Lawmakers approved the proposal to revise an EU directive and regulation on market abuse designed to restore confidence in the financial markets and boost investor protection.
Backing a European Commission proposal tabled in July, the MEPs said market abuse such as insider dealing and market manipulation should be punished by prison sentences.
The text is now being submitted to the full European Parliament for a plenary vote tentatively scheduled for January 2013.
"The EU cannot be seen to be the soft option or a safe haven for perpetrators of market abuse. That is why for the first time we are introducing EU-wide criminal sanctions," said Arlene McCarthy from the Socialists and Democrats group, responsible for steering the legislation through Parliament.
"The Libor scandal has demonstrated that the culture in the financial sector has not changed and that they cannot be trusted to self-regulate," she added.
McCarthy said that the real lesson to be learnt from the crisis is the need to focus on putting in place rules and sanctions to prevent crises, and not reacting after the banks have yet again undermined people’s confidence and trust in the markets.
Same criminal sanctions in member states needed
The new rules, however, have to be backed by tougher criminal sanctions, including prison terms, throughout the EU.
Currently, there are big differences between definitions of offences and the penalties applied for them in different member states. This means that market abuse can easily be carried out across borders and fraudsters can operate where the penalties are the most lenient.
To iron out the differences between EU countries, MEPs want to oblige all member states to ensure that maximum prison sentences for the most serious forms of insider dealing or market manipulation are at least five years throughout the EU.
At present, the maximum prison sentences for insider dealing vary from 30 days in Estonia to 12 years in Italy and Slovakia.
At the same time, the maximum jail terms for market manipulation range from 30 days in Estonia to 15 years in Slovakia.
The economic and monetary committee backed maximum prison sentences of at least two years for other types of market abuse. To ensure that they act as a deterrent, the MEPs want the sanctions to be made public and the fraudsters named unless such disclosures would jeopardise ongoing investigations.
The MEPs also want insider dealing and market manipulation to be punishable regardless of whether they were intended or reckless, attempted or committed.
Europeans want scofflaws behind bars
Ahead of the vote in the Parliament, the global campaign group Avaaz released a poll showing that 90% of the people in France and 89% in Germany and Britain believe that bankers responsible for fraud or manipulating markets should face criminal sanctions such as prison time.
Avaaz additionally handed in a petition to McCarthy, signed by over 720,000 people, calling for such sanctions.
Alex Wilks, campaign director at Avaaz, said the MEPs vote was a crucial step in the EU clamp down on abusive bankers.
"MEPs have faced down the corporate lobbyists and listened to their constituents. Over 700,000 citizens have asked for this reform and 90% of European polled want it," Wilks said.
"We'll now maintain the pressure on EU leaders to adopt the criminal sanctions without diluting them," the campaign director continued.
The poll by Avaaz also showed that a large majority in Germany (60%), France (56%) and the UK (70%) think that guilty bankers should be sent to prison rather than the banks themselves pay fines.
Most people in the UK (64%) and Germany (67%) also think that their government mainly listens to big banks when considering laws and regulations on banking.
In a ranking of the five biggest banks for each country, the ones blamed for the worst abuses of the financial system are Barclays and RBS in Britain, Société Générale in France and Deutsche Bank in Germany.