The Wall Street Journal recently ran an article:
Crypto Might Have an Insider Trading Problem. This article is just the latest in a long series that confuses insider trading, an offence under securities laws, and acting on secret knowledge outside of a securities context.
Different Kinds Of Wrong
There are three different fact patterns that often get lumped together in media coverage and casual discussions:
1. Someone buys tokens before they become available to the public and then sells them for more money to the public later (i.e. "private sale")
2. Someone buys tokens before they become available for trading on a major cryptocurrency exchange then sells them afterwards at a profit
3. Someone sells tokens before bad news becomes widely available, and they learned about the news through their industry position
How might the above scenarios be dealt with from a legal perspective?
#1: Private Sales
A distributor that takes a chance on a new retail product will demand a steep discount in order to carry it, market it, and deal with the risk of it not selling. This is roughly the position of the funds that buy tokens early, before they become available on famous exchanges (if only because large exchanges typically only carry more popular tokens, and a new token will rarely be popular immediately). Even if large profits are involved, there's nothing untoward about buying low and selling high. There's nothing wrong with these activities being secret either, since they're private transactions and most private transactions are a secret to those not involved in them.
Potato chips have a great margin, and it's a secret what the grocery store pays for them, but there's nothing wrong with the retail price. The retail market is large, but also fickle, and there's actually a lot that distributors and retailers do to create value that the manufacturer doesn't. Token projects are similar in kind. Early buyers come before success is assured - they put down significant money that has a meaningful impact on the token projects. It may even be necessary for further development of the token/blockchain system, and to the extent that this is happening with private actors who have deep pockets, it may even reduce the risk that less-informed buyers might otherwise be exposed to.
The difference between a big buyer's early purchase price (wholesale) and the later (hopefully higher) trading price reflects risk. It's far from certain that any given token has a bright future ahead of it, so the people who buy based on this conviction ought to be rewarded if they picked correctly. There are thousands and thousands of token projects that have gone nowhere and never achieved the high prices that critics decry. But it's usually not these kinds of private sales that attracts the most criticism.
#2 & #3: Acting On Secret Knowledge
Some people obtain information because their jobs give them access to information before it's widely known. If the person's employer prohibits them from taking action on that information, or if they misappropriate it by providing confidential information to others, they may have committed an actionable wrong, but the claim is in relation to the breach of confidence.
insider trading if securities are involved. For 99% of the economy, the goods or services in question aren't securities, so any legal claims will be the ordinary sort between two parties, and not involving the government prosecuting anyone. There is no Ministry of Confidentiality that prosecutes people for breaching non-disclosure agreements. It is different than insider trading offences pursued by the Ontario Securities Commission or another arm of the government.
The WSJ has seized upon an example where someone may very have profited off their insider knowledge at a cryptocurrency exchange. But that could also be luck in a bull market, and no one would be writing the article if they had lost money! This is a risky type of trade. There's a high degree of risk in trading based on expectations about how markets might move in response to a new trading venue or information about a protocol change. Whether or not this particular example was luck, is it a problem? Is it wrong?
Acting On Information Not Widely Known
Someone who trades pulp and paper probably keeps a close eye on new factories opening up and upcoming product changes. They can use this knowledge to buy at better prices than someone that doesn't pay attention. This is expected and it's not wrong.
People who work at Costco and find out about TVs that will be going on sale soon may have an advantage over others, but it's not wrong for them to act on that unless forbidden by the terms of their employment. It probably would be against the terms of employment to share that knowledge with others, but if they use it just for their own TV buying decisions that might be permitted. It probably wouldn't be permitted to buy thousands of TVs and sell them to a rival company based on Costco's upcoming sales, but it wouldn't be a wrong against the public like insider trading offences because the TVs aren't securities and the securities regulators don't police non-securities (although in this case, Costco as a public company could potentially bring this to the attention of a securities regulator if the problem was significant).
Is Costco different than someone who works at a cryptocurrency exchange buying tokens before they become available on the platform? Conceptually, people might say yes because they view tokens as being more like securities than TVs at Costco. But legally, the TVs and tokens are more alike than public company shares are. It is the non-securities status that makes the difference.
Other Legal Doctrines
There are many things people can sue for, and the above isn't an exhaustive account of a surprisingly complicated area. But it is true that securities laws only apply to securities, and the government rarely gets involved in private disputes over misappropriated secrets that don't involve securities trading (other than providing neutral courts for the parties to sort out their dispute). So if the tokens aren't securities, the term
insider trading is probably not the right one to use. And it may very well not be legally wrong at all, depending on how the person came about their knowledge and their relationship with the source of the knowledge.
It's also worth noting that what many members of the public would consider
insider trading isn't always prohibited. It is a rather complicated area of law, and the boundaries of insider trading are defined over time as courts, tribunals, and legislatures grapple with the question of who should get to trade.
Extending Insider Trading To Cryptocurrency
A rule of law reason not to extend the securities law insider trading offence to other markets is that it's hard to say where to draw the line. Right now the line is drawn around the securities markets. For almost every other product, there is no line at all, and this provides a clear rule. Rules are often best when they're clear and easy to understand.
From an economics perspective: many famous economists have advocated for the repeal of insider trading laws on the basis that they would make markets more efficient. I'm not sure if that's true, but the current approaches may not be the best way to address the problem.
One approach that's been taken by New York State is to charge offences based on an insider trading fact pattern, but not charging insider trading as a free-standing offence. This seems to be the case in announced on June 1st, 2022 involving the OpenSea NFT market: https://www.justice.gov/usao-sdny/pr/former-employee-nft-marketplace-charged-first-ever-digital-asset-insider-trading-scheme.
It remains to be seen if the New York State approach ends up in Canada.
If you are reading this article and considering a situation that may be "insider trading" in the broadest sense, you should contact a lawyer. Don't rely on anything in this blog post as advice because the above post is an incomplete way of addressing a complicated issue.