Laying the Groundwork for Future Shadow Trading Enforcement

The U.S. Securities and Exchange Commission (SEC) established the idea of shadow trading as a punishable offence in 2021 with a case against a pharmaceutical company executive for trading in a competitor’s stock ahead of a merger. The case focuses on insiders with non-public information trading in competitor’s or closely aligned companies’ stock to evade insider trading restrictions.

The defendant in the case brought a motion for summary judgment, which was denied on November 20, 2023. The court concluded that information can be classed as “material” to more than one company and that information does not need to come from the issuer of the security to be material. The court concluded that non-public information as it relates to one company could be material to another, provided a “market connection” between the two companies exists and can be proven.

This denial opens the door for the SEC to pursue other cases of shadow trading.

Our guidance

Ideally, firms will already have a process in place to monitor for client and employee personal trading in a security ahead of an aberrational price movement. In light of this case, firms should consider expanding their investigation process to assess whether the firm and/or relevant employees possess confidential information about another comparable issuer that could be material. Enhancements to the investigation process could include, for example:

• Checking the firm’s restricted list to see if the firm is in possession of MNPI about a comparable issuer.
• Reviewing whether the firm has any non-disclosure or confidentiality agreements in place with respect to a comparable issuer.
• Reviewing whether investment personnel met directly with a comparable issuer or met with a research consultant to discuss a comparable issuer.
• Reviewing firm trading in comparable issuers.

Additionally, firms involved in private markets transactions that intentionally receive confidential information about securities issuers may consider taking additional steps to prevent shadow trading. For example, these firms may consider proactively restricting any public issuers identified as market comps when evaluating a potential transaction.

How we help

ACA’s ComplianceAlpha^® regulatory technology (RegTech) platform contains a number of solutions to scan for and identify shadow trading risks, all in one dashboard. It can help you detect risk through enhanced surveillance capabilities, derive deeper insights through connected data, and simplify the submission of requests and disclosures for employees. By bringing together risk and compliance activities, surveillance, testing, and analytics in one platform, ComplianceAlpha provides a unified view of risks and behavior across a firm.

Within ComplianceAlpha, you can leverage key solutions to support your firms risk management and surveillance tasks. These solutions include:

• Market Abuse Surveillance (MAS) solution which helps firms manage their trading risk in a way that meets regulatory expectations in line with industry best practices. MAS identifies items of interest (IOI) based on algorithmic searches across multiple asset classes, including equities, fixed income, currencies and derivatives. It tests portfolios after meetings with expert networks or issuers and drills down into your firm’s trading activity when compared to corporate actions, significant price movements, and important events such as expert network meetings or issuers or political intelligence research.
• Employee Compliance solution that streamlines the management of your firm’s personal trading surveillance, employee certifications, outside business activity reporting, and more. It helps your firm’s compliance team quickly and accurately identify potential conflicts of interest while simplifying the submission of approval requests and disclosures for employees.
• eComms Surveillance software which can help you manage your employees’ use of electronic platforms to communicate with colleagues and clients and test for the use of off channel communications. Our solution is an integrated, machine learning-based surveillance and investigations platform that combines mobile and voice data for a holistic view of potential behavior risks across your firm.
• Control Room feature of ComplianceAlpha that manages multiple restricted lists, including historical records, as companies move across restricted and grey lists for a firm and uncover information including the type of conflicted activity, linked companies, and linked employees.

See our RegTech solutions in action

Click here to watch on demand demos that illustrate ComplianceAlpha's functionality and explains how it can elevate your firm's daily compliance functions.

To learn more about this case, or how ACA can help you detect shadow trading within your firm, please reach out to your ACA consultant or contact us here.

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