Why is 'inside trading' illegal?

Because insider trading undermines public confidence in the integrity of the capital markets. Investors confidence is key to an efficient capital market and if that trust is eroded then capital markets will fail. Not everyone is in a position to decline to be a part of the financial market. There are players in the game such as those who are willing to hedge, speculate, or preserve their wealth. And there other people whose sole source of income in their later years would be the funds they invested in capital markets. At the end of the day, our Society benefits from efficient capital markets in which funds flow freely to their most productive uses. For the capital market to be efficient investors need to have faith that the financial markets are transparent and just and provide them with an opportunity to make money from the risk they take. If a selected few rigs the game to the loss of others then it isn't fair.

To give you a more direct example of insider trading harming our society would be the example of FrontPoint. Dr. Yves Benhamou was a person overseeing a certain hepatitis C related drug. He provided the negative news of the failure of drug trails to a portfolio manager of FrontPoint, Joseph F. “Chip” Skowron before the news was made publicly available by the company that was developing the drug ( Human Genome Sciences (HGSI)). Frontpoint's portfolio manager Skowron sold all the holdings of HGSI and saved his firm over $25 million. But when it was found out what Skowron had done the public lost confidence in FrontPoint and started pulling their money out of it. Within a year or two FrontPoint lost 90% of the assets under its management and went from 10$ billion hedge fund to just $1 billion hedge fund. Even though the company was clean and only one of its portfolio managers was involved in insider trading the pubic confidence took a hit because of unethical actions of one portfolio manager.

Skowron later said: "Over 200 people lost their jobs because of me. My wife and my children endured extraordinary embarrassment, isolation, and absence because of my choices because of the empire I thought I needed to build."

One of the codes of ethics of the industry I am part of states that:

"Promote the integrity and viability of the global capital markets for the ultimate benefit of society."