Why is insider trading illegal, and what is the rationale?

Why is insider trading illegal, and what is the rationale?

• A. It gives insiders an unfair advantage and undermines market fairness and investor confidence.
• B. It helps improve liquidity and market efficiency.
• C. It has no impact on market fairness.
• D. It is permissible if information is publicly available.

Answer: (A)

Insider trading is illegal because it breaks the rule of fair play in markets: people with nonpublic, material information should not be able to profit at the expense of others. When insiders trade on information that isn’t public, they gain an advantage that the average investor doesn’t have, so prices cease to reflect all available information for everyone. This erodes trust in the market, deters participation, and can lead to lower liquidity and distorted price discovery, since trading pressures aren’t based on public signals alone but on hidden knowledge. Trading on publicly available information isn’t the issue—it’s the use of nonpublic information that creates the unfair edge. The rationale behind the prohibition is to protect fair competition, maintain confidence in price formation, and preserve the integrity of the financial system. That’s why the option capturing the idea that insiders gain an unfair advantage and that market fairness and investor confidence are undermined is the best answer.

Insider trading is illegal because it breaks the rule of fair play in markets: people with nonpublic, material information should not be able to profit at the expense of others. When insiders trade on information that isn’t public, they gain an advantage that the average investor doesn’t have, so prices cease to reflect all available information for everyone. This erodes trust in the market, deters participation, and can lead to lower liquidity and distorted price discovery, since trading pressures aren’t based on public signals alone but on hidden knowledge.

Trading on publicly available information isn’t the issue—it’s the use of nonpublic information that creates the unfair edge. The rationale behind the prohibition is to protect fair competition, maintain confidence in price formation, and preserve the integrity of the financial system. That’s why the option capturing the idea that insiders gain an unfair advantage and that market fairness and investor confidence are undermined is the best answer.