Economics and Law
University of Economics, Prague
May 2010
Vladimir Koranda
Grounds for Insider Trading Regulation
Abstract
This paper estim at e s positive and negative effects of insider trading
regul ation with aim on the cost of capital and investor utilit y . The ke y issue
is more information awareness than insider trading ban, particul arl y
disclosure dut y, which st rongl y dimi nishes possibl e benefits of illegal
insider t radi ng. Paper further compares European general di sclosure regim e
and “abst ain or di sclose” rule in USA based on l egal insider t rading
cumulat ed abnorm al returns studi es and their effi cienc y whi ch showed up to
be the s ame. T his comparison further shows that disclosure dut y brings no
harm to companies. Another stud y regard ing possibl e benefits of insider
trading moving prices closer to rationall y expected equilibri um is
considered in the context of disclosure dut y anal ysis. The results shows that
current regul ation, parti cularl y the disclosure dut y and insi der t rading ban ,
except market abuse monitoring parallell y perform ed b y m arket operators , is
economicall y justifi ed.
Percep tion in society
First rules banni ng i nsider were int roduced b y U.S. S ecurities Exchange Act
(1934). No serious doubts about these rules occurred t il l Manne ´s book
Insider Trad ing and the Stock Market (1966). He cam e wit h, for the time
being different point of view - possibl e benefits of insider trading . Man y
economic wo rks developing the idea followed . You can see a quite
repres ent ative summ ar y of t he grounds able t o possibl y infl uence utilit y of
insider trading and also some part of development in this area for example in
work of Bainbridge (1999), who also states the general issue (total effect) is
still not resolved convincible, although the defen ders of the regulation
prevail not onl y in legislative but also i n academi c circles as well. 1 In the
recent years , calls for tot al deregul ation have been even m ore diminished.
Majorit y of recent research es are usuall y m ore oriented at transaction
reportin g and disclosure benefits and their regulation than insider trading
(ban) itself. Rules became broader and more states begin or better to sa y
becom e prepared to be abl e to enforce them . Except USA t he regul ation is
quite young (there was no regulat o r y ban in France till 1970, Great Britai n
till 1980, Germ an y, Netherl and and Spain 1989 2 and till the sam e year as
well in J apan. 3 On t he other hand, Europe capit al m arket framework based
1
Bainbridge S.M., Insider Trading, 1999, p. 773 (web)
Comparative Implementation of EU Directives (I) – Insider Dealing and Market Abuse, The British Institute of
International and Comparative Law, Corporation of London, december 2005
3
Sanger D.E., Japan Adopts Insider – Trading Regulations, New Yourk Times, February 1, 1989 (web)
2
1
the Directive on Market s in Fi nanci al Instrument 2004/39/EC (MiF ID )
allowed secondar y (MTFs) m arkets wi thout an y obli gatory m arket abus e
regul ation.
The pict ure of perception among ordinary people is even clear er than among
above mentioned economic and law ex perts. Media t ak e a ver y negative
stand and pa y great attention to cases of insider trading .
1. Argu men ts again st insider trading
Works on this topic , I m ean those deal ing with the usual issue of insider
trading ban (benefits ), oft en begin with arguments against regul at ion,
without regard to the side of author. Should not b e chronologicall y
mentioned the arguments for the regul ation firstl y? Or are t he y so cl ear and
natural, that the y do not to be m entioned at all? The explanation could also
be the y in comparison to the lat er em erged argum ents t he y are economi call y
vague or were ori gi nall y not persuasi vel y economicall y grounded.
On U.S. Securities Commission web page is menti oned t hat the Securiti es
Exchange Act had 2 main objectives: “ require that investors receive
financial and other si gnifi cant inform ation concerning sec urities being
offered for public sale; and prohibit deceit, misrepresent ati ons, and other
fraud in the sale of securities ”.
As otherwise probabl y little connect ed issues would have been arisen, I
believe, that the S ecurities Exchange Act was based m ore on rather comm on
economic philosophi cal or l aw presumpt ions than on hard st atistic dat a and
mathem atical comparison of utilit y. However, th at i s the case of
overwhelmi ng majorit y of law and probabl y not onl y the st at e law but even
the private l aw in broad er sense (autonomous law) . Then, t he first step of a
person chall enging t he necessit y of law in effect should be to estimat e its
contribution.
Let us start with general arguments to get a deeper background for bett er
understandi ng the following more empiri cal evidence.
