OK. Prediction market trading by employees can violate codes of conduct and federal law (state law, maybe, too!) if based on confidential information, and this could mean reputational damage for companies. So what should public companies do? After a deep dive on prediction markets (really helpful if you’ve been burying your head in the sand, as I have), this MoFo alert has detailed suggestions.

Because prediction markets do not involve “securities,” a company’s insider trading policy, surprisingly, may not be the best primary policy to address the risks of insider trading on prediction markets. Moreover, insider trading policies often apply to directors, officers, and certain employees that can be expected to receive traditional material non-public information, but the wide-ranging nature of prediction markets could extend to scenarios where lower-level employees could potentially misuse information.

A company’s code of conduct or ethics (the “Code”) generally applies enterprise-wide and may be a better source to primarily address prediction market activity more broadly. For instance, a Code could be revised to:

– Reinforce that employees may not use confidential information for personal gain in any form;
– Clarify that wagering, betting, trading, or engaging in any transactions based on inside information is prohibited;
– Capture misconduct that may not fall squarely within federal securities law but that still violates fiduciary duties or company policy.

[M]any insider trading policies narrowly prohibit trading in a company’s own securities and, in some cases, derivatives or hedging instruments tied to company securities. Fewer policies explicitly address event-based contracts referencing the company, markets that do not require trading in the company’s stock, or trading on platforms outside of traditional broker-dealers and exchanges.

As prediction markets expand, companies should consider clarifying that trading on the basis of MNPI is prohibited regardless of the form of the instrument used to monetize the information. To the extent a company’s Code is updated as described above, companies should consider expressly cross-referencing relevant provisions of the Code in their insider trading policy. In addition, while prediction market activity could conceivably be addressed in a Rule 10b5-1 trading plan, companies may not wish to be viewed as approving or even encouraging employee use of prediction markets. Further, the event-driven nature of prediction market contracts could also make Rule 10b5-1 coverage unworkable.

The alert also suggests that companies could consider requiring employees to disclose any prediction market or online wagering accounts — or prohibit such accounts altogether (especially in highly regulated industries). Plus annual or quarterly certifications that employees have not engaged in prohibited trades in prediction contracts might “reinforce expectations and provide a record of compliance efforts.” As always, training is your best friend. Make sure your employees know what your policies permit and prohibit and what trading activity is illegal.

– Meredith Ervine