Hostname: page-component-76fb5796d-25wd4 Total loading time: 0 Render date: 2024-04-26T11:44:37.067Z Has data issue: false hasContentIssue false
  • English
  • Français

Insider Trading: What Really Protects U.S. Investors?

Published online by Cambridge University Press:  16 April 2019

Roger M. White Open the ORCID record for Roger M. White [Opens in a new window]
Roger M. White*
Affiliation:
White, roger.white@asu.edu, Arizona State University W. P. Carey School of Business
*
White (corresponding author), roger.white@asu.edu
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

I examine the ability of the U.S. investor protection regime to limit insider trading returns, absent Section 16(b) of the Securities Exchange Act of 1934 (the short-swing rule). I find that in this setting, U.S. insiders execute short-swing trades that i) beat the market by approximately 15 basis points per day and ii) systematically divest ahead of disappointing earnings announcements. These results indicate that the bright-line rule restricting short-horizon round-trip insider trading plays a substantial role in protecting outside investors from privately informed insiders in the United States.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 55 , Issue 4 , June 2020 , pp. 1305 - 1332
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2019

Footnotes

For feedback that greatly improved this manuscript, I thank my dissertation committee members at Emory University: Ilia Dichev (chair), Clifton Green, and Ed Owens. I am also grateful for helpful feedback from Bernard Black (the referee), Olivia Burnsed, Jivas Chakravarthy, Suman Chattopadhyay, Jesse Ellis, Jarrad Harford (the editor), Bright Hong, In Do Hwang (discussant), Weishi Jia, Lisa LaViers, Melanie Millar, Robert Mocadlo, Shiva Rajgopal, Tom Shohfi, Han Stice, Charles Trzcinka, Devin Williams, Dan Zhou, and workshop participants at Emory University, Yale University, Southern Methodist University, Penn State University, Arizona State University, the University of Illinois, and the 2016 Midwest Finance Association annual meeting. Chip Presten (Baker, Donelson, Bearman, Caldwell & Berkowitz) and Urska Velikonja (Georgetown University School of Law) also provided their invaluable institutional knowledge, for which I am thoroughly indebted and appreciative.