1.1. Market integrity , investor confiden ce p rotection
Market integrit y and investor prot ection, decl ared in articl e 15 preambl e of
the Market Abuse Directive (MAD) and taken over b y national fra m eworks,
is quite vague. It sounds less effectiv el y or concretel y than more sociall y
orient ed American j ustification - fraud and misappropri ation theor y (whi ch
on the other hand struggl es with a legal loophol e allowing secondar y
insiders to escape punishm ent under condition there is no speci al
rel ationship between an insider and tippi e 4). MAD, concerned legislation and
the concerned report s and preparator y working paper s are not more specifi c
about this aim of insider t radi ng regul ati on.
4
e.g. US Supreme Court decisions, Chiarella (1980), O´Hagan (1997) or
Koranda V., Analyza Insider Trading v CR, Cekia 2008, p. 17
2
Damages caused b y insider trading for short time invest ors are wit hout
doubts including the critics of regul at ion. However, it is not known or
proved convincingl y if t he aggregat e impacts of insi der trading are
negati ve. 5
We can tr y t o come with some indirect evidence .
Bai nbridges (1999) tries foll owing: “Japan only r ecently began regulating
insider trading and its rules are not enf orced. The same appears to be true
of India. Hong Kong has repealed its i nsider trading and its rules are not
enforced. Both have vigorous and hi ghly liquid stock market. 6
Czech Republic wa i ted on its fi rst case from 1992 till 2002 (first serious
cas e det ect ed and ti ll 2009 for first punishment ). It does not mean the laws
were not enforced , as it is ver y di fficult just to det ect insi der trading and
even harder to prove it. There was a bi g medi a case around 2005 in Japan.
Hong Kong cert ainl y continued its i nsi der trading regulat i on from 1996 til l
2001 without an y signals of l ater repealing. India appli ed the regulati on
from 1992, insider trading rul es appl ied also in nei ghboring Pakist an,
Ce ylon and Mala ysi a in the year 2001 7 without an y si gnal of later repealing.
There are probabl y no developed capi tal markets without insider trading
regul ations si nce 2000. Most si gnificant newl y comi ng compani es
definitivel y prefer t o be admitt ed to the regu l ated market to MTF 8. However,
it could be j ust due to soci al “sti gm at ization” of insider trading or some
fashion to be listed on a market with the highest level of investor protection.
Thus, although these facts are not to be omitted, should be considered
criticall y.
1.2. Liquidity and o ther not widely recognized argu ments
There are no discrepanci es, that long -t ime invest ors are l ess affect ed b y
insider t rading. Thus we could suppose t hat more touched short time-, small traders and speculat ors - these liquidit y provi ders – would be discouraged
from trading “against insiders ” under no regul ations and liquidit y would
decreas e. However this has no to be necessaril y t ruth, as insider trading
could move pri ces closer to rationall y expected equilibrium (see l ater) and
thus lover the risk of future losses allowing a risk avers ive investor to
invest more. 9 Thus, t he relativel y lesser l iquidit y could be eventuall y hi gher
5
e.g. Bhattacharya S., Nicodano G. Insider Trading, Investment and Liquidity: a Welfare Analysis, discussion
paper No. 2251, Centre of Economic Policy Research, London 1999, p.4
Dedek D., Insider Trading, Investor Protection and an Orderly Capital Market: Lessons for the Czech Republic,
VP no. 21, CNB, Praha 1994, p. 19
6
Bainbridge S.M., Insider Trading, 1999, p. 786 (web)
7
Answers of IOSCO members to CNB regarding insider trading regulation 2001, CNB archive
8
The current ones are not leaving, however there can by some legal obstructions like duty to buy out
shareholders disagreeing to leave a regulated market.
9
There is a reference to a study Leland, H., Insider Tading: Should it be prohibited?, Journal of Economic
Theory 4 (1972),p. 103-124 in Bhattacharya S., Nicodano G. Insider Trading, Investment and Liquidity: a
Welfare Analysis, discussion paper No. 2251, Centre of Economic Policy Research, London 1999, p.
3
in abs olute numbers. This i ssue can be assessed in the context of furt her
findings (see in t he summar y).
Hi gher bid -ask spreads of market m akers as their insurance against better
inform ed insiders are sometim es mentioned, however the em pirical evidence
does not support such theories. 10 The same case is with possible insider’s
manipulati on. You can find a stud y proving no relevance in Se yhun. 11 It was
based on report ed i nsider transaction s which can differ wi th illegal ones .
