Insider trading happens when a person or company uses information that is not available to the public to make a profit or avoid losses in financial markets. 

The US Securities and Exchange Commission prosecutes approximately 50 insider trading cases per year, with those caught facing up to two decades behind bars. 

However, a study of the US markets estimates that insider trading occurs in one in five mergers and acquisition events and in one in 20 quarterly earnings announcements. These estimates imply that there is at least four times more actual insider trading than there are prosecuted cases.

“Therefore, what we see in prosecutions is the tip of the iceberg. We further estimate that the probability of detection/prosecution of insider trading in both M&A and earnings announcements is approximately 15 per cent,” research co-author finance professor Talis Putnins noted. 

The UTS professor said that while it is generally agreed that prosecuted cases reflect only a fraction of all illegal insider trading, opinions about the total amount of illegal insider trading have varied widely.

“While some regulators downplay the prevalence of undetected insider trading as negligible, other observers argue it is rampant,” Professor Putnins said. 

“Given the substantial penalties for convicted insider trading violations, including financial, reputational and potential jail time, and smaller potential profits, the probability of detection and prosecution has to be relatively low, otherwise no one would attempt it.” 

In order to study insider trading, the UTS professors developed a model to predict its extent based on detailed information from all prosecuted insider trading cases in the US over the last 21 years, combined with data on daily price and trading activity on US stock markets.  

They noted that insider traders would take advantage of volatile stocks as a way of hiding their profits. 

“We also found that insider trading is more likely when there is more liquidity, which allows insiders to conceal their trades and earn higher profits, and when the value of information is larger as measured by market reactions to the announcement of the information,” Dr Vinay Patel, senior lecturer in finance at UTS business school, found. 

“So, more volatile stocks that see greater share price movements, and popular stocks that attract a high volume of trading, are more frequent targets for insider trading.”