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Law in Context

Abstract from Volume 25 No 2 (2007) Law and Finance

The Need to Prohibit Insider Trading

Dr Keith Kendall is a Senior Lecturer in the School of Law at La Trobe University in Melbourne. He holds degrees in law from Monash, Melbourne, La Trobe and Chicago universities and graduated with honours in account­ing and finance from Monash University. He has published several articles on taxation, the tax profession and securi­ties regulation (mainly insider trading) in both scholarly and profes­sional journals. He earned his SJD degree at La Trobe University with a thesis on insider trading. Before joining La Trobe University School of Law, he worked in the Tax Division of Deloitte Touche Tohmatsu in Melbourne and was an Assistant Lecturer in the Department of Accounting and Finance at Monash University.

While insider trading is almost universally prohibited, academic debate continues regarding its justification. The most persuasive argu­ments to date have been in favour of allowing insider trading. Prospect theory is presented here as a theoretical framework by which the prohibition against insider trading may be justified. It is argued that losses perceived to be caused by insider trading would be sufficient to discourage a sufficient number of investors from participating in the securities markets such that the efficiency of the markets could be com­promised due to the resultant loss in liquidity. An effective prohibition on insider trading contributes to improved market efficiency by removing a psychological obstacle to market participation for a large number of individual investors.

(2007) 25 No 2 Law in Context 106

   
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