The Insider Trading Prohibition: A Legal and Economic Enigma

36 Pages Posted: 21 Mar 2002

See all articles by Stephen M. Bainbridge

Stephen M. Bainbridge

University of California, Los Angeles (UCLA) - School of Law


The prohibition of insider trading in U.S. federal securities law typically is justified on fairness or equity grounds. Predictably, these arguments have had little traction in the law and economics community. At the same time, however, law and economics scholars have not coalesced around a single view of the prohibition; instead, competing economic arguments generated an extensive debate that is still active. Those law & economics scholars who favor deregulation of insider trading typically argue that efficiency is the sole basis for analyzing a legal regime, and that the prohibition lacks any rational economic basis. This article critiqued two pro deregulation arguments: (1) the effect of insider trading on the pricing of securities and (2) the claim that insider trading is an efficient compensation scheme. The article found neither argument persuasive. Those who favor regulating insider trading typically respond either by rejecting the claim that efficiency is the controlling criterion or by attempting to show that the prohibition is justifiable on efficiency grounds. The pro regulation arguments critiqued herein include: (1) insider trading injures the firm whose securities were traded; (2) insider trading injures shareholders of the firm whose securities were traded; and (3) insider trading violates norms of fairness. In sum, this article contended that neither side had carried the field, but suggested that the argument in favor of regulation probably was winning at the time. The article concludes with some observations on the concept of efficiency as a normative principle.

JEL Classification: K22

Suggested Citation

Bainbridge, Stephen Mark, The Insider Trading Prohibition: A Legal and Economic Enigma. Available at SSRN: or

Stephen Mark Bainbridge (Contact Author)

University of California, Los Angeles (UCLA) - School of Law ( email )

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