It seems Senate Majority Leader Bill Frist (R-TN), of video diagnosis fame, is embroiled in an insider trading scandal. Frist's family founded and still runs Hospital Corporation of America, the nation's largest hospital chain. (Incidentally, they perform abortions at HCA's hospitals.) Frist apparently sold 2.3 million shares a week before the stock of the company started to tank, leaving open speculation that Frist traded on insider information.
A little bit of history: Insider trading is placing a trade to buy or sell securities based on material knowledge of a company's assets and liabilities that is not available to the market as a whole. Insider trading was legal until the Securities and Exchange Act of 1934. During the depression, there was a great deal of speculation about what caused the market crash, and insider trading was labelled as one of the causes. CEOs had made heaps money selling their firm while making public statements to the contrary.
Still, there were almost no prosecutions for insider trading until the 1980s. Then, a young New York lawyer made a name for himself by handcuffing corporate criminals and walking them in front of the cameras. Rudy Guiliani took down leading Wall Street figures Ivan Boesky and Michael Milken among many others and made insider trading an enforced crime.
So if it wasn't a crime except in the last 20 years, what's the big deal? The argument against insider trading is the following: if CEOs and others are allowed to trade based on their private information, they will have an unfair advantage in the marketplace. Ordinary investors will demand a higher return in compensation for being placed at an informational disadvantage. This will drive up investment costs and weaken economic growth.
There are two problems with this. First, word does get out. A number of academic papers have highlighted price movements that occur before the announcement of news. Second, the market sees information and reacts very quickly.
In fact, you can make a fairly strong case that insider trading should be legal because it makes prices more efficient. The stock market in a capitalist society serves to direct investment where it is most productive. By allowing insider trading, the CEOs and other people in the know will eliminate the short term mispricings that occur before private information is revealed. As an example, suppose a company is being sued for producing a harmful product. This news is not available to the public. In the meantime, the stock price will be higher than the company is actually worth, leading some people to invest unproductively. If insiders were allowed to trade based on their information, they would sell shares until the price dropped to what the company is worth after settling the liability.
Of course, regardless of whether insider trading should be illegal, it is a crime. Certainly the most powerful senator should be expected to obey the law. I have no tolerance for corporate criminals who in many ways do more damage to society than their volient street thug counterparts.