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- Without laws against insider trading, insiders will get an unfair advantage because they'll dump stock that's about to go down or buy stock that's about to go up.
- What about situations in which stock is about to go down, and the insider refrains from buying more; or in which the stock is about to go up, and the insider refrains from selling? His inside information allows him to refrain from acting at a time when he might otherwise act to his detriment. But this is not illegal, even though it gives him an advantage.
- Suppose the insider gets a tip that suggests that the stock is about to go up, but refrains from buying because that would be insider trading. Then another trader, unaware of the situation, sells the stock at $5.00/share. The stock subsequently rises to $10.00/share when the market-moving information becomes public. It would have benefited that naive trader if the insider had bought the stock and thereby driven the price up before the trader sold his.
- Suppose there are two companies, A and B, both with stock price of $5.00/share. As far as outsiders can tell, they're both equally promising. However, insiders know that company A's sales numbers for this quarter are going to be terrible because its products are shoddy and overpriced. Investors remain unaware of this and keep buying the stock. They get a nasty surprise when the numbers come out, and they lose their money.
- Wouldn't it have been better if insiders had acted on the bad news and driven the price down, which would have prompted shareholders to investigate or at least conjecture as to possible causes of this selling behavior; and if they couldn't figure it out, at least take it into account as a red flag? Also, it would have been better for wealth creation if company A's stock price had gone down as soon as such a decrease is warranted, because it would have made company B a more attractive investment and thereby put resources to more productive uses.
- Banning insider trading hinders market prices from adjusting to reflect the true value of companies. It could make people not want to trade in the stock market, because for all they know they are buying stock at prices higher than what they should be, or selling at prices lower than what they should be.