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Why insider trading should be legal

Friday, 26 Jul 2013 | 12:11 PM ET

Dylan Matthews of the Washington Post's Wonkblog officially joins the cause.

They are justified as providing an even playing field for small investors, but obviously such a playing field doesn't exist. You really don't stand as good of a shot of beating the market as a guy with an E-Trade account as you do when you're, say, Steve Cohen. So you shouldn't try. Making insider trading legal would make it clearer to individual investors that picking and choosing stocks is a sucker's game, and deter more of them from trying, to their financial benefit.

Keeping it banned creates an illusion of fairness that leaves everyone worse off. Felix Salmon, arguing for bans on insider trading, wrote, "If you want a nation of shareholders, you need to give individuals some faith that they won't get picked off like so many fish at a poker table." But we don't want a nation of shareholders — or we shouldn't, in any case. We want a nation of index fund holders, and banning insider trading makes that harder.

But that understates the case. Insider trading is actually an active good. Markets work best when goods are priced accurately, which in the context of stocks means that firms' stock prices should accurately reflect their strengths and weaknesses. If a firm is involved in a giant Enron-style scam, the price should be correspondingly lower. But, of course, until the Enron fiasco was unearthed, its stock price decidedly did not reflect that it was cooking the books. That wouldn't have happened if insider trading had been legal. The many Enron insiders who knew what was going on would have sold their shares, the price would have corrected itself and disaster might have been averted.

If you missed it earlier this week, here's the video where Cadie Thompson, Patti Domm, Jeff Cox and I argue about these points.

—By CNBC's John Carney. Follow me on Twitter @Carney

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