BLOG - Thursday, 24 October 2024

Insider Trading Unveiled: The rising threat and how to combat it

It is commonly known that there has been a noticeable rise in insider trading cases globally in recent years. Several factors contributed to this trend, but it's essential to recognise that the actual increase may be a combination of more activity and more advanced detection techniques.

We have explored some key reasons behind the rise in insider trading.

Economic uncertainty, especially following the COVID-19 pandemic, has led to more volatile financial markets. During periods of high volatility, insider information (such as earnings reports, merger announcements, or policy changes) can offer a higher advantage, making insider trading more tempting for those with access to non-public information.

Secondly, advanced digital platforms and tools have made trading easier, but they have also enabled bad actors to more efficiently access sensitive information. Moreover, new technologies, like blockchain and decentralised finance, can create opportunities for financial crimes, including insider trading.

The increase in cross-border investments has complicated regulatory oversight. With global markets being interconnected, it has become easier for individuals to use non-public information about one market to trade in another, making detection more difficult.

In some regions, especially in emerging markets, there may be weaker enforcement of securities laws or less stringent regulations, providing fertile ground for insider trading. Even in well-regulated markets, corporate executives sometimes push the boundaries, taking advantage of grey areas in the law.

Regulatory agencies globally have become more sophisticated in detecting insider trading. They use Artificial Intelligence (AI) and other advanced tools to detect unusual trading patterns. This increased detection can create the impression of rising insider trading cases, as more offenders are caught.

As companies face more pressure to deliver short-term results, executives and employees may feel incentivised to use insider knowledge to protect or enhance personal wealth. This can include non-public earnings reports, news about mergers and acquisitions, or other significant business developments.

The rise of cryptocurrency trading has added a new dimension to insider trading. Crypto markets often operate with less regulation than traditional financial markets, and cases of insider trading involving cryptocurrency assets have increased as a result.

While there is indeed an uptick in the number of insider trading cases globally, this is likely driven by a combination of heightened market risks, technological advancements, and improved regulatory surveillance. Additionally, some sectors (like crypto) may be seeing a larger proportion of insider trading due to lax oversight compared to traditional financial markets.

Combatting insider trading within an organisation requires a combination of clear policies, strong internal controls, regular monitoring, and an ethical culture.

Key strategies to effectively combat insider trading include the following, i.e.,


Establish Clear Insider Trading Policies

• Entities should create comprehensive written insider trading policies that clearly outline what constitutes insider trading, the rules surrounding it, and the consequences of violations.


• Entities can implement blackout periods during which employees cannot trade company stock, particularly around earnings reports, mergers, acquisitions, and other material events.


• Consider a pre-clearance process that will require senior executives and employees with access to sensitive information to get pre-approval before trading company stock.


• Conduct regular training sessions to educate employees about insider trading rules and how they apply to their roles.

Strong Internal Controls
Entities can/should:

• Limit access to sensitive information only to employees who need it for their work. Implement a need-to-know basis policy for material non-public information (MNPI).


• Secure communications and document access systems to prevent unauthorised data leaks. Use encryption, multi-factor authentication, and data access logs to control and monitor access.


• Secure sensitive areas (like boardrooms or offices where sensitive discussions occur) and ensure physical documents are safeguarded.

Real-time Monitoring and Surveillance
Entities can/should:

• Use technology to track employee trades in company stock, particularly for those with access to material non-public information. Flag any suspicious patterns for further investigation.


• Leverage data analytics tools to monitor transactions, employee activity, and communication to detect anomalies and patterns that may indicate potential insider trading.


• Implement anonymous reporting systems for employees to report suspicious activities (Whistle-blowing systems).

Culture of Compliance and Ethical Behaviour

• Senior leadership should model ethical behaviour and make it clear that insider trading is unacceptable and will be met with serious consequences.


• Regularly train employees on the legal, financial, and reputational risks of insider trading, and encourage a culture of accountability and integrity.


• Periodically remind employees of the policy, particularly around major events like earnings reports or strategic initiatives.

Legal and Disciplinary Action
Entities can/should:

• Ensure there are clear, swift, and transparent consequences for violations of insider trading policies. This could include termination, reporting to regulatory bodies, and legal prosecution.


• Stay in close contact with regulatory authorities or other relevant bodies to ensure compliance with legal frameworks.


• Conduct periodic audits or hire external reviewers to assess the effectiveness of your internal controls and insider trading compliance measures.

Third-party Risk Management
Entities can/should:

• Ensure that external partners, consultants, and vendors who may have access to insider information are also compliant with insider trading laws.


• Use Non-Disclosure Agreements (NDAs) to prevent the disclosure of confidential or material information to unauthorised third parties.

Regular Updates and Audits
Entities can/should:

• Regularly review and update insider trading policies and procedures to ensure they are current with legal and regulatory changes.


• Perform routine audits of stock trading activity to detect potential abuses, especially for high-risk employees.


• By combining these proactive and reactive strategies, organisations can build an environment where insider trading is minimised and quickly addressed if it occurs.

Written By: Gerrit Jordaan