Insider trading, spoofing, and marking the close raise concerns because of the costs they can impose on others. Those costs depend partly on market design in how orders become binding, volume is reported, information rights are allocated, and settlement prices are determined. Exchange competition and financial innovation can address many of the negative externalities associated with these behaviors.
Exchanges can compete by developing rules that make participants bear more of these costs. Investors and management can choose among different combinations of liquidity, information, and protection. The libertarian case for deregulation is to give this process more room and allow financial innovation to discover ways of reducing externalities, supported by enforceable property rights and contracts.
The Purpose of Financial Markets
Financial markets serve different purposes to each of its participants.
Investors move purchasing power across time and take risk with the expectancy of earning additional returns. Businesses raise capital and expand the real economy. Producers and consumers hedge risks. Dealers and market-makers connect participants who trade across time, while hedge funds incorporate dispersed knowledge into prices.
These functions create competing demands. A market that welcomes additional informed trading may produce more informative prices while becoming more expensive for participants who trade for utility reasons. A market that protects liquidity providers from informed counterparties may offer cheaper execution while incorporating information more slowly.
Different participants can reasonably prefer different combinations. Competition among exchanges should help discover those combinations. That competition becomes less useful when the most consequential exchange features are fixed by law.
Insider Trading & Corporate Governance
Insider trading imposes negative externalities on a firm’s shareholders. Informed insiders can impose losses on liquidity providers, who respond by widening spreads which definitely increases the firm’s equity cost of capital.
Insider advantages can also discourage outsiders from conducting research via increased adverse selection, which may over the long run reduce price efficiency (i.e. the relationship between insider trading and price efficiency may not be strictly positive as incorporating one person’s information can come at the expense of what others would otherwise acquire).
Those objections give shareholders reasons to restrict insiders, as well as giving issuers reasons to advertise credible restrictions when raising capital. But perhaps not every company should be compelled to adopt substantially the same arrangement.
Consider a private company like Anthropic or OpenAI seeking financing. Its founders and employees possess information that prospective investors cannot fully observe, yet investors can nevertheless negotiate a price, obtain disclosure rights, impose trading restrictions, and demand governance protections.
Capital allocation remains possible despite substantial information asymmetry, showing that equal knowledge is an unnecessarily demanding prerequisite for voluntary investment. The libertarian argument for shareholders and management to negotiate informational rights and trading restrictions does not require permissive insider policies winning this competition.
Investors might well overwhelmingly prefer strict prohibitions and public disclosures, but what matters is allowing them to reveal their preferences and let financing costs attain equilibrium to those preferences.
In general, we should see corporate information as property produced within an organization financed by investors and governed through contracts, where contractual arrangements can specify whether employees may trade, when they may trade, what they must disclose, and whether any resulting profits belong to the company. Investors should evaluate those terms alongside compensation, voting rights, and other features of ownership.
Spoofing
Suppose a trader displays substantial buying interest to make an asset appear more strongly supported, sells into the resulting response, and withdraws the displayed bids before they execute. The strategy exploits the difference between an order’s informational influence and its actual exposure to execution.
There is a competitive response in that another trader should sell into the supposedly fictitious bids, and that if the spoofer never wanted to buy, receiving the shares should be an unpleasant outcome.
An exchange could potentially address this gap by changing what displaying an order commits the trader to do, perhaps it might impose a minimum executable lifetime or delay cancellation relative to incoming executions. Under such a design, displaying a large order carries a more substantial obligation.
There is probably a trade-off as genuine market makers also need to withdraw quotations when information changes, and requiring them to leave stale prices available can increase their losses and lead to wider spreads or lower depth. Venues could also experiment with periodic auctions or other approaches.
Competition is useful precisely because the correct balance is uncertain. Exchanges should be able to offer different answers, and customers should be able to judge the resulting execution quality.
Marking the Close
Suppose a large financial obligation depends on a price observed during a thin closing interval. A trader might accept losses on purchases that push that reference price upward because the resulting gain on a much larger related position exceeds the trading loss.
Other traders may recognize that the price is distorted, yet their ability to correct it still depends on available capital, access to the relevant market, and enough time before the benchmark becomes final.
The contract designer should therefore ask how much economic weight the settlement procedure places on a narrow set of transactions. A contract might use a time-weighted average price, a volume-weighted average, an auction, or observations drawn from multiple markets.
Every choice slightly changes the exposure being traded, since a longer averaging window may make a brief price distortion less valuable, but also produces a settlement price that differs from the instantaneous close. These are reasons to allow competing contracts and continuous competition and innovation.
The Market for Market Integrity
The common thread is that exchange competition creates a market for market integrity. Reliable quotes and robust settlement procedures are valuable services.
Exchanges should compete openly to provide them, with customers choosing the protections they value and the costs they are willing to pay.
That freedom should come with responsibility in that Exchanges should stand behind their published rules, face liability for broken commitments, and enforce their contractual agreements with participants. This gives them a direct financial interest in identifying misconduct and developing mechanisms that make it unprofitable. Integrity becomes part of the product, and improving it becomes a business.
Prescriptive regulation obstructs this discovery process by restricting the arrangements competitors can offer. Exchanges should be free to experiment with order commitments, auctions, fees, information policies, and settlement methods. Entry and switching should be open, allowing better designs to attract business and unsuccessful ones to lose it.
Government need not prescribe the rules of trading. Enforceable property rights and contracts provide the legal foundation; competition supplies the incentive to discover better institutions. Financial innovation should be free to price and internalize trading externalities, with exchanges earning their customers’ trust through the integrity they deliver.
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