There are also reali stic presumption s confirming these em piricall y proved
count erargum ents. Bid-ask spreads are driven b y compet itiveness of market
makers and market partici pants trad ing needs . As manipul ati on is concerned,
insider would not be probabl y willing to go against market respectivel y
against inside information.
1.3. Cost of Capital - CAR computing, direct MT F data
Cost of capit al is the most si gni ficant and probabl y best computable benefit
of insider trading regulation. In this st ud y it is p resu med that abnormal
cu mulated returns of insiders – how insider s outperform the rest of the
market, equals the higher cost of cap ital, i.e. how less will the compan y
seeking whol e or usuall y additional capit al on the market get for the
subscription in case there is no insider trading regul ation? We can use 2
methods – C ARs (cumulated abnorm al returns) and direct measuring based
on MTFs ´ dat a. Results of the bot h method s should be decreased b y the
number that insider is abl e to reach b y l egal i nsider t rading (see in secti on 3
below).
How to count illegal insider trading C ARs?
Dubow, Montei ro (2006) 12 used several ke ywords to look up important
compan y announcement 13 for FTSE350 14 companies. Count ed normal CARs
during the period -240 to -10 da ys before the announcem ent, filtered market
driven movements 15 and com pared it to t he 2 trading da y ret urn s before the
announcement s (thereaft er sta tisti call y signifi cant total CARS – 2 days
before and 2 da ys after and from it fu rther st atisticall y si gnificant 2 da ys
pre-CAR were selected 16). It is not known how bi g devi ation occurs b y
insider trading outside the observed 2 -day preannouncem ent period.
10
E.g. Dedek D., Insider Trading, Investor Protection and an Orderly Capital Market: Lessons for the Czech
Republic, VP no. 21, CNB, Praha 1994, p. 22
11
Seyhun H.N., Investment intelligence from insider trading, Massachusetts institute of Technology 1998, p. 1723
12
Dubow B., Monteiro N., Measuring Market Cleanliness, Occasional Paper Series 23, FSA, 2006
13
Financial results were excluded as considered they can bear no material information due to ad hoc disclosure
duty.
14
„The FTSE 350 Index is a market capitalisation weighted stock market index incorporating the largest 350
companies by capitalisation which have their primary listing on the London Stock Exchange.“ Wikipedia.org
15
the extent to which the stock´s return on the whole market return
16
The total (4-day) CAR statistically significant at the 1% level (i.e. if it is less or equals to the 50 th most
negative simulated total CAR and greater or equals to the 50 th most negative simulated total CAR from 10 000
and the 2-day pre-CAR statistically significant at the 10% level. See above, p. 20
4
Dubow, Mont eiro focused on assessm ent of regul ator y change impact (how
man y si gnifi cant announcement were preceded b y insider trading – before a
aft er the change). For the 350 largest LSE companies , t he y recorded 55
significant announcements (19 accompani ed b y insider trading) during the
period 1998 -2000 and 54 significant announcemen ts (20 accompanied b y
insider trading) duri ng the period 2002 -2003. 17
From the number above, we can bt w. observe part of dissuasive effect of
insider trading regulation , which itsel f seem s to be quite high (around
65% announcem ents without statisti call y signi ficant si gn of i nsider t radi ng ).
Note that it can gi ve no information about the extent of vol umes that would
have been traded b y insiders, had insider t rading been l egaliz ed. However ,
the figure 0,062 material information per compan y a year could be enough
to proportionall y m easure m arket cl eanliness but not enough to compu te
insiders gains , as it is clearly 18 too small to fit the reali ty .
We can see, even is we use ver y so phisti cat ed statisti cal met hod it still does
not mean we are able to measure such latent acti vit y as illegal insider
trading. Ma y be it is time to tr y som ethi ng less difficult – to work wit h MTF
markets where all insider trading is l egal. For a market ope rator it is
possible to map th ose company executives transaction (main executives
are nam ed in com pan y regist rars) an d count the cu mu lated abnormal
returns of insiders , i.e. how much such insiders outperforms annual share
price change.
