Legal insider trading hurts small investors

This letter to the editor of the Montreal Gazette appeared in the 2003-10-7 edition under the heading “Rules on legal insider trading unfair to small investors”.

Your editorial on insider trading, “Get tough on market fraud” (Gazette, 5 Oct.) fails to make a sufficiently clear distinction between legal and illegal insider trading. The law permits company officers, directors, and employees to buy and sell shares in their own companies, as long as the legal requirements regarding insider trading are followed.

Unfortunately, the rules regarding disclosure of insider trades stack the deck against small investors. Although different jurisdictions have different rules, all modern markets suffer from a defect which leads to unfairness. The original concept of the “market” involved offers to buy and to sell in a setting where all the players could see and hear each other, and could identify any individual making an offer. Thus, an offer for an “insider” trade would be clearly recognized as such by the other players, even before that trade could be executed. The insider offer would itself influence the market, usually in a direction to make the insider trade less profitable. For example, if a company CEO put a large block of his company’s shares up for sale, potential buyers would be wary of the future prospects for that company’s stock, guessing that the CEO had inside information. These buyers would be reluctant to buy, driving down the company’s share price.

In today’s markets, stock trades are put on offer by brokers, executed by computers, and disclosed (in the case of legal insider trades) days or weeks after the fact. Small investors do not have the information to act on the insider trade until it’s far too late to benefit.

Now that modern stock exchanges are computerized, this situation is no longer acceptable. Today, it is possible to notify interested players the moment that an insider makes an offer to trade his or her company’s shares. For example, email messages could be sent within milliseconds of the offer appearing. If there were a legislated time delay between the notification of the insider offer to trade, and the execution of any trades resulting from that offer, this would give the opportunity for other investors to influence the market.

With instant notification, there will be less incentive for insiders to engage in illegal activity. Fairer stock markets will attract more small investors, thus boosting the economy.

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