References

Agrawal, A., and Jaffe, J. F.. “Does Section 16b Deter Insider Trading by Target Managers?” Journal of Financial Economics, 39 (1995), 295–319.Google Scholar
Amel-Zadeh, A.; Faasse, J.; and Lotz, J.. “Are All Insider Sales Created Equal? Evidence from Form 4 Footnote Disclosures.” Working Paper, Oxford University (2018).Google Scholar
Amoako-Adu, B., and Smith, B. F.. “Dual Class Firms: Capitalization, Ownership Structure and Recapitalization Back into Single Class.” Journal of Banking & Finance, 25 (2001), 1083–1111.Google Scholar
Anthony, L.“Section 16 Insider Reporting and Liability for Short-Swing Trading.” White Paper, Legal & Compliance LLC (2014).Google Scholar
Ausubel, L. M.“Insider Trading in a Rational Expectations Economy.” American Economic Review, 80 (1990), 1022–1041.Google Scholar
Banks, T. L.Corporate Legal Compliance Handbook. 2nd ed.New York, NY: Aspen Publishers Online (2010).Google Scholar
Bettis, J. C.; Coles, J. L.; and Lemmon, M. L.. “Corporate Policies Restricting Trading by Insiders.” Journal of Financial Economics, 57 (2000), 191–220.Google Scholar
Bhattacharya, U., and Daouk, H.. “The World Price of Insider Trading.” Journal of Finance, 57 (2002), 75–108.Google Scholar
Black, B. S.“The Legal and Institutional Preconditions for Strong Securities Markets.” UCLA Law Review, 48 (2001), 781–855.Google Scholar
Boehmer, E.; Masumeci, J.; and Poulsen, A. B.. “Event-Study Methodology under Conditions of Event-Induced Variance.” Journal of Financial Economics, 30 (1991), 253–272.Google Scholar
Brochet, F.“Information Content of Insider Trades Before and After the Sarbanes–Oxley Act.” Accounting Review, 85 (2010), 419–446.Google Scholar
Bucklo, E. E.“The Supreme Court Attempts to Define Scienter Under Rule 10b-5: Ernst & Ernst v. Hochfelder.” Stanford Law Review, 29 (1977), 213–240.Google Scholar
Bushman, R. M.; Piotroski, J. D.; and Smith, A. J.. “Insider Trading Restrictions and Analysts’ Incentives to Follow Firms.” Journal of Finance, 60 (2005), 35–66.Google Scholar
Cao, C.; Field, L. C.; and Hanka, G.. “Does Insider Trading Impair Market Liquidity? Evidence from IPO Lockup Expirations.” Journal of Financial and Quantitative Analysis, 39 (2004), 25–46.Google Scholar
Carangelo, R. F.; Ferrillo, P. A.; Schwartz, D. J.; and Altemeier, M. D.. The 10b-5 Guide: A Survey of 2010–2011 Securities Fraud Litigation. New York, NY: Weil, Gotshal & Manges LLP (2012).Google Scholar
Carhart, M. M.“On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.Google Scholar
Chen, Z.; Guan, Y.; and Ke, B.. “The Short-Swing Rule and Insider Trading.” Working Paper, City University of Hong Kong and Nanyang Technological University (2014).Google Scholar
Cheng, C.; Huang, H.; Li, Y.; and Lobo, G.. “Institutional monitoring through shareholder litigation.” Journal of Financial Economics, 95 (2010), 356–383.Google Scholar
Christensen, H. B.; Hail, L.; and Leuz, C.. “Capital-Market Effects of Securities Regulation: Prior Conditions, Implementation, and Enforcement.” Review of Financial Studies, 29 (2016), 2885–2924.Google Scholar
Chung, K. H., and Charoenwong, C.. “Insider Trading and the Bid-Ask Spread.” Financial Review, 33 (1998), 1–20.Google Scholar
Coffee, J. C.“Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation.” Columbia Law Review, 106 (2006), 1534–1586.Google Scholar
Cohen, L.; Malloy, C.; and Pomorski, L.. “Decoding Inside Information.” Journal of Finance, 67 (2012), 1009–1043.Google Scholar
Comolli, R., and Starykh, S.. Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review. New York, NY: NERA Economic Consulting (2015).Google Scholar
Cornell, B., and Sirri, E. R.. “The Reaction of Investors and Stock Prices to Insider Trading.” Journal of Finance, 47 (1992), 1031–1059.Google Scholar
Corrado, C. J., and Zivney, T. L.. “The Specification and Power of the Sign Test in Event Study Hypothesis Tests Using Daily Stock Returns.” Journal of Financial and Quantitative Analysis, 27 (1992), 465–478.Google Scholar
Cziraki, P., and Gider, J.. “Perks or Peanuts? The Dollar Profits to Insider Trading.” Working Paper, University of Toronto and University of Bonn (2016).Google Scholar
Davis, J. B.Statistics Using SAS Enterprise Guide. Cary, NC: SAS Institute (2007).Google Scholar
DeAngelo, H., and DeAngelo, L.. “Managerial Ownership of Voting Rights: A Study of Public Corporations with Dual Classes of Common Stock.” Journal of Financial Economics, 14 (1985), 33–69.Google Scholar
Dellavigna, S., and Pollet, J. M.. “Investor Inattention and Friday Earnings Announcements.” Journal of Finance, 64 (2009), 709–749.Google Scholar
DeMarzo, P. M.; Fishman, M. J.; and Hagerty, K. M.. “The Optimal Enforcement of Insider Trading Regulations.” Journal of Political Economy, 106 (1998), 602–632.Google Scholar