I have not discover ed an y such computations and suppose the y have
probabl y not been done yet, as i n Europe 19 insider trading was not an issue
till late 80s and then onl y regulat ed m arkets existed there (till MiF ID) . It
changed with the existence of Europe an MFTs such as Turqu oise (from
2008, under the roof of London Stock Echange) or Freiverkehr (10/2005) b y
Deuts che Boerse. Man y list ed com panies are duals list ed also on other
markets under certain kind of Market abuse (i nsider t radi ng) regulations .
However e.g. on Frei verkehr (Free Market), there are around 300 German
companies, some of them prett y liquid, under no insider tradi ng regulation. 20
2. Argu men ts for in sider trading
The critic st art ed to be seriousl y taken with Mann e’s book Insider Trading
and the Stock Market ( 1996). He ident ified 2 pri ncipals i n which insider
trading benefits societ y - moving pri ces closer to the level, t he y would be at
There was next another „random movement“ adjustment, but with only slight difference in results, See above,
p. 23, 24
18
For all 28 stock issues on the Czech regulated Markets it would correspond to the total number of 1,8 material
information a year, however only the biggest company CEZ makes around 5-8 such announcement in a year…
By decreasing the filters more random CARs would be regarded as insider trading.
19
I did not found any note about markets without insider trading regulation in the USA.
20
There is also such a market in the Czech Republic, organized by RM-System, Ceska Burza cennych papiru a.s.
since 8/2005. There are 35 issues, however 30 of them are almost illiquid, the remaining 5 relatively liquid ones
together have total yearly trade volume around Euro 10 mil., so any such research would be without sense.
17
5
when i nformation i s disclosed and as a wa y of compensating m anagers. 21
Others foll owed wit h several other however not widel y re cognized reasons.
2.1. Insider Tradin g Moves Prices Closer to Reali ty
It is a logical st atement. However, how to m easure the benefits, and how to
compare them with advant ages of regulat ion probabl y not yet eval uat ed?
There is an approach used b y Bhatt achar ya, Nicodano (1999) 22. The y
compared utilit y of insider trading bri nging the market prices closer to
Rational Expectations Equilibrium (and thus decreasi ng risks stemming
from wrong evaluati on) to losses of outsiders.
The y modeled tree scenari os: A ) ideal - ever ybod y dispose s with inside
inform ation B) illegal insider t rading banned C ) insider allowed), in 3 time
stages (initi al, int erim, final). The modeled agents (with randoml y assi gned
time-consumption preferences) were al lowed to chose between riskles s
investment and risky long term invest ment under a set of future expected
values combinati ons (lower -hi gher), possibl y to consum e (sell) in interim
stage. To filt er gains or l osses due to liquidit y shocks caused b y
unpredict able market movements caus ed b y “noise t raders” all scenarios
were also comput ed under different set of liquidit y shocks probabilities .
From the cont ext can be assumed , there was no insider regulation at all
taken into consideration the scenario C and insider has onl y l imited budge t can not borrow or sell short, does not cooperate with other invest ors 23 and
thus her/his t rades are sm all. 24
We are free to doubt if the last conditi on would fit realit y without insider
trading ban as reall y st rong inside information m ultiplies t he average dail y
trading volum e si gnificantl y (multiplication b y 4 or more i s not rare under
such ci rcumst ances, in 2005 multiplication b y 2 5 could be observed at
Unipet rol - one of t he Prague Stock Exchange blue chi p s). 25
Even s o, the result that losses of outs ider are more t hen compensat ed b y
addition inform ation provided due to insider t radi ng in certain model ed
situation (without any clear winner), is interesting from the regul ator y point
of view. Firstl y it shows that that information awareness is more impor t ant
that than possibl e connected m oral or social issues. Second, insider trading
(with the reservation of disclosure dut y impact below) coul d be benefici al
onl y at l ower l evel , so it would b e suitable to hold i t on su ch lower l evel the prop er task for i nsider trading ban . Those insiders who are not
21
Bainbridge S.M., Insider Trading, 1999, p. 773 (web)
Bhattacharya S., Nicodano G. Insider Trading, Investment and Liquidity: a Welfare Analysis, discussion paper
No. 2251, Centre of Economic Policy Research, London 1999
23
Regarding to transaction reporting - at the p. 7 they state, borrowing would reveal insider identity, thus there is
probably no transaction reporting taken into account, as reporting includes the insider identity. Disclosure regime
was established in MAD directive in 2003 and there are several notes, hinting no disclosure regime is taken into
consideration.
