading on Unique Knowledge

To understand the social benefits of insider trading, we have to first realize that stock prices mean something. They reflect real facts about the world, such as the assets and liabilities of a particular corporation and how effectively its current management is using resources to satisfy customers.

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