Should insider trading policies bar “shadow trading”?

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There’s been a lot written this week about whether the SEC has gone too far in pursuing an Enforcement case against an employee who had material nonpublic information about a merger – so he bet on the stock of a peer company of the target – presuming that announcement of the deal would boost all stocks in that sector. That’s a good bet. [Sidenote – this enforcement action is taking place five years after the trade in question. That’s a long time.]

The legal question is whether this is “misappropriation” under insider trading lore, as noted by Liz Dunshee in this blog. Cydney Posner’s blog explains how this “shadow trading” has been the subject of a study that shows that shadow trading was “significantly higher when source firms do not prohibit employees from engaging in shadow trading relative to when they prohibit shadow trading. Although mostly untested in the U.S. judicial system, such company regulations arguably create a fiduciary responsibility for employees not to exploit their private information in economically-linked firms.”

This raises a question: should you be tweaking your company’s insider trading policy to bar employees from this kind of trading? “Prohibiting transactions in the securities of other companies” is a provision found in some insider trading policies. It seems prudent to me to do so. It certainly seems smart from a reputation standpoint, you want to keep your staff from being in the news for this sort of thing. But there’s also that slippery slope – once someone makes a few thousand bucks off this kind of thing, I think they start looking around for other ways to make easy money and they might fall into some schemes that aren’t in such a gray area…