24
i.e. if the variations in the aggregate liquidity trading are small, relative to its average level, p. 2
25
See more in Koranda V., Analyza Insider Trading v CR, Cekia 2008, p. 95
22
6
discouraged b y the t hreateni ng punishm ent (there alwa ys be such) could help
to decrease risk connect ed with interim price inaccurac y.
Probabl y even more “disqualif yi ng ” for the result of the study above is
general disclosure dut y in Europe and the finding that inside informati on are
not withheld from public b y the US companies, even if it is possible under
their disclosure regi me (see section 3 below ), which shifts the real mark ets
close to pareto-op ti mal scenario A – everybody dispose with inside
information . Thus extent that insider t rading could benefi t is much more
limited in practice and the final result s compared to losses of outsiders
would be much more n egative . Note that vast m aj orit y of insi de
inform ation stems from compan y acts, certain share have state authoriti es
(courts, competition, patent authoriti es), which publish their decision
immediat el y and only small part is left for other external inside
information (such as take -over bids, where also qu ite detail ed information
schedule has to be followed ). Thus, insider trading ban has a second
purpos e, to t ake away the motive to keep inside inform ation undisclosed.
There is a stud y proving the opposite, i.e. i nsider trades raise vol atilit y , 26
which in other words means pri ces further from Rati onall y Expect ed
Equilibrium. It st at es “more insider trading is found to be associ ated wit h
higher market vol atilit y even aft er one controls for the vol atilit y of
monetar y and fiscal policies, and maturit y of the st ock market ”. It uses dat a
of 27 countri es from 1985 -95, (b y som e of them the period starts l ater, as
their regul ations were passed meantim e ). However, works based on rather
soft 27 comparative st atistic could be tri ck y.
Such studi es and ideas probabl y led ( MAD directive in 2003) to more robust
legal fram ework in Europe – particul arl y t ransaction reporti ng (according to
US example), and compulsor y disclosure duties contrar y to US fram ework
(see lat er section 3 ).
2.2. Insider Tradin g as Partial Comp ensatio n to Managers
Manne´s second argument for insider t rading as compensation to m anagers
has 2 bases - compan y savings on manager’s salar y and perform ance
motivation – i.e. to creat e events which can be t raded on. This argument is
not widel y recognized. 28 Bainbridge (1999) sums up a coupl e of
26
Du Julan, Shang-Jin Wei, Does Insider Trading Raise Market Volatility, International Monetary Fund working
paper 03/51
27
As the main input source insider trading perception index data from World Competitiveness Report 1998 were
used. The index was constructed on the question: ”Insider trading is not common in domestic stock market” (see
page 37 of the their work), which is without doubts very subjective. For example Czech Republic is taken into
account as the country with lowest rate of insider trading in 1998. However, in 1998 the year the specialized
competent authority was established, with 6 years modern capital market history, at the end of economical “wild
east era” there was only little notion about insider trading not speaking about its tackling and detecting in the
Czech Republic. First case was detected in 2002. Insiders had little reason to be afraid from any administrative
action …
28
e.g. Giberson M., Overview of Henry Manne’s, “Insider Trading: Hayek, Virtual Markets, and the Dog that
Did Not Bark”, 2007 (web)
7
count erargum ents – diffi cult y t o rest rict the t radi ng to persons, who
produced the information, hard estim ation of returns from insider and
manager’s future performance and sm al l utilit y of such compensation for
risk averse managers. 29 Moral hazard (risky projects resulting in losses) also
uses to be mentioned oft en. Finall y, we can also include t he 7,3 % legal
insider t radi ng prem ium … (see legal insider t rading i n sect ion 3 ) as a next
reason to regard the exten t to which a company may ben efit from insider
trading as comp ensation to managers not significant .
2.3. Costs of regulation
This reason is rarel y motioned, which could hint som ething about its
signi ficance. The costs are reall y m argi nal. The arguments provided here are
rather vague, as I am not in a position to disclose how m uch peopl e and
equipm ent are engaged at issuers, b rokerages, market operators, C NB and
what dam ages were detected o r refunded in the Czech Republic . Under ver y
rough estimat es around 10% yearl y insider regulation cost s w ere refunded
and 20% refund is i n progress during the last 8 years . Not e, effect is limit ed
b y damages det ected and it accounts o f course, onl y margi nal part of total
savings due t o dissuasive effects.
