Skip to content
Best Practices Employee Conflicts of Interest Insider Trading MNPI & Enterprise Conflicts Regulations

Casting Further Light on Shadow Trading

When a biopharmaceutical industry executive reportedly learned in 2016 that a rival planned to buy the company he worked for, he is alleged to have bought options in another competitor’s stock prior to the news of the acquisition going public. This led to him being accused by the SEC in 2021 of insider trading. But while the SEC prosecutes approximately 50 insider trading cases a year, this was not the typical misappropriation of information or tipper/tippee liability but an instance of what has since been dubbed ‘shadow trading’.

Shadow trading occurs when corporate employees use material non-public information (MNPI) – inside knowledge, such as details about upcoming M&A announcements – to trade securities of economically linked firms (for example, those of a competitor or sector peer) to circumvent insider trading laws. But rather than trading the underlying company shares, some individuals use vehicles containing the stock, such as exchange-traded funds (ETFs), to conceal insider trading.

Shadow trading isn’t limited to financial service firms but affects companies across a wide range of industries, and is most prevalent in the healthcare, technology, and industrial sectors. According to a recent academic analysis, shadow trading occurs in 3-6% of same-industry ETFs in a five-day window before an M&A announcement. This equates to at least $212 million in deal volume per year – $2.75 billion from 2009 to 2021 – and doesn’t include shadow trading that occurred prior to other (non-M&A) price-sensitive news announcements.


If the ETFs are highly liquid and traded frequently, detecting shadow trading – as the name might suggest – is more challenging. Unless they’re able to spend hours and days going through complex data, compliance teams can struggle to piece together hidden trades and transactions to uncover shadow trading and other insider trading violations.

In addition to access to a broad range of data identifying securities linked to business entities, industries and different economic activities type, compliance teams also require the means to analyze these dimensions against employee trades, MNPI, and watchlists, restricted lists or blackout lists. They also need to be able to restrict sector trading by bankers, traders, and research analysts, and perform sector surveillance to capture shadow trading scenarios. The key to monitoring shadow trading is compliance software and workflow automation.

With the right technology in place, shadow trading can be stopped at the source – negating the need for complex and almost impossible investigations. An automated platform allows the compliance team to screen trades before major events such as M&A; raise cases; and ensure that information is properly gathered and stored in case it has to be turned over to regulators for wider investigations. Automation is also crucial for ensuring that all employees receive the training they need to understand shadow trading and their individual responsibility to remain compliant, and are keeping up to date with regulatory developments.

With regulatory scrutiny of shadow trading only likely to intensify, firms should review their policies and procedures to ensure they cover this form of market abuse, update them as needed; and implement automated compliance that allows them to monitor* for, identify and ultimately prevent it.

*Read about monitoring for shadow trading in Steve’s Shadow Trading: How To Monitor For This New Compliance Risk blog.