Learn how employee pre-clearance procedures can protect you and your company from allegations or ill-effects of insider trading, and why it’s essential for maintaining regulatory compliance.
Introduction
In today’s fast-paced world, investors are always on the lookout for an edge to maximize their profits. But when company insiders use their privileged access to buy or sell securities, it creates an uneven playing field. Ultimately it can harm the public’s trust in the financial markets. That’s why regulators take insider trading so seriously and impose heavy penalties on those who engage in it (read about who and why it hurts).
To maintain integrity and prevent insider trading, many companies have implemented pre-clearance procedures for employee trades. These procedures require employees to seek approval from designated compliance officers before buying or selling securities, even if the trades are unrelated to the company.
For example, imagine an employee of a biotech company who learns that the company’s experimental drug has passed a crucial FDA trial. If the employee were to use this non-public information to purchase shares in the company before the news becomes public, it would be considered insider trading. However, if the employee were to seek pre-clearance from the compliance officer, the officer would likely prohibit the trade, as it would be based on insider information. The employee would then have to wait until the news becomes public before trading, at which point the information is available to everyone.
In a nutshell, pre-clearance is the process of obtaining approval from a designated compliance officer before an employee can buy or sell securities in the company’s stock. The compliance officer reviews the employee’s request and determines if the trade complies with the company’s insider trading policy. If the trade is approved, the employee can proceed with the transaction. If the trade is not approved, the employee must refrain from trading until further notice.
Elevate Your Pre-Clearance Process
Effective pre-clearance processes are crucial to prevent legal and reputational risks associated with insider trading. Compliance teams need to go beyond a simple “yes” or “no” response and implement streamlined procedures. To optimize your pre-clearance process, we recommend implementing the following steps.
1. Crafting Rules to Ensure Trading Compliance
Incorporating pre-clearance rules into a company’s code of ethics, conduct, or trading policy is essential for maintaining compliance. Companies must develop pre-clearance rules that fit their unique business requirements, such as a restricted list of companies, a blackout period on trading, or restrictions on certain types of securities. These rules can be implemented into the company’s policies and used during pre-clearance to approve or deny personal trades.
2. Keep a Pulse on Employee Trading Activity and Holdings
To effectively manage the risk of insider trading, compliance teams should establish a clear understanding of each employee’s current holdings and interests. Requiring employees to regularly report and attest to their earnings and holdings can provide a real-time view of their portfolio, enabling accurate and compliant decision-making. This also helps to maintain an audit trail that demonstrates the company’s commitment to regulatory compliance.
3. Strengthen Your Pre-Clearance Process Against Unethical Trading Practices
It is important to include measures in pre-clearance rules to prevent front-running and tailgating. These practices occur when an employee intentionally delays making a client’s big trade until after executing their own personal transaction in the same product. By implementing such provisions, compliance teams can deter unethical behavior and ensure a fair and transparent trading environment.
4. Monitor Employee Trading Activity with Compliance Checks
An effective approach is to create an insider list of employees with access to price-sensitive information and cross-reference it against employees attempting to make trades while in possession of inside information. This helps to identify potential violations and maintain a fair and transparent trading environment.
Pre-clearance is an important procedure for compliance and protection against insider trading. The cases of insider trading in India (read our blog about this here) and other parts of the world demonstrate the need for vigilance and adherence to regulatory requirements. By implementing pre-clearance procedures and investing in the right tools, companies can prevent unauthorized access to confidential information and mitigate the risks associated with insider trading. Ultimately, pre-clearance plays a vital role in maintaining the integrity of capital markets, and companies must prioritize its implementation for the greater good of investors and the economy at large.
References:
https://www.thermaxglobal.com/wp-content/uploads/2019/12/FAQs-on-Insider-Trading.pdf