Ori ginall y I did not want to deal with the issue i f the enforcement or its part
– det ecti on for example - can be entrusted to privat e sphere. As trading is
internationalized and man y dual listing s exist, often it is necessar y to reach
behind the boarder of your jurisdiction. To re veal insider trading circles it is
necess ar y to have an approach to dat abanks under dut y of confidenti alit y or
personalit y ri ght protection. To ascert ain the extent of insider trading or
distinguish it from ordinar y hedging access to data from several brok ers and
markets throughout the world is necessar y. This area i s full of legal
obstacl es and thus not a ver y good one to start with anarcho -capit alism or
free envi ronm entali sm or similar things. However to t urn it upside down,
taking into consideration that it is proper and effecti ve to entrust this task to
state th ere is no reason why market abuse monitoring should be
performed parall ell y by mark et operator as articl e 26.1. MiFID di rective
requi res , the sam e applies even more to manipulation . Simple suspici ous
trans actions reporting (compare arti cle 4.9. MAD) would do nicel y.
3. Information Efficiency - L egal and Illegal Insider Trading , Disclosu re
Regi me
The M AD directive (2003) also di rective also established different
European disclosure regi me. While in the U.S. disclose or abstain rule is
applied and disclosure is recommended onl y when inform ation evades 30, in
Europe all information must be discl osed unl ess a com pet ent authorit y
approves dela y (it happens ver y rarel y, for around 30 Czech listed
or Kotasek J., Ochrana vnitrnich informaci, Tribun EU, Brno 2008, p. 25-28
29
Bainbridge S.M., Insider Trading, 1999, p. 781, 782 (web)
30
see the term fair disclosure at http://en.wikipedia.org/wiki/Insider_trading
8
companies approval is asked once or t wi ce a year). 31 Disclosure dut y brings
materi al information to the market without dela y 32 and thus no doubt s
increas es inform ation awareness of investors. However, does disclosure dut y
bring all m aterial i nform ation?
Man y current works regardi ng this topic , especiall y those st ud ying the
insider gains, were done on the base of insider tradi ng transactions
reporting, i.e. legal transaction of insiders , whi ch of course can give onl y a
part of the picture – how insiders best the rest without inside (mat eri al 33)
inform ation. Nevertheless, it is another signifi cant source of inform ation.
Moreover, wit h the comparison of insider gains under both US and European
regim es their effici enc y also can be assessed .
Se yhun (1998) used US data from legal insider t rading t ransaction reporting
from 1975 -1994 and cal cul ated insider best the rest of the mark et by 7,2%
(4,5% purchases, 2,6% sales) in average 34. Jeng, Mat rick, Zeckhauser used
the sam e dat a from 1975 -1996 and his result is 7,4% (and that 7 ,4, for
purchas es and 0 for sales, as was consi dered that sales are mostl y liquidit y
trans actions – i.e. to get liqui dit y not to profit). The y also mention
following: “Eckbo and Smith (1998) use performance -evaluation methods on
monthl y dat a for the comple t e sample of value -wei ght ed insi der holdings in
Norwa y from 1985 -1992. In contrast on he results on U.S . data, the y find
that insiders do not earn abnormal ret urns. The difference ma y st em from
differences in a variet y of institutional and m ethodol ogical s ources.” 35 The
reason could also be that Scandinavians simpl y more obey laws. Thus I
decided to use more represent ative st ud y below.
Ausenegg, Ranzi (2009) cal cul ated CARs from transaction reporting from
Austri a, Belgiu m, France, Germany, Italy, Netherland s and Switzerland
in the period 2002 -2007: the average CAR duri ng the 20 trading da ys
following the transaction was 0,40% for purchases and 1,61% for sales (note
also quot ed result according to the com pan y size). 36 Thus the total C AR is
31
Note: If only small part of material insider information disclosure is delayed under the European framework
and probably big part “voluntarily” disclosed under US regime, what illegal insider trading are we, actually,
talking about? Except this small part of delayed disclosures it could be “incomplete” material information (for
example some companies publish their quarterly results after 5 or 6 weeks from the quarter end and sometimes
they differ significantly from market/analysts expectations without any profit warnings or outlook updates,
although it is clear quite precise results must be at disposal continuously in present times).
32
Illegal disclosure delays (under European framework) do not often occur. Also the probability such tort
remains undetected and unpunished especially in the case of higher share price shift is low.
33
Information with potential to change the price significantly – for example take over bid or financial results
34
Seyhun H.N., Investment intelligence from insider trading, Massachusetts institute of Technology 1998, p.
