There is a tantalising possible answer to the insider trading conundrum which may not completely eliminate unfairness, but is less damaging to the integrity, spirit and economic foundations of public stock market trading.
I used to sit on the board of a public company. I was scrupulously compliant with insider trading guidelines and laws and I assumed everyone else was. But I later became reasonably confident that one of my colleagues, honest in all other matters, had sold a few shares that he shouldn’t have. It was not much, but it was illegal.
Life went on, no one was really hurt. I assume he excused it in the same way as one might excuse the small deceits of tax minimisation. It was small-scale stuff. The problem, of course, is that small-scale stuff easily becomes large-scale stuff via the gravitational pull of the slippery slope.
The laws against insider trading are, and always have been, a triumph of legal fiction over human nature. We have constructed a world where we imagine that a board director is a vault, impervious to pressure, who returns home to his or her spouse and discusses only the weather, food and family.
This is, of course, nonsense.
The reality of material non-public information is that it doesn’t sit still. It moves. It is a gas that expands to fill the container of human gossip, and the container is always porous. An honest CFO might not trade, but he might leave a dinner table to take a call in another room, just barely overheard by his wife who mentions it to a cousin. The cousin, trying to impress a date, mentions it at a bar. The date, a junior analyst at a hedge fund, puts two and two together and buys an option.
Corporations maintain compliance departments of Byzantine complexity to prevent insider trading. Executives endure blackout periods. Lawyers hover over every earnings announcement. In the US (which has generally led the world in this sort of regulation), the Supreme Court has spent four decades trying to find a way to criminalise the leaks in a workable way. In the Dirks v Securities and Exchange Commission case it decided that a tipper must receive some personal benefit for the tip to be illegal. In the later Salman v United States it decided, unanimously, that a gift of confidential information to a trading relative could itself count as that benefit.
Which may sound sensible, but the problem is obvious. The leaks are not the exception – they live deep within the way societies operate. There is the laptop left open in the airline lounge, the lift conversation conducted at the volume of the mildly deaf, the printer in the corporate finance department, the IT contractor who saw the embargoed announcement at two in the morning while patching a server and thought, hmm.
Consider Justin Chen, sentenced to 27 months in prison last month. The lesson was not that insider trading is rare. Quite the opposite. Chen was not a company director or activist investor. He worked as a securities filing agent, one of the many invisible cogs that now sit between listed companies and the investing public. His crime was to exploit information that happened to pass across his desk before it passed across everyone else’s.
And then there are other layers – the private-jet flight plan, the sudden block booking at a hotel near the target’s headquarters, the lawyer’s intern who notices which files got moved. None of these indicates illegality, but they do indicate that some people have (or acquire) information that others don’t.
Information does not escape through a single breach in the wall. It seeps through the entire wall, continuously, in every direction.
This is not an argument that insider trading laws are completely pointless. They are not. Markets function only because investors broadly believe that they are participating in a reasonably fair game. Remove that confidence and participation shrinks and suspicion replaces trust. A market in which insiders may legally exploit privileged information quickly becomes a market that outsiders avoid.
Even so, for decades a vocal minority of economists and libertarians have looked at this mess and thrown up their hands. Their argument is simple – if cheating is so ubiquitous, and the information is going to leak anyway, why not just make it legal? Let the insiders trade, the logic goes, and the market will discount it. The problem with this argument is that no one wants to live in that world. A suboptimal and threadbare law is better than no law at all. A few people sent to prison each year almost certainly does cause someone else to think twice, and deterrence that only works sometimes is still deterrence.
Now, finally, after years of chasing ghosts and whispering spouses, the market has handed us a possible solution. It’s the year’s hottest new asset class.
It’s prediction markets.
We have spent the past two years watching Polymarket, Kalshi and their ilk transform from crypto-adjacent curiosities into legitimate pricing engines for the future. They have nailed election outcomes better than the pollsters. They price the probability of a recession, the outcome of the Oscars, a football match, in many cases beating the polls and the professionals and their mathematical models.
And now, they offer a tantalising possibility of an answer to the insider trading conundrum.
Imagine a world where the CFO, instead of a single whispered conversation on the golf course, logs onto a prediction market and buys “Yes” contracts on “Company X Acquires Company Y”. Is this illegal? Currently, yes. Should it be? I (and others) argue that it should not.
Here is the reason. The CFO would certainly profit on his or her insider knowledge, but the very placing of the bet shifts the odds instantly, and every other punter can see it and act. The information asymmetry, which the Securities and Exchange Commission tries so desperately to eliminate by shutting mouths, is eliminated by incentivising the mouths to open. It would leave the CFO with a successful bet, to be sure, but with far less economic impact than buying actual shares. He would not be taking the money from a less-informed pension fund manager and lining his own stockbroking account.
Someone is, of course, still on the other side of a prediction contract. But that someone is a voluntary speculator who has chosen to take a view on an uncertain event, and who can see the odds move against them within seconds of the CFO’s money arriving. That is a materially different relationship from the one between an insider and a fund obliged by its mandate to hold the stock.
There is an obvious objection to all this. The disclosure effect I am describing depends entirely on the bet being visible, and visibility depends on the size of the bet relative to the market. On a thin contract, a large insider position moves the price sharply and everyone watching can see it. On a deep and liquid one, the same position barely registers, and a patient insider could accumulate it as quietly as he currently accumulates call options.
The mechanism, in other words, works least well precisely where the money is largest. I do not think this sinks the idea, but it does shape it – any such regime would need position-disclosure thresholds and other constraints, so that the market can see not only that the odds have moved but that they have been moved by someone who knows.
In short, prediction markets – the great, impersonal aggregators of the wisdom of crowds – immediately reflect an aggregation of information. The little guys are not at such a huge disadvantage. They may not know why the odds are moving, but they know that someone, somewhere, knows something. It is the democratisation of suspicion.
It is fair to ask what the ethical difference is between profiting on insider information on the stock market versus the prediction market. It is this: the current system allows the information holder to profit quietly and in the shadows, leaving the rest of the market to wonder why they are losing money. A prediction market makes the knowledge public instantly. They are not the same thing. They may not completely eliminate unfairness, but they are less damaging to the integrity, spirit and economic foundations of public stock market trading.
Nothing can completely level the playing field. But prediction markets may produce something considerably better than today’s peculiar equilibrium, where everyone pretends sensitive information remains perfectly secret despite overwhelming evidence to the contrary. DM
Steven Boykey Sidley is a professor of practice (ex-JBS, University of Johannesburg), a partner at Bridge Capital and a columnist-at-large at Daily Maverick, where he writes the weekly Crossed Wires column. His new book, It’s Mine: How the Crypto Industry is Redefining Ownership, is published by Maverick 451 in South Africa and the Legend Times Group in the UK/EU, available now.
