What Is Insider Trading? Common Causes and Solutions

What Causes Insider Trading?

While greed might be the go-to explanation for inside trades, the reality is much more complicated than that. Take it from Tipper X, a former hedge fund analyst convicted of insider trading. Tipper X, whose real name is Tom Hardin, began working with the FBI to nab Wall Street criminals and is now a well-known crusader against insider trading. According to Hardin, there are several different factors that may contribute to illegal trades.

Following the Crowd

The only thing worse than acts of misconduct is normalized acts of misconduct. In Hardin’s experience, many insiders tried to justify their illegal trades because they believed “everyone was doing it.” In many cases, insiders would even talk openly about their illicit trades and tip off friends, family, and colleagues with nonpublic information. However, it’s important to keep in mind that what’s popular isn’t always the right thing to do. As your mother might say, “if everyone jumped off a bridge, would you?”

Assuming Insider Trading is a Victimless Crime

Insider trading is easy to rationalize because perpetrators can’t see the impact it has on others directly. While insider trading may not produce victims in the “traditional” sense, it can still harm everyday people with its unfair impact on the market. Essentially, illegal trades manipulate the market, lower market liquidity, and allow the elite and well-connected to profit at the expense of regular stock traders. In addition, insider trading leads to a major loss of trust in your business and the market as a whole. In order to preserve fairness and trust in your company, employees need to understand that insider trading is not a victimless crime.

Self-Preservation

The decision to buy and sell stock can be boiled down to two main factors: gaining profits and avoiding losses. However, loss aversion is often tied to more than just money. Many employees get sucked into shady trading because they fear losing their jobs or social reputations. In Hardin’s case, he wound up taking an inside trading tip because his boss told him the company would not survive without some major cash inflow. “It was also made clear to me my job was on the line,” Hardin says, “That if I didn’t start to produce, I’d be fired.” When the pressure to generate short-term profits outweighs the company’s long-term investment in ethics, employees often turn to unethical practices as an act of self-preservation.

“Ostrich” Mentality

Like an ostrich, many employees choose to bury their heads in the sand and ignore misconduct rather than put a stop to it. This mentality can be easy to justify—after all, if you’re not directly involved and the business is profiting, what’s the harm? The problem is that willful ignorance allows misconduct to grow and spread freely across an organization. According to Hardin, management needs to be especially vigilant and willing to question dubious ethics. Otherwise, it sends a message to employees that says, “‘Don’t tell me. I really don’t want to know whatever it is you’re doing.’”

Weak Compliance Cultures

Perhaps the #1 reason businesses get caught up in insider trading? The company’s overall compliance culture is weak. Companies need to put ethics and compliance at the forefront of all their decision-making. Otherwise, employees will implicitly understand that compliance isn’t a priority, opening the door for more compliance risks down the road. Creating a robust policy against illegal insider trading, investing in training, and regularly measuring training results are good first steps towards creating a more compliant work culture.