The SEC is always working to ensure financial corporations are complying with the law, and few areas seem to draw as much attention – from the public and from regulators – as insider trading. Despite long-held guidelines around insider trading, hardly a month goes by without headlines around the country declaring another insider trading scandal.
Without clear protections in place, financial advisory firms are at risk of being held liable in insider trading cases – even if it was done without their knowledge. As a result, we encourage you to study up on the subject and determine the insider trading policy best practices fit for your firm.
What qualifies as insider trading?
Unfortunately, even financial professionals can sometimes be uncertain of what qualifies as insider trading, so let’s begin with a definition. The SEC’s own Investor.gov defines insider trading as “buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.”
In other words, if an adviser is privy to information that the general public isn’t and then buys or sells stock accordingly, that’s insider trading.
Is it the same as insider buying?
Insider buying is when someone buys stock of the company they work for. The big difference between insider trading and insider buying is that one is illegal (trading) and the other isn’t (buying) – as long as it’s based on public information.
What does insider trading look like in 2023?
While the definition of insider trading hasn’t changed, how it plays out in real life is constantly shifting with each new case. Whether it’s a hacker accessing investment recommendations the day before they go out to the public, a CEO profiting off a crypto rebrand, or a politician getting the inside scoop on a merger during a golf outing, insider trading comes in many forms.
Insider trading occurs at two levels:
- Firm-wide – when a trader or portfolio manager uses insider info to attempt to boost performance and benefit the firm.
- Employee – when an individual trades on insider info for their own profit.
Financial firms are tasked with preventing both, which can be quite overwhelming.
Rule 10b5-1 gets an update
Rule 10b5-1 of the Exchange Act provides a set of guidelines for how investment advisory firms can free themselves from liability when insider trading occurs by an employee or client.
Despite a clear definition and instructions on how to comply, the SEC noticed that a lot of funds that technically complied with Rule 10b5-1 were still abnormally profitable. In December of last year, the SEC updated Rule 10b5-1, which aims to further close loopholes these corporations may be exploiting. The new amendments to Rule 10b5-1 include additional disclosures, cooling off periods and additional restrictions.
Insider trading policy best practices in 2023
As with many areas of compliance, one of the best ways to protect your firm from insider trading is to make sure everyone knows the rules and then employ effective monitoring to ensure the rules are being followed.
1. Make sure you have clear policies and procedures in place
Your firm’s policies and procedures are ground zero in the effort to protect your company from the threat of insider trading. Review Rule 10b5-1 with your team and develop guidelines that make the boundaries clear so your employees know exactly what’s allowed and what isn’t.
2. Get the right tech in place
The right technology can do wonders for providing an affirmative defense against liability if and when insider trading occurs. By ensuring that your people have access to reporting tools and know how to use them, you can prove that your firm has done its due diligence in complying with the law.
The trade monitoring solution you choose should enable your firm to monitor firm-level and individual trades, conduct regression testing and spot trends before it’s too late. On the individual side, you want to be able to incorporate and consider trading activity in the context of political contributions, gifts, attestation responses and more. Your compliance technology could also play a key role in helping you meet books and records requirements and prepare for regulatory exams.
3. Build a culture of compliance
Building a culture of compliance at your firm is a top-down effort. If you’re not promoting compliance at events and highlighting your policies and procedures frequently, then you cannot expect team members across your company to give compliance much thought.
We recommend taking a “trust but verify” mentality across the board – no matter how high up an individual is. When lower-level employees see higher-level employees being held to the same standards, they will be far less likely to feel that they can get away with bending the rules.
To build the right culture, compliance needs to be front of mind in every area of your practice – from hiring to performance reviews and beyond.
Is your firm protected from insider trading?
There is no silver bullet that can entirely eliminate the risk of insider trading, no matter how big or small. But you can control your policies, tools and culture in a way that diminishes it as a possibility.
ComplySci offers employee compliance tools to help financial institutions mitigate insider trading risk. Request a demo today.