How Germany got too tough on insider trading

For a 48-year-old former public relations specialist who is currently facing trial over charges of large-scale insider trading, the potential jail term of up to five years is almost a side show. If found guilty on all charges, he can expect to be ordered to pay €24mn to the German government — almost twice the profit he is accused of having made in the allegedly illicit trades, and much more than he ever owned. The debt would probably haunt him for the rest of his life.

The case shows how massively the stakes for insider traders in Germany have risen since the government reformed the country’s disgorgement laws in 2017. Since then, every single euro that was involved in an illegal transaction will be seized by the government, regardless if it represents the principal or profits. In effect, insider traders are being treated like drug dealers who cannot subtract their cost of buying cocaine from their profits.

This can have consequences that “are representing a second, life-long punishment that is much more extreme than the original sentence”, says Björn Boerger, a partner at law firm Knauer. He is representing the key defendant in another high-profile insider trading case in Germany, a former asset manager who admitted to front-running his own trades, generating a total of €8mn in profit. After his case was retrialed last year in Frankfurt, his jail term was reduced by a year to two years and six months. However, Frankfurt judges upheld an earlier verdict that ordered the defendant to pay €45mn to the government — the total cumulated trading volume of his more than 50 trades.

Legal experts warn that this draconian approach is clashing with a fundamental principle of Germany’s rule of law — the notion that every convicted criminal must have a meaningful chance to reintegrate into society after serving jail time. Unlike in the US, where fraudster Bernard Madoff in 2021 died in prison serving a 150-year sentence, and prosecutors this month demanded a jail term of up to 50 years for Sam Bankman-Fried, maximum time in jail in Germany is usually capped at 15 years. Even life-long sentences can be suspended after that period of time.

By contrast, there is no cap when it comes to disgorgement, which in insider trading cases can easily result in very large penalties due to the fast-moving nature of stock market trading. Investors often use the same principal in concurrent transactions when they buy and sell stocks. Imagine a trader who buys shares for €1,000 and sells them for €1,200, then uses the €1000 again to buy different shares that he again sells for €1,200. If a court concluded that the trades were based on insider information, the trader would be forced to pay €2,400 to the court. “This is totally absurd,” says Felix Rettenmaier, the lawyer for the former PR adviser who is currently facing trial in Frankfurt.

Moreover, there is no way out for a convicted insider trader. Even if they filed for personal insolvency under German law, the obligation to meet the court’s disgorgement order would remain in place. “These rules can easily result in the total economic annihilation of an affected individual,” says Rettenmaier.

While honest investors may feel little pity for insider traders, the current rules may be so harsh that they could actually backfire for society and markets. Some legal experts argue that they may make it harder to track down insider traders in the first place as the rules create massive disincentives for whistleblowers. As German courts have no discretion over the level of disgorgements, even insider traders who turn themselves in and implicate partners in crime cannot expect leniency.

The best option for insider traders who want to come clean may be to quietly relocate to a country with no extradition agreement with Germany, according to a white collar crime lawyer.

German lawmakers could take their cues from European regulators who for years have been actively incentivising whistleblowing, offering immunity to companies who actively flag illicit price fixing.

Germany’s extremely harsh stance on insider traders is not only counter-productive but also at odds with other features of laws that make it harder to track down insider trading. For instance, public prosecutors and the police are barred from tapping the phones of suspected insider traders as it is not included in a list of grave offences that justify such an intrusion of privacy under German law. As a consequence, prosecutors often struggle to pin down the precise source of information. Rather than punishing insider traders overly harshly, priorities might be better focused on making it easier to catch those who have yet gone unnoticed.

olaf.storbeck@ft.com