41,42
35
Jeng L.A., Metrick A., Zeckhauser R., The Profits to Insider Trading: a performance-evaluation study,
working paper 6913, National Bureau of Economics, Cambridge 1999, p. 5
36
Large companies are supposed to be more information efficient than smaller companies, as they are more
heavily followed by financial analysts and a have a larger fraction of institutional stockholders – facts that
typically reduce information asymmetries. This assumption is confirmed by our findings … In the twenty trading
days after the transaction disclosure we find insignificant CARs of 0.04%. For the corresponding sale transaction
our results reveal significant CARs … of -1.40% twenty trading days after the disclosure date.
For purchase transactions in small companies we find … significant CARs of +0.83% in the twenty trading days
after the disclosure. For sale transactions in small companies we document … significant CARs of -1.94% in the
twenty trading days after the disclosure.
9
the sum and counts 2,01%. To compare this 20 da ys CAR with Jeng, Se yhun
and Met rick, Zeckhauser, the fact that third of the yearl y CARs was reached
in the first month after the t ransaction is taken into account. 37 We can see
that 1/3 of 7,4 % for first mont h is quite close to 2,01% for first 20 da ys.
The quot ed results by the wa y also confi rm a presumption that legal insider
trading (based on better insider ordinary acquaintance with the compan y)
does not generat e such as strai ght forward returns as illegal insider and its
main power lies i n middle term.
We can see outsiders are informed quite the same under both US and
European disclosure regi me and insider can do by aroun d 7,3 % better
than the rest of t he m arket an ywa y, without using (m aterial) inside
inform ation.
From the fact that US insider has th e same abn ormal returns as th e
European it can be assumed that he is n ot better informed. That m eans the
US compani es do not withheld more i nside information from the public
compared to Europ ean compani es even if they are allowe d to. Information
are published an yw a y in the same extent as b y European compani es either
for m arketing, reput ation or insider rules compli ance reasons.
Seeing it upside down Europ ean compani es are not forced to publish
more than they w ould have been with out disclosure duty and do not
suffer from any disadvantages b y the general disclosure dut y compared to
companies under US fram ework . These facts with the possibilit y to ask for
dela y approval and the rarit y of such approval petitions also shows the
damages from disclosure duty could be marginal at th e worse (when a
compan y would like to keep the inform ation privat e under US regim e or is
approved dela y under European regim e , but it is forced to publish due to
unintended partial exposure, whi ch however happens rarel y and which would
also mean the information reaches the markets an ywa y i n quite a short
period . Thus, the resulting saving s on the lower cost of company capital
gathered from risk aversive (better i nformed) investor s largely exceed
the marginal l osses suffered from unwilling disclosures.
Summary
Aussenegg W., Ranzi R., Corporate Insider Trading and the Short-run Price impact of Private Information in
Continental Europe, Proceedings of the 2009 MFA Annual Meeting 2009 (web)
Bainbridge S.M., Insider Trading, 1999 (web), p. 2,3
37
„We find that about 1/6 of these abnormal returns accrue within the first 5 days after the trade, 1/3 within the
first month, and ¾ within the first 6 months.“
Jeng L.A., Metrick A., Zeckhauser R., The Profits to Insider Trading: a performance-evaluation study, working
paper 6913, National Bureau of Economics, Cambridge 1999, p. 5
10
Current l egislation , at least its fundamental parts, is economicall y justifi ed ,
except m arket abuse monitoring parall ell y performed b y m arket operators .
The ke y issue does not seem insider trading b an, but inform ation awareness.
Disclosure dut y bri ngs with margi nal exception all mat eri al information to
the market without dela y and t hus no doubts increases inform ation
awareness of invest ors. It has the same effi cienc y under both different US
and Europ ean framework . Lower cost s of capital due to hi gher information
awareness more than compensat e company limitations and possible dam ages
resulting from such dut y.
Insider t radi ng ban holds it extent at a l ower level, where it is less inj uring
or possibl y benefici al in total effect (what is, however, ver y improbable
under current discl osure dut y) as additional price information/correction
moving pri ces closer to rati onall y expect ed equilibrium . It also support s
fulfillment of disclosure dut y, as there is no motive to keep it secret .
Published i nsi der trading transaction reporting provides information on l egal
insider trades and thus further strengthens inform ation awareness.
