Insider Trading Regulations? Just a Legal Placebo
In university classrooms and in the speeches of supervisory authorities, insider trading is presented as absolute evil: executives and insiders illegally exploit confidential information to enrich themselves at the expense of ordinary investors. A threat, we are told, to the integrity of the markets and the confidence of savers.
Yet a new study published in the Oxford Journal of Legal Studies by Luca Enriques and Alessandro Romano (both from Bocconi’s Department of Legal Studies) with Yoon-Ho Alex Lee (Northwestern University) strongly challenges this reassuring narrative. According to the three scholars, insider trading rules function as a kind of legal placebo: they make investors believe they are protected, when in reality the “clever ones” still have ample room for speculation.
The study starts from an almost trivial consideration. Those who know important news about their company in advance can enrich themselves not only by buying or selling their company’s shares, but also by exploiting the same data to trade in related securities. This was the case, the authors point out, with the launch of Disney+: an insider could have taken advantage either by buying Disney shares before the announcement or by betting against Netflix, which lost eight billion in market capitalization in a matter of minutes. The second, more subtle strategy has a name: shadow trading.
And here lies the paradox. Traditional insider trading and shadow trading have identical effects, both on the functioning of markets and on managers’ incentives. But regulators treat them in radically different ways. In Europe and the UK, shadow trading is formally forbidden, yet there is not a single instance in which it has actually been discovered and punished. In the US, on the other hand, its regulation is largely left to private negotiations between companies and employees. In essence, managers are prohibited from touching their own company’s shares, but it is often tolerated that they operate “in the shadows” on related securities. “The ban on traditional insider dealing,” the authors write, “gives investors a false sense of security, while insiders can still take advantage through shadow trading.”
Why this disparity? The answer, the authors explain, is disarming: investors perceive only traditional insider trading as a threat. This is demonstrated by a survey of 200 American investors: 62% indicated classic insider trading as a source of illicit gains, while only 0.5% cited shadow trading. “Investors only recognize traditional insider trading as a harmful practice,” the researchers observe, “while almost no one identifies shadow trading as a profitable strategy.”
This is where the ban acts as a placebo: the markets appear protected, confidence remains high, and investors continue to participate. Meanwhile, insiders still have an escape route to monetize confidential information. It is no coincidence that the authors talk about “fraud against the market, rather than market fraud.”
One disturbing fact remains: what should protect savers ends up benefiting well-organized professionals—insiders, hedge funds, institutional investors—leaving small investors with the illusion of being protected. It is possible that this system, however deceptive, is even more efficient than a total ban, because it preserves the confidence of ordinary investors and, at the same time, allows information to be quickly reflected in stock prices. But the bitter irony remains: what appears to be protection is, in reality, largely a sham.
Luca Enriques, Yoon-Ho Alex Lee, Alessandro Romano, “The Placebo Effect of Insider Dealing Regulation”, Oxford Journal of Legal Studies 2025, Vol. 45, No. 3 pp. 753–774, DOI https://doi.org/10.1093/ojls/gqaf019
