What is insider trading?
Insider trading involves the unlawful use of privileged information to trade securities. It typically involves three main elements:
Privileged information: This refers to precise, non-public, market-sensitive information. When disclosed, it can significantly affect a security's price. Examples include merger plans, financial results, regulatory updates or leadership changes. The information is "privileged" because it provides a major advantage to those who possess it.
Insiders: An insider is anyone with access to privileged information. This includes directors, board members and major shareholders, as well as employees, advisors and personal connections. Insider status often depends on the circumstances under which the information is obtained.
Trading based on privileged information: The offence occurs when insiders use this information to buy or sell securities before the public knows, gaining unfair advantages. Even sharing "tips" can count as insider trading. The scale of the transaction doesn’t matter—what’s illegal is the misuse of non-public information.
Forms of insider trading
"Front running": anticipating client orders
This unfair practice involves brokers or traders using their knowledge of client orders to trade for their own benefit before executing the client’s orders. By anticipating price movements, they profit at their clients’ expense.
Example: Citadel Securities (2020)In 2020, FINRA fined Citadel Securities $700,000 for front running between 2012 and 2014. Citadel's traders manually executed large client orders while also trading on their own behalf. This practice caused a conflict of interest, with client orders often sidelined.
"Scalping": creating artificial demand
Scalping occurs when an insider promotes a security they’ve already invested in, boosting its price by generating artificial interest. Once the price rises, they sell their holdings at a profit, often misleading their followers.
Example: Forster Winans (1985)Forster Winans, a Wall Street Journal journalist, pre-informed brokers about his stock market columns. The resulting price movements allowed brokers to profit, with Winans receiving a cut. Convicted of fraud and theft, he served 9 months in prison.
"Reverse insider trading": avoiding losses
In this scenario, insiders use privileged information to minimise losses. For example, selling shares before bad news is made public. Even without profit motives, this is still market abuse.
Example: Martha Stewart (2003)Martha Stewart sold nearly $230,000 worth of shares in ImClone Systems before bad news caused the stock to crash. Although her profits were modest, she was convicted of obstructing justice and served 5 months in prison.
"Daisy chains": cascading insider networks
Daisy chains involve the spread of privileged information through a network of individuals. Each person uses the information to trade advantageously, making these cases harder to trace.
Example: Poughkeepsie Hospital network (2023)In 2023, a group of doctors and their connections used insider knowledge of a pharmaceutical acquisition to make $4 million in profits. The chain included over 11 people, with sentences handed down for key players in 2024.
What sanctions does an insider trader face?
United States
Qualification: Crime ("Felony")
Criminal penalties: Up to 20 years of imprisonment for individuals
Financial and administrative sanctions:Restitution of illicit profits
Fines: up to $5 million for individuals, $25 million for companies
Prohibition from holding management positions
France
Qualification: Offence, Administrative violation
Criminal penalties: Up to 5 years of imprisonment
Financial and administrative sanctions:Fines: up to €100 million or 10 times the profits made
United Kingdom
Qualification: Crime ("Criminal offence"), Administrative violation
Criminal penalties: Up to 7 years of imprisonment
Germany
Qualification: Criminal offence ("Straftat"), Administrative violation
Criminal penalties: Up to 5 years of imprisonment
Financial and administrative sanctions:Fines: up to €15 million or 15% of turnover for companies, up to €5 million for individuals
The approaches to insider trading differ significantly between the United States and Europe, reflecting contrasting legal traditions.
The American approach to insider trading is subjective, focusing on the relationship between the insider and the source of the information. It is grounded in the concept of a "breach of fiduciary duty," which refers to the violation of an obligation of loyalty and confidentiality. A crime is considered to occur when someone uses confidential information in breach of this duty, which can stem from a specific relationship, such as between an executive and shareholder or lawyer and client, or from circumstances that create a trusted connection.
In contrast, the European approach is more objective and revolves around the possession and use of privileged information itself. Under this framework, simply holding and using such information to execute a transaction constitutes an offence, regardless of how it was obtained or whether a duty of confidentiality exists. The fault lies in the unfair informational advantage, as equal access to information is a fundamental principle.
Are cryptocurrencies affected by insider trading?
Yes, cryptocurrencies are highly susceptible to insider trading, as demonstrated by the high-profile Coinbase case. In April 2022, the US Department of Justice charged three individuals, including Ishan Wahi, a former Coinbase product manager, with insider trading involving token listings.
Wahi, who worked on Coinbase’s listings team, tipped off his brother and a friend about upcoming crypto listings on 14 occasions. They purchased these tokens on other exchanges before the public announcements and sold them at a profit once the listings went live. Coinbase’s reputation and market size ensured that any token listed on its platform experienced a sharp and immediate price increase. Between June 2021 and April 2022, the scheme generated over $1.5 million in profits. In May 2023, Wahi pleaded guilty and was sentenced to 2 years in prison.
Since this case, responsible exchanges like Bitpanda have enhanced internal controls to protect sensitive information. For instance, Bitpanda has implemented strict protocols to limit employee access to confidential data.
