If you believe that insider trading disappeared with “Big Hair,” the Go-Go’s and Gordon Gekko, think again. Two studies recently conducted by professors at the Stern School of Business at New York University and Canada’s McGill University have concluded that up to 25 percent of all Wall Street deals may involve 
insider trading.
In an article by Andrew Ross Sorkin for The New York Times (June 17, 2014) entitled: “Study asserts startling numbers of insider trading rogues,” we learn that the professors studied trades, penalties against companies and litigation from 1996 to the present day in an attempt to understand why stock prices fluctuated so much before they were made publicly available for purchase. According to Mr. Sorkin’s article in regard to the conclusion of the studies:
“The results are persuasive and disturbing, suggesting that law enforcement is woefully behind — or perhaps is so overwhelmed that it simply looks for the most egregious examples of insider trading, or for prominent targets who can attract headlines. The professors are so confident in their findings of pervasive insider trading that they determined statistically that the odds of the trading ‘arising out of chance were ‘about three in a trillion. (It’s easier, in other words, to hit the lottery). But, the professors conclude, the Securities and Exchange Commission litigated only “’about 4.7 percent of the 1,859 M. &A. deals included in our sample.’”
Not only is the stock price influenced by the insiders but the penalties seem nearly nonexistent despite our belief that things have radically changed from the days of back rooms and deals made over lunches in Oak paneled restaurants.
Government can’t help us
The professors found that the government’s ability to penalize offenders, even if they feel there is wrong-doing is woefully inadequate.
“The professors found that ‘it takes the S.E.C., on average, 756 days to publicly announce its first litigation action in a given case. Thus, assuming that the litigation releases coincide approximately with the actual initiations of investigations, it takes the S.E.C. a bit more than two years, on average, to prosecute a rogue trade.’ The average ‘rogue trade’ the professors found, was worth about $1.6 million.”
Long after you believe you are getting in on the ground floor of a “can’t miss deal,” chances are that a major player has already made their money, perhaps artificially inflated or depressed the stock price, cashed in – and moved out.
Here is where another finding was brought to light:
“The professors found that the bigger the deal and the more trading volume in the stock of the target company, the more likely there will be insider trading. ‘Overall, our interpretation of the evidence is that informed traders are more likely to trade on their private information when the anticipated abnormal stock price performance upon announcement is larger and when they have the opportunity to hide their trades due to greater liquidly of the target companies.’”
Findings concluded that just because a deal is huge, with many players involved in the transaction is no guarantee there will be more leaks. Apparently, when a deal is juicy, people on the inside shut up about it. Another finding is the number of foreign companies conducting inside trades. The SEC needs to be looking beyond our shores for wrong-doing, not just U.S.-based companies.
Ethical expectations
Ethically, are we powerless?
At first glance it would seem, as has been often stated, that the “little guy” has no chance.
While the SEC bureaucracy seems agonizingly slow to prosecute the insiders, perhaps there are things we, as investors can demand.
The first demand, I believe, is for investors to push the SEC and those who oversee the agency. It costs little more than our time to flood our congress people with emails demanding faster prosecution and more aggressive regulation of insider trades.
Second, if we are investors in publicly-traded companies, what harm would we create if we wrote to the Chief Financial Officer asking what steps were employed to insure that no inside information was being disclosed now – or in the future? While I would suspect that one or two such letters or emails might find their way into “trash” or a wastebasket, a hundred or 500 such letters might evoke the CFO to consider internal meetings and seminars on ethics.
Finally, it is up to us as “little guys” to expect ethical behavior and understanding of ourselves. Knowing what we know, should we jump to invest when a friend, or a friend of a friend, tells us that they have inside knowledge? Or are we better off seeing what the market forces do to a stock a week, a month or even a year after the company has merged or has begun trading?
The same rules that applied to any stock when the Go-Go’s were singing, “We Got The Beat,” still pretty much apply in today’s world of the Ga-Ga. Fundamentals, a solid business plan, strong management and all of those old-fashioned things endure. So does ethical behavior.
