The preservation of healthy financial markets relies on having safe, properly regulated environments where investors can confidently trade securities. Unfortunately, high-profile insider trading cases have grabbed the spotlight in recent years.
Financial firms have an obligation to consumers, and the broader financial market, to actively monitor and take action against insider trading. Complexities can arise, however, when firms have valid personal trading policies that individuals may take advantage of through use of Material Non-Public Information (MNPI) and unethical behaviour.
The Role of MNPI in Insider Trading
Cases of insider trading have often been seen where a person privy to MNPI within their organisation has either made a trade or passed information to a friend to a relative to make a trade, which financially benefits these parties.
MNPI is confidential information about an organisation and its dealings that may include information such as initial public offerings (IPOs), mergers and acquisitions, executive and board member changes, and stock buyback schemes. In short, the data is considered “material” if it can influence an investor’s decision to buy, sell, or hold the company’s securities.
When Personal Trading Becomes Insider Trading
Conflicts of interest arise in personal trading (also known as personal account dealing) when securities transactions are made for an individual’s direct or indirect benefit by leveraging an unfair advantage. Personal trading consequently becomes insider trading when an individual takes advantage of MNPI to anticipate changes that help them profit (or, in some cases, avoid losses) from stock and securities trading activity.
Those engaging in insider trading may underestimate (or perhaps disregard) the severe consequences of their actions, with the wider-reaching effects on economic markets even more sizable. Financial markets rely heavily on liquidity which makes it easy to trade securities without affecting price. Unfortunately, when markets are manipulated, liquidity is impacted, and investor returns are compromised.
Additionally, consumer confidence in financial markets can be severely damaged. As insider trading activity is uncovered, consumers can perceive markets to be “rigged” and their investment opportunities to be diminished.
The OECD reports that direct and indirect public investor ownership of the global stock market capitalisation sits at around 14%. So when investor confidence is hurt, overall economic growth can also take a massive hit.
Minimising the Risk of Insider Trading
While not all personal trades are likely to result in cases of insider trading, proactive monitoring and management of personal trading activity are critical. See the following steps that every compliance department can take to reduce risk.
Implement robust policies and procedures:
- Clearly define acceptable and unacceptable behaviour when employees engage in personal trades.
- Outline how monitoring and reporting will happen on all personal trading activity.
- Specify how you will regulate the trading of securities by key management personnel, directors, executives, and anyone with access to MNPI.
Deliver training across your organisation:
- Communicate your policies with training mechanisms that let employees raise questions or create dialogues about ethical and compliant trading behaviours.
- Help employees understand the consequences of insider trading and how they can avoid conflicts of interest.
- Provide guidelines for reporting potential conflicts of interest and communicate policies for the confidentiality of “whistleblowers” identities.
Define and communicate blackout periods:
- Make sure everyone understands blackout periods and trading windows to prevent anyone in possession of MNPI making personal trades during times when that information is likely to create unfair gains from transactions.
- Remind staff that blackout periods are commonly observed before the release of publicly-traded company earnings reports, M&As (mergers and acquisitions), or strategic investment activities.
- Ensure all employees know when blackout periods and trading windows will commence and end.
Record and maintain insider lists:
- Make it mandatory within your personal trading policy for employees to disclose any conflicts of interest (such as possession of MNPI) and inform compliance teams when changes happen.
- Maintain a list of those with MNPI, including employees, contractors, advisors, accountants, and other resources who may come in contact with sensitive information during business dealings.
- Have accurate data about contact details, why these people are on the insider list, and dated additions and changes.
Have a pre-clearance process in place:
- A documented pre-clearance process enables employees to request permission to make personal trade transactions of the organisation’s securities, and ensures that personal trades avoid conflicts of interest.
- The process also allows the relevant organisational authority, e.g. chief compliance officer, chief financial officer, or other senior officers, to properly evaluate whether the personal trading activity should be approved or denied.
Monitor personal trading activity:
- Make it part of your procedures to monitor trading activity continually.
- Pay close attention to irregularities in employee trading patterns, which can sometimes be an early indicator of insider trading activity.
- Follow up and review changes and irregularities, as they may uncover broader patterns occurring over extended periods.
By implementing these steps, you can minimise conflicts of interest and maintain trust within your organisation, its clients and stakeholders.
Regulatory Technology (RegTech) solutions, such as MCO’s Personal Trade Manager (PTM), can also be implemented to automate these processes in line with your firm’s policies. Compliance resources can save significant time while ensuring full audit trails of all requests, approvals, and denials by using a compliance management software solution instead of outdated manual processes.
Monitoring and Managing MNPI
All communications between sell-side brokers and buy-side participants must be recorded, logged, and readily available to ensure dealings are handled ethically. Proper record-keeping of voice and eCommunications are a vital part of understanding if MNPI has been used inappropriately within securities transactions to identify issues and enable further actions to be taken.
Recording and Maintaining Insider Lists
A list of people who have access to MNPI is called an “insider list”. These lists can include employees and anyone outside the organisation who has access to insider information, such as contractors, advisors, accountants, and other resources who may come in contact with MNPI during business dealings.
Your records should maintain accurate information about these people’s contact details, why they are on the insider list, and dated additions and changes to the list.
It is also crucial to record when people are removed from insider lists to identify when they stopped being in possession of MNPI. Insider lists are vital when responding to requests for information from regulatory bodies during market surveillance activities.
Building Efficiency into Insider List and MNPI Management
Insider lists and tracking of employees with MNPI can become complex and labour-intensive to manage through spreadsheets and disconnected systems. So when further investigation is needed or when regulatory bodies request information, systems that automate the capture, maintenance, and reporting of your data offer considerable benefits to compliance teams.
When implementing or reviewing the appropriate compliance management solution for managing insider lists and MNPI, ensure that it will:
- Capture data including MNPI summary information, details of who had access to MNPI and when, and dated histories of when access occurred, changed, or was relinquished.
- Allow for separate’ event insider’ lists to capture details of people given temporary access to information based on events, such as deals, corporate events, and publications of financial statements or profit warnings.
- Allow for separate ‘permanent insider’ lists to track anyone with access to inside information at all times.
- Support a review process for compliance teams to formally validate the MNPI being monitored and reported.
- Quickly produce accurate reporting as required by the regulatory bodies of your region(s).
- Centralise and streamline information. With a centralised solution that includes insider list and MNPI management as part of a larger compliance suite, you’ll minimise the number of systems compliance personnel need to learn and navigate daily, further boosting productivity.
The Technology to Identify and Address Insider Trading Risk
Conflicts of interest have attracted increased focus for many regulators around the globe in recent years. And simply having systems in place to monitor potential issues is no longer enough. Your technology must be adequate and capable of proactively flagging suspicious activity to compliance teams and quickly producing reporting and documentation to confirm or disprove assumptions of wrongdoing.
MCO’s integrated compliance management suite enables firms to identify conflicts of interest more efficiently across their organisation. MCO provides a consolidated platform for compliance teams to manage areas of potential conflict, including:
- Personal account dealing
- Trade surveillance
- MNPI disclosure
For more information about how MCO’s innovative compliance management platform can help your firm effectively manage conflicts of interest, schedule your no-obligation meeting with MCO APAC Director, Kelly-Ann McHugh, or request your demo now.
Uncover the strategies you need to reduce risk and strengthen your overall compliance management process.
Access your Ultimate Guide to Conflicts of Interest or your Know Your Employee Brochure for more information.