An academic study has found that as much as 85% of illegal insider trading goes undetected, revealing a massive enforcement blind spot in U.S. stock markets.
The paper uses structural estimation models to uncover the true scale of insider trading, correcting for the fact that detected cases represent only a non-random, visible subset of a much larger problem.
“We estimate that the prevalence of illegal insider trading is at least four times greater than the number of prosecutions.”
Analyzing 21 years of U.S. market data (1996–2016), the study estimates that insider trading occurs in approximately 19.8% of mergers and acquisitions (M&A) and 5.1% of earnings announcements. In contrast, the detection and prosecution rates hover around 13–14%, meaning only about 1 in 7 violations are caught.
The study introduces a two-stage “detection-controlled estimation” model that isolates the decision to trade illegally from the probability of being caught. According to the findings:
- Higher liquidity stocks are more likely to see insider trading, as the volume helps mask unusual activity.
- More valuable information, such as high-return announcements, correlates with a higher likelihood of illegal trading.
- More people with access to private information (e.g., legal/financial advisors) increase the chance of leaks.
But even when these risk factors are present, the study finds regulators rarely detect the trades unless there are strong price or volume anomalies right before a public announcement.
Enforcement Gaps and Whistleblower Impact
The authors highlight systemic limitations in regulatory capacity. While the U.S. Securities and Exchange Commission (SEC) has prosecuted roughly 50 insider trading cases per year, its model suggests hundreds go unnoticed annually.
Notably, detection rates doubled after the SEC Whistleblower Program launched in 2010, with detection around earnings trades rising from under 10% to nearly 30% by 2016.
The program’s deterrent effect is also evident: insider trading prevalence declined during the same period.
Echoing classical economic theory, the study finds that insiders modulate their trading behavior based on perceived risk. When detection probabilities increase, due to stronger surveillance or aggressive prosecutors like Preet Bharara, insider trading falls. Conversely, legal rulings that lower prosecution odds lead to spikes in undetected activity.
The study paints a sobering picture of capital markets where insider trading is far more pervasive than public records suggest.
It calls for enhanced surveillance, smarter allocation of enforcement resources, and regulatory reforms that account for strategic behavior and systemic concealment.
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CITATION:
Patel, Vinay, and Tālis J. Putniņš. How Much Insider Trading Happens in Stock Markets? SSRN, 2023. https://ssrn.com/abstract=3764192
