The Placebo Effect of Insider Dealing Laws

Our recent article, The Placebo Effect of Insider Dealing Regulation, forthcoming in the Oxford Journal of Legal Studies, explores the curious case of how regulators in the EU, UK and United States treat two forms of insider trading—what we call 'traditional insider trading' and 'shadow trading'. The former, familiar to all, involves corporate insiders trading in the shares of their own firm. The latter, less familiar and often legally overlooked, involves trading in the shares of 'economically connected firms', such as competitors and suppliers.

Both forms of insider trading involve exploiting material non-public information. Both harm uninformed investors. Both affect price accuracy and corporate governance. And yet, only one is pursued with regulatory zeal.

Traditional insider trading is the poster child of securities law enforcement. Shadow trading, by contrast, is formally prohibited in Europe and the UK but never prosecuted, and contractually negotiable in the US. A legal system that bans one and ignores the other is like locking the front door while leaving the windows wide open.

Why this selective prohibition (the US) or enforcement (the UK and the EU)?

We offer an answer that is, admittedly, a touch cynical—though no less plausible for it. What if regulators are not inept, but instead brilliantly attuned to 'investor psychology'? Public enforcement of traditional insider trading offers a 'placebo' effect: retail investors see headlines, feel protected, and continue to participate in public markets. Shadow trading, meanwhile, remains largely invisible to them—and thus does little to undermine their trust. Enforcement can be selectively aggressive, while insiders continue to profit. Everybody wins. Except, of course, the retail investors.

You might suspect we’re being overly dramatic. But we bring some evidence to support our thesis. We surveyed 200 US retail investors, presenting them with three scenarios where both traditional and shadow trading could profitably occur. While 62% identified a traditional insider trading strategy, just one person—0.5%—identified a shadow trading strategy for each of the scenarios, and just a few of them identified one for at least one of the scenarios.

This matters. If outsiders don’t perceive shadow trading as a threat, then it doesn’t shake their confidence. If it doesn’t shake their confidence, they stay in the market. And if they stay in the market, firms get liquidity and insiders get their profits. Meanwhile, the information contained in shadow trades improves price accuracy. Regulatory win-win?

Perhaps. But from an economic perspective, there is no good reason to regulate traditional insider trading aggressively while tolerating shadow trading. The effects on market liquidity, information production, and governance incentives are no less severe in shadow trading. And bargaining over such trades—if allowed—would involve not just one firm, but entire supply chains. Transaction costs skyrocket.

And yet, US law treats shadow trading (almost) as an optional clause in a compliance manual. EU and UK regulators, though nominally stricter, appear to have been consistently disinclined to go after this form of market abuse.

Who benefits from this design? The answer may be found in public choice theory. Our framework suggests that corporate insiders, asset managers, and market intermediaries take advantage from the status quo. Insiders get to trade—just not too visibly. Active funds and hedge funds, if close enough to information, can do the same. Passive fund managers, meanwhile, rely on public trust to attract flows and benefit from improved price efficiency. Even if none of these actors consciously lobbied for the current regulatory design, they have little reason to challenge it.

In short, the status quo may be less a regulatory accident than an equilibrium: a legal placebo that preserves confidence, permits profitable trading, and offends no powerful constituency.

Of course, this arrangement depends on shadow trading remaining... in the shadows. As cases like SEC v Panuwat gain publicity, and as firms tighten internal policies, the spotlight may shift. If investors begin to realise that they are routinely being traded against by insiders from other firms, the placebo effect may wear off. What happens then is anyone’s guess.

Until that day arrives, insider dealing regulation remains a masterclass in managing perceptions: a system that enforces fairness where it’s most visible and allows profit where it's least understood. Efficient? Perhaps. Fair? Hardly. But undeniably brilliant in its design.

This write-up is based on a first draft by ChatGPT, based on the authors' original article and subsequently edited by the authors.

The full paper can be accessed here.

Luca Enriques is Professor of Business Law at Bocconi University and a Visiting Research Fellow at the Institute of European and Comparative Law, University of Oxford.

Yoon-Ho Alex Lee is Professor of Law at Northwestern Pritzker School of Law.

Alessandro Romano is Assistant Professor of Law at Bocconi University.