Want a tip? You should just assume that many traders are clued-in to confidential financial information all the time - before you get a look at it.
A new academic study by researchers at NYU’s Stern School of Business and McGill University and detailed in the New York Times found persuasive evidence of trading on nonpublic information in one-quarter of merger-and-acquisition transactions from 1996 through 2012.
This largely confirms, with rigorous data scrubbing, the general sense among seasoned investors that hints, clues and outright inside information make their way onto trading desks with some regularity. The study’s authors note that the Securities and Exchange Commission appears outnumbered and ill-equipped to investigate suspicious trading, going after less than 5% of the cases cited in the research.
As Yahoo Finance contributor Henry Blodget notes in the attached video: “The lesson we learn repeatedly is that there is a group of insiders that are much closer to information – whether high-frequency trading or company research or this kind of thing where you get advance notice of a tip – that just puts people on the outside at a colossal disadvantage.”
The study used trading patterns in stock options in the 30 days leading up to an M&A announcement to isolate instances of obvious, clued-in trading ahead of the news. This is also where regulators frequently hunt for insider trading, screening options data from prior weeks each time a deal is revealed.
Despite the high-profile prosecutions of traders at large hedge funds Galleon Group and SAC Capital by the SEC and U.S. Attorney of New York, only a few eyebrow-raising trading evidence results in an investigation.
It’s worth noting that not all activity by investors who appear wise to nonpublic information rises to the level of criminal insider trading. Technically, insider trading only occurs if the trader has reason to believe that the source of the information is someone who has a legal duty to keep the information confidential.
This effectively lets off the hook the legions of traders who simply scan the markets – or have software scan them – in search of anomalous trading patterns that suggest someone, somewhere, knows something. There is a virtual industry devoted to exactly this approach.
In any case, it seems regulators can scarcely hope to make much of a dent in the tipster trading game. As the study’s authors put it in the Times piece: “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.”
Often this means the authorities wind up snagging the clumsiest perpetrators – the sort of opportunist who decides to open an account and make his first options purchase a week before a blockbuster takeover is divulged. The SEC in April announced charges and settlements with a handful of individuals who had traded on passed-along knowledge of eBay Inc.’s (EBAY) 2011 acquisition of GSI Commerce – three years after the events occurred.
And, as noted, the law has sought to make an example of big hedge-fund firms suspected of systematically cultivating inside sources, skirting the edge of the law and perhaps breaching it with some frequency.
Based on the results of this research, though, it’s hard to see how these trophy targets will do much to stem the flow of suspect information to those lucky enough to be in earshot of the tips.
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