How Blockchain Can Fix the Problem of Insider Trading

Insider trading may sound bad. But where the law is concerned, it’s the letter that counts.

In the 2016 Supreme Court case Salman v. United States, the Court cleared up some fuzzy loopholes in previous wording around the rules of insider trading. And the rules seem to leave room for creative use of blockchain investing platforms.

On the heels of the Salman decision, several questions about the boundaries of insider trading have been cleared up. But an important one remains, and it’s one that leaves a lot of room for collaborative investing on the blockchain.

Salman Solidified Insider Trading Parameters

The Salman decision found a grocer named Bassam Salman guilty of knowingly trading on confidential information and profiting upwards of $1.5 million after acting on an insider tip from his brother-in-law, an investment banker at Citigroup.

Salman’s defense argued that his brother-in-law didn’t benefit from the tip, referring to a previous court case, United States v. Newman, which seemed to leave open the possibility of legal insider trading if the tipper wasn’t compensated (monetarily or otherwise).

But the Court nixxed that defense, falling back on a still previous case, 1983’s Dirks v. SEC, in which the “personal benefit” incurred by the tippee is implied anytime s/he “makes a gift of confidential information to a trading relative or friend.”

Salman didn’t pay his brother-in-law for the insider tip, but because he’s family, the Court still sees the brother-in-law as benefiting from the trade. The Court’s opinion stated that it’s “the same thing as trading by the tipper followed by a gift of the proceeds” to the tippee.

One Question Remains: What is a Friend?

Following the Salman ruling, the Supreme Court made it clear that the relationship of the tipper and the tippee is an important factor when determining if an insider trading prosecution can move forward.

The most interesting language is the use of the phrase “relative or friend” drawn from the Dirks ruling. As former federal prosecutor Arlo Devlin-Brown notes, it leaves open the question what the court considers a “relative or friend.” Devlin-Brown worked on a number of insider trading cases, and is partner at Covington & Burling.

“What if it’s just a distant relation like a third cousin or some sort — I think that’s somewhat of an open question,” says Devlin-Brown. “Does a friend include someone who is your Facebook friend whom you’ve met maybe never?”

Or, for that matter, what about an anonymous trader who you’ve not only never met, but about whom you know nothing except their crypto address? Qualifying such a person as a “friend” would be a stretch by any standards.

Trading Insider Tips on the Blockchain Doesn’t Qualify Under the Salman Decision

Because the legality of insider trading hinges upon the relationship between tipper and tippee, anonymous, decentralized trading platforms like the Pareto Network seem almost custom built around this ruling. Users are free to share intel without worrying about legal repercussions, because the rules of insider trading don’t encompass blockchain’s peer-to-peer relationships.

In the traditional, hierarchical models of banking and finance, top-down relationships and insider-outsider relationships are governable. But blockchain is opening new pathways in what’s possible with insider trading, because it democratizes access to information. This disruptive technology is changing the way we invest, and we’re at a unique moment in history where the rules for blockchain trading haven’t been written yet. Meanwhile, applying the rules for traditional trading leaves plenty of room for freedom and creativity.

It’s nice that this comes from a ruling in which the government cleared up the boundaries of insider trading, and not one that made them blurrier. Investors can draw a certain measure of security from knowing that they’re in good standing by utilizing the anonymous relationships native to blockchain as a way to trade information without falling afoul of the law.