Based on t he finding s above we can also concl ude that absence of regul ation
or weak enforcem ent also decreases liquidit y, as the liquidit y providers are
discouraged to trade agai nst better informed insiders.
To find out perform ance of an ill egal i nsider , probabl y the most precise dat a
about i nsider t rading can be reached b y comparing MT F companies´ insider
trading CARs on a liquid European MTF (decreased of gains from legal
insider t rading transaction – 7,3%) with the ye arl y average share
perform ance, as there is no i nsider regul ation .
More com plicated situation can occur i n case of MTFs, where companies
(invest ors) are allowed to be admitt ed and t raded under rel ativel y low
regul ation requi rem ents . So far, MTF were accepted as a “j ungle” compared
to regulat ed m arket s, but a pl ace allowing trad ing invest ment inst rument s
under some formal structure. If similar regulation is applied to them it could
dissuade issuers and make it impossibl e for other person than issuer to ask
for listing on MTF. Relevant research is in progress at EU l evel.
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References:
Aussenegg W., Ranzi R., Corporate Insider Trading and the Short-run Price impact of Private
Information in Continental Europe, Proceedings of the 2009 MFA Annual Meeting 2009 (web)
Bainbridge S.M., Insider Trading, 1999 (web)
Bhattacharya S., Nicodano G. Insider Trading, Investment and Liquidity: a Welfare Analysis,
discussion paper No. 2251, Centre of Economic Policy Research, London 1999
Dedek D., Insider Trading, Investor Protection and an Orderly Capital Market: Lessons for the Czech
Republic, VP no. 21, CNB, Praha 1994
Dubow B., Monteiro N., Measuring Market Cleanliness, Occasional Paper Series 23, FSA, 2006
Du Julan, Shang-Jin Wei, Does Insider Trading Raise Market Volatility, International Monetary Fund
working paper 03/51
Elder L., Legalize Insider Trading, Capitalism Magazine, 2004 (web)
Figiel S., Die Weitergabe von Insiderinformationen in Aktienkonzernen, V&R unipress, Deisenhofen
2005
FSA, Insider Dealing in the City, London March 2007 (web)
FSA, Newsletter on Market Conduct and Transaction Reporting Issues, issue no.21, July 2007
Giberson M., Overview of Henry Manne’s, “Insider Trading: Hayek, Virtual Markets, and
the Dog that Did Not Bark”, 2007 (web)
Jeng L.A., Metrick A., Zeckhauser R., The Profits to Insider Trading: a performance-evaluation study,
working paper 6913, National Bureau of Economics, Cambridge 1999
Koranda V., Analyza Insider Trading v CR, Cekia 2008
Kotasek J., Ochrana vnitrnich informaci, Tribun EU, Brno 2008
ESME Report, Market abuse EU legal framework and its implementation by Member States: a first
evaluation, June 2007
Sanger D.E., Japan Adopts Insider – Trading Regulations, New York Times, February 1, 1989 (web)
Schacht M., Das Insiderhandelsverbot bei Öffentlichen Übernahmeangeboten, Nomos, Baden-Baden,
2002
Seyhun H.N., Investment intelligence from insider trading, Massachusetts institute of Technology
1998
Simon K. A., The misappropriation theory: a valid application of section 10(B) to protect property
rights in information, section IV., 1998 (web)
Grossmann S., Stiglitz J.E., On the Impossibility of Informationally Efficient Market, American
Economic Review 70, June 1980 (web)
Wang W. K. S., Steinberg M. I., Insider Trading, Aspen law & Business, Inc., 1996
other:
AMF, Markets Surveillance & Investigations, Surveillance and Intelligence group meeting, Berlin,
February 16th 2006
Answers of IOSCO members to CNB regarding insider trading regulation 2001, CNB archive
Bafin, Issuer Guideline, July 15th 2005
CESR/06-562b, Market Abuse Directive Level 3 – second set of CESR guidance and information on
the common operation of the directive to the market, June 2007
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CESR/07-402, Market Abuse Directive - Level 3 – second set of CESR guidance and information on
the common operation of the Directive to the market
deutsche-boerse.com
Directive 89/592/EEC coordinating regulations on insider dealing
Directive 2003/6/EC on insider dealing and market manipulation
FSA, FSA Handbook
Gesetz über den Wertpapierhandel, effective from January 5th. 2007
Ruling of the European Court of Justice C-391/04 Georgakis
Securities Exchange Commission web
http://www.rmsystem.cz/
www.wikipedia.org
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