Employees who work at firms in the financial services industry are privy to sensitive information of all kinds. There are many ways for employees to abuse this information beyond garden-variety insider trading. As the ways bad actors can misuse information and manipulate the market get increasingly sophisticated, the need for equally sophisticated compliance technology to keep up continues to grow.
Insider trading involves trading a public company's stock or other securities based on material, nonpublic information about the company for personal gain. For example, if an employee knows about an upcoming merger or acquisition, they buy shares in their company or the target company before the news becomes public, anticipating that they'll profit from increased stock prices.
Read about Insider List and Information Management under MAR
Insider Trading Risk Extends Beyond the Individual
Bad actors can enlist other people in their trading schemes to distance themselves from illegal behavior. Tipping involves providing insider information to a friend or family member so they can trade on the information—and the insider employee can receive a cut of the profits.
Another scheme involves leaking information to other firms in exchange for kickbacks. This can involve complex networks passing information through multiple intermediaries to obscure the source.
And even if a gossipy employee shares insider information with no plans or expectations for trading, the behavior still carries extensive risk for both the individual and the firm.
Read a report on the state of Market Abuse Surveillance in the Financial Services Industry
With Shadow Trading, Insider Trading Extends Beyond the Company
A recent SEC action in the U.S. highlights the emerging risk of Shadow Trading. Shadow Trading occurs when individuals use insider information not to trade in the stock of their own company but in the stock of another company where there's a market connection or an economic link.
Firms need to be aware of the many ways that employees can take advantage of access to insider information and use it for illegal personal gain
There are myriad other schemes that rogue employees can try to implement to make a quick profit, hide their activities and manipulate the market. A solid compliance program will have policies and procedures in place to monitor them all.
MNPI Remains a High-Risk Area for Compliance
Front Running
Employees at brokerage firms or investment banks engage in front running by trading stocks based on advance knowledge of large client orders. Knowing that a large order will likely move the stock price, they trade ahead of the order to profit from the price movement.
Piggybacking
Similar to front-running, piggybacking involves employees trading based on the trades of influential investors or clients. By mimicking the trades of those with insider knowledge, they hope to achieve similar gains.
Pull of the Rug
Pull of the rug is a coordinated effort where traders create a false sense of security in the market through coordinated buying. Once other investors are lured in and the price rises, they abruptly sell off their holdings, causing the price to decrease and leaving the new investors with significant losses.
Pump and Dump
In a pump and dump scheme, insiders use their position to artificially inflate the stock price by spreading false or misleading information. Once the price is high, they sell their shares at a profit before the truth comes out and the price drops.
Short Selling
If an insider knows negative information about their company that hasn't been made public, they might try and engage in short selling. This scheme involves borrowing shares to sell at the current price, then repurchasing them at a lower price after the information is released and the stock price drops.
Spoofing
Spoofing involves placing large orders and intending to cancel them before execution to create a false impression of demand or supply and manipulate market pricing.
Layering
Layering involves submitting multiple orders at different price levels to manipulate the market's perception of supply and demand. By creating an illusion of market interest, traders can influence prices to their advantage before canceling the orders.
Wash Trading
Wash trading occurs when traders simultaneously buy and sell the same financial instruments to create artificial trading activity. This practice is used to mislead the market about the actual level of demand and can inflate trading volumes without any actual change in ownership.
Read a White Paper on Compliance in the Digital Age: Addressing the Risk of Market Abuse
Without guardrails, legal trading practices can also cross the line into manipulation and fraud
In some situations, it's perfectly legal to disclose insider information or trade while possessing it—within strict parameters. It becomes unlawful when insiders exploit sensitive information they possess for personal gain, often drawing a very fine line for companies and employees.
Market Soundings
A Market Sounding is a process where firms share sensitive information with potential investors to gauge interest in a possible transaction before it is publicly announced. This process helps determine the potential size, price, and conditions of the transaction. Market soundings are particularly useful for initial public offerings and mergers and acquisitions to understand demand and set appropriate terms.
To mitigate risk that the information shared will be abused, issuers must follow strict guidelines set by regulators. These guidelines include obtaining consent from potential investors to receive inside information, maintaining detailed records of the information shared, and ensuring that the information is disclosed in a controlled manner.
Read more about Market Soundings including an update on new guidelines in Hong Kong
Analyst Briefings
Analyst briefings are meetings where company executives present information to financial analysts to provide insights into the company's performance, strategy, and future prospects. The goal is to ensure that analysts have accurate and up-to-date information to include in their reports, which can influence investor decisions and market perceptions. Often, these meetings are held in advance of earning announcements.
Analyst briefings can pose insider risks if not conducted properly. Companies must adhere to strict regulations regarding the disclosure of material information to ensure that all investors have equal access to significant data under rules, including Regulation Fair Disclosure in the U.S. To mitigate these risks, companies should obtain consent from analysts to receive potentially sensitive information before sending and ensure that any disclosed information is simultaneously made available to the public according to regulatory requirements.
Executive Trading Plans
Executive trading plans, including SEC Rule 10b5-1, are prearranged plans that allow corporate insiders, such as executives and directors, to buy or sell company stock at predetermined times and prices. These plans are designed to help insiders manage their equity holdings in a structured manner, ensuring that their trades are not influenced by material nonpublic information. By setting up these plans in advance, executives can avoid the appearance of trading on insider information and maintain compliance with securities regulations.
Read more about MNPI and Insider Risk from 10b5-1 Executive Trading Plans
You're not going to identify any of these risks from a spreadsheet
Regulators use sophisticated technology and analytics to monitor employee and firm trading in stocks, options and bonds for potentially suspicious activity. Tracking who has access to insider information on a static spreadsheet will not be enough to keep up.
Can your compliance program identify and mitigate concerns before the regulators do? And can you effectively control the flow of insider information across your firm to mitigate the risk of insider trading in the first place?
MCO provides firms with a single platform to combat fraudulent insider trading schemes enabling management of the flow of insider information across the firm combined with monitoring and surveillance of employee and firm trading activity across multiple data sources.
Ready to learn more? Contact us for a demo today!
