Insider trading – what it is and how to mitigate the risks

Insider trading is a complex and heavily regulated practice that has been the subject of much academic research and legal debate. This article explains insider trading, its legal implications, and best practices for companies to protect their business.
Per Friberg

Per Friberg

Head of Financial Crime Surveillance
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Introduction

Insider trading is a complex and heavily regulated practice that has been the subject of much academic research and legal debate. News outlets frequently report on insider trading cases and their severe consequences for the implicated individuals and businesses.

It is a behaviour that prevents full and proper market transparency, which is a prerequisite for trading among all economic actors in integrated financial markets.

Insider trading is a severe crime that can harm both the companies whose confidential information is leaked and the integrity and efficiency of financial markets where listed companies' shares are traded. But what exactly constitutes insider trading, and what can companies do to minimise the risks?

Per Friberg, Head of Financial Crime Surveillance at Trapets, explains insider trading, its legal implications, and best practices for companies to protect their business.

What is insider trading?

Insider trading is a crime included under the umbrella of market abuse. It occurs when someone with access to inside information uses it to buy or sell financial instruments to which that information relates, either for their own account or on behalf of a third party.

Insider trading is also committed when a person uses inside information to change or cancel an order for a financial instrument that was placed before they obtained the information.

A closely related crime is unlawful disclosure of inside information, which means leaking inside information to a third party, with or without a recommendation to act on the information.

What is considered inside information?

Inside information is information of a precise nature, which has not been made public, relating to one or more financial instruments. Such instruments include stocks, bonds, derivatives, or other related instruments that are admitted for trading. 

If the information were to be made public, it would likely significantly affect the prices of the financial instruments.

In this context, information of a precise nature refers to a specific set of circumstances or events that currently exist or are likely to occur in the future.

This information must be detailed enough for a reasonable investor to determine its potential impact on the prices of related financial instruments.

Some examples of inside information include:

  • A public bid for a company's shares at a price significantly higher than its current market value.
  • A large breakthrough order for the company, or the receipt of an order for a new product with great potential.
  • A financial result that deviates significantly from the expectations in the market, whether positive or negative.

How does insider trading affect companies?

Insider trading is an illegal act as it gives an unfair advantage to those with access to inside information when trading in financial instruments.

It undermines the integrity and efficiency of the financial markets since it distorts the market prices for the supply and demand of financial instruments and erodes investors' confidence.

Many companies depend on a fair and orderly market to attract new investors and raise capital to grow their business. If potential investors lack confidence in a market because too much insider trading is happening, they will stay away from that market.

Consequently, many companies couldn't start up or continue with their business. Investors willing to invest in the stock market are a vital part of companies' funding and future business development and growth.

Moreover, insider trading can damage the reputation and value of the companies whose information is misused.

For example, an employee with continuous access to inside information can pass it on to acquaintances with instructions to trade specific stocks related to that information to earn risk-free money from that trading.

For the company, this is not only a reputational risk and a gross breach of trust from the employee but also a criminal act to illegally disclose inside information.

How to prevent insider trading at your company

While it can be difficult for a company to protect itself from an employee who suddenly goes rogue, there are some measures you can take to prevent illegal disclosure of inside information and insider trading at your company.

These measures include:

  1. Limit the number of employees with access to inside information and ensure they know their legal obligations and responsibilities.
  2. Implement physical and digital security measures to prevent unauthorised access or illegal disclosure of inside information.
  3. Educate employees about the risks and consequences of insider trading and provide them with guidance and support if they have any questions or concerns.
  4. Continuously review your arrangements, systems, procedures, and routines according to requirements from supervisory authorities.
  5. Routinely use smart logs that cover all actions by individuals in relation to the handling of insider information. Analyse digital footprints and prohibit risky behaviours among all employees.
  6. Take necessary safety precautions with digital devices provided to employees in the office.
  7. Observe and learn from other organisations with in-depth experience with high-level security measures, such as military intelligence operations or the Swedish Security Service.
  8. Do in-depth due diligence, preferably by external expertise, before hiring staff that handle inside information as part of their daily work duties. The weakest link is always the people you hire who have access to inside information.

In conclusion

Insider trading occurs when someone with access to inside information uses it to buy, sell or amend orders related to financial instruments.

Insider trading distorts market prices, erodes investors' confidence, and damages companies' reputation and value.

To prevent insider trading, companies can limit the number of employees accessing inside information, implement security measures, educate employees, continuously review arrangements, use smart logs, and take necessary safety precautions.

About the author

  • Per Friberg

    Per Friberg

    Head of Financial Crime Surveillance

    Per has a background in investment banking and has extensive experience as a sales trader of European and US equities and derivatives. He has worked as a criminal investigator of market abuse at the Swedish Economic Crime Authority and at the National Anti-Corruption Unit at NOA within the Swedish Police Authority.

Market Abuse Regulation

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