The Hidden Costs of Insider Trading: How Nonpublic Information Erodes Market Trust and Exposes Firms to Risk

The financial services sector operates on a foundation of trust. Investors rely on the belief that markets are fair, transparent, and free from manipulation. Yet, insider trading—where individuals exploit nonpublic information for personal gain—directly undermines this trust. Recent enforcement actions by the U.S. Securities and Exchange Commission (SEC) and Department of Justice (DOJ) highlight how access to material nonpublic information (MNPI) not only distorts market integrity but also exposes firms to severe regulatory and reputational risks. For investors, understanding these dynamics is critical to navigating a landscape where compliance failures can trigger cascading consequences.

The Mechanics of Market Erosion

Insider trading creates an uneven playing field. When individuals trade on MNPI, they gain an unfair advantage over retail investors and institutional players who rely on publicly available data. For example, in 2025, Ryan Squillante, a former equity trader at Irving Investors LLC, used MNPI to short Praxis Precision Medicines Inc. stock before a negative drug trial announcement, netting $46,421 in profits. His actions, which spanned 15 transactions, not only enriched him illegally but also distorted price discovery, a cornerstone of efficient markets.

The ripple effects extend beyond individual trades. When such misconduct is exposed, it erodes confidence in the firm's governance. Consider the case of Justin Chen and Jun Zhen, employees of EdgarAgents.com, who accessed MNPI from SEC draft filings to trade in four companies, generating over $1 million in illicit profits. Their arrest at JFK Airport underscored the global reach of regulatory scrutiny and the reputational fallout for firms associated with such activities.

Regulatory and Reputational Fallout

The penalties for insider trading are severe and multifaceted. Firms face not only financial penalties but also operational disruptions and loss of client trust. In 2025, the SEC secured a $1.36 million settlement from Alfred V. Tobia, Jr., a corporate executive, and his sister-in-law for trading on MNPI. While the settlement resolved the case, it highlighted the SEC's focus on “tippee liability,” where even indirect recipients of nonpublic information are held accountable.

For financial services firms, the reputational damage can be long-lasting. Momentum Advisors, LLC, for instance, faced settled charges in March 2025 for breaches of fiduciary duties and misuse of fund assets. Though not a direct insider trading case, the firm's failure to implement robust compliance mechanisms created an environment conducive to misconduct. Such cases signal to investors that weak internal controls can attract regulatory scrutiny, deterring long-term capital inflows.

Investment Implications and Mitigation Strategies

For investors, the key takeaway is clear: firms with a history of regulatory violations or weak compliance frameworks are high-risk propositions. Consider the case of Acadia Pharmaceuticals, where George Demos, a former executive, traded on MNPI to avoid $1.3 million in losses. The company's stock price plummeted after the FDA's adverse decision, and while the SEC's enforcement action addressed the individual, the broader market perception of the firm's governance was tarnished.

To mitigate these risks, investors should prioritize firms with transparent governance and robust compliance programs. Look for companies that:
1. Publicly disclose compliance initiatives, such as regular employee training on MNPI handling.
2. Maintain strong board oversight, with independent committees reviewing risk management practices.
3. Adopt advanced surveillance tools, like the Consolidated Audit Trail (CAT), to detect suspicious trading patterns.

Additionally, investors should scrutinize firms in sectors with high exposure to MNPI, such as biotechnology (e.g., drug trial results) or mergers and acquisitions. For example, the 2025 case involving Andre Wong, a former Lumentum employee, demonstrated how even small-scale insider trading can attract regulatory attention, particularly when data analytics tools flag anomalous trading behavior.

The Path Forward

The SEC's 2024–2025 enforcement actions signal a renewed focus on individual accountability and cross-border collaboration. With the use of sophisticated tools like CAT and shadow trading theories expanding the scope of liability, the cost of noncompliance is rising. For financial services firms, the message is unequivocal: compliance is not optional but a strategic imperative.

Investors, meanwhile, must remain vigilant. By aligning their portfolios with firms that prioritize ethical governance and transparency, they can help reinforce market integrity. After all, a fair market is not just a regulatory ideal—it's the bedrock of sustainable returns.