Ponder This: Should Insider Trading Be a Crime?

It’s too early to determine exactly what happened at Galleon Group, the multibillion-dollar hedge fund whose embattled co-founder Raj Rajaratnam is at the heart of what the Securities and Exchange Commission is billing as the largest insider trading case in decades.

Without commenting specifically on the case, the details of which are still forthcoming, I believe that the insider trading charges against Rajaratnam are immoral, unjust and wrong.

In today’s economic climate, Rajaratnam is an easy target. He’s rich, portly and successful – the textbook definition of the “fat cat” we’re now conditioned to despise. But like Martha Stewart and Imclone’s Samuel Waksal, it’s likely the SEC will pursue a witch-hunt against Rajaratnam for a crime that shouldn’t actually be a crime at all.

To start, consider that any company – Advanced Micro Devices (AMD), Sun Microsystems (JAVA) or Google (GOOG) – belongs to its shareholders, not to regulators, the government, or the “public” at large. It’s those shareholders who have the right to decide how company information is used.

By forbidding company executives to make use of a firm’s own proprietary information, insider trading laws infringe on the right of a firm’s owners to run the company as they see fit and capitalize on the value they have created and own. Like the “say on pay” legislation popular with lawmakers, but not corporations, firms that wished to enact guidelines as to how executives can trade or pass information to others would be free to do so on their own, not by force from the government.

The egalitarian belief behind insider trading prosecutions is that everybody should have exactly the same information, even the folks who haven’t worked a day in their lives to gather that knowledge themselves.

So we encourage CEOs to be shareholders yet make it a criminal act for them to trade based on their own hard-earned experience. Instead, they're expected to trade their millions of shares only after Joe Six-Pack has been fully briefed, despite the fact that he’s not even a current shareholder of the firm.

Imagine if you knew a brothel or gentleman’s club was going to be built next to your home, perhaps thanks to a local contractor or maintenance man hired to install the stripper poles. If insider trading laws were applied to the real estate market, you would not be permitted to sell your home until news about the bordello had been plastered across the front page of the local paper. Would that be fair?

Every time you make a trade, you do so with your own proprietary knowledge that you believe will yield a profit. Insider trading laws effectively require individuals with that knowledge to act against their own interests. That isn’t just irrational. It’s insane