Dessent, M. H.“Weapons to Fight Insider Trading in the 21st Century: A Call for the Repeal of Section 16(B).” Akron Law Review, 33 (1999), 481–522.Google Scholar
Easterbrook, F. H., and Fischel, D. R.. The Economic Structure of Corporate Law. Cambridge, MA: Harvard University Press (1991).Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.Google Scholar
Fernandes, N., and Ferreira, M. A.. “Insider Trading Laws and Stock Price Informativeness.” Review of Financial Studies, 22 (2009), 1845–1887.Google Scholar
Ferrell, A., and Saha, A.. “Forward-Casting 10b-5 Damages: A Comparison to Other Methods.” Journal of Corporation Law, 37 (2011), 365–386.Google Scholar
Field, L.; Lowry, M.; and Shu, S.. “Does Disclosure Deter or Trigger Litigation?” Journal of Accounting and Economics, 39 (2005), 487–507.Google Scholar
Finn, E., and Markus, E.. Second Circuit Holds That Two Series of Common Stock Are Not Matchable Under the Short-Swing Profit Rule. Houston, TX: Andrews Kurth LLP (2013).Google Scholar
Fishe, R. P. H., and Robe, M. A.. “The Impact of Illegal Insider Trading in Dealer and Specialist Markets: Evidence from a Natural Experiment.” Journal of Financial Economics, 71 (2004), 461–488.Google Scholar
Fishman, M. J., and Hagerty, K. M.. “Insider Trading and the Efficiency of Stock Prices.” RAND Journal of Economics, 23 (1992), 106–122.Google Scholar
Fried, J. M.“Reducing the Profitability of Corporate Insider Trading through Pretrading Disclosure.” Southern California Law Review, 71 (1997), 303–392.Google Scholar
Gibbons v. Malone. 801 F.Supp.2d 243 (S.D.N.Y. 2011).Google Scholar
Glaeser, E. L., and Shleifer, A.. “Legal Origins.” Quarterly Journal of Economics, 117 (2002), 1193–1229.Google Scholar
Goldmark, J. A.“2nd Circuit Limits Short-Swing Insider Trading Claims.” Davis Wright Tremaine LLP (2013).Google Scholar
Goldstein, P.“Section 16(B)—If at First You Don’t Succeed….” Working Paper, Harvard Law School Forum on Corporate Governance and Financial Regulation (2017).Google Scholar
Gompers, P. A.; Ishii, J.; and Metrick, A.. “Extreme Governance: An Analysis of Dual-Class Firms in the United States.” Review of Financial Studies, 23 (2010), 1051–1088.Google Scholar
Hirshleifer, D.; Lim, S. S.; and Teoh, S. H.. “Driven to Distraction: Extraneous Events and Underreaction to Earnings News.” Journal of Finance, 64 (2009), 2289–2325.Google Scholar
Holmstrom, B., and Kaplan, S. N.. “Corporate Governance and Merger Activity in the United States: Making Sense of the 1980s and 1990s.” Journal of Economic Perspectives, 15 (2001), 121–144.Google Scholar
Ishizumi, K.“Insider Trading Regulation: An Examination of Section 16(b) and a Proposal for Japan.” Fordham Law Review, 47 (1978), 449–494.Google Scholar
Jackson, H. E., and Roe, M.. “Public and Private Enforcement of Securities Laws: Resource-Based Evidence.” Journal of Financial Economics, 93 (2009), 207–238.Google Scholar
Jacobs, A. S.“An Analysis of Section 16 of the Securities Exchange Act of 1934.” New York Law School Law Review, 32 (1987), 209–700.Google Scholar
Jagolinzer, A. D.“SEC Rule 10b5-1 and Insiders’ Strategic Trade.” Management Science, 55 (2008), 224–239.Google Scholar
Jagolinzer, A. D.; Larcker, D. F.; and Taylor, D. J.. “Corporate Governance and the Information Content of Insider Trades.” Journal of Accounting Research, 49 (2011), 1249–1274.Google Scholar
Jeng, L. A.; Metrick, A.; and Zeckhauser, R.. “Estimating the Returns to Insider Trading: A Performance-Evaluation Perspective.” Review of Economics and Statistics, 85 (2003), 453–471.Google Scholar
Jennings, R. W.; Marsh, H.; and Coffee, J. C.. Securities Regulation: Cases and Materials. 7th ed.Westbury, NY: Foundation (1992).Google Scholar
Johnstone, S.“Why HK Class-Actions Are a Flawed Debate.” International Financial Law Review, 34 (2015), 38–39.Google Scholar
Kahn, C., and Winton, A.. “Ownership Structure, Speculation, and Shareholder Intervention.” Journal of Finance, 53 (1998), 99–129.Google Scholar
Ke, B.; Huddart, S.; and Petroni, K.. “What Insiders Know About Future Earnings and How They Use It: Evidence from Insider Trades.” Journal of Accounting and Economics, 35 (2003), 315–346.Google Scholar
Kyle, A. S.“Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 1315–1335.Google Scholar
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R.. “Law and Finance.” Journal of Political Economy, 106 (1998), 1113–1155.Google Scholar
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R.. “Investor Protection and Corporate Governance.” Journal of Financial Economics, 58 (2000), 3–27.Google Scholar
Lenkey, S. L.“Insider Trading and the Short-Swing Profit Rule.” Journal of Economic Theory, 169 (2017), 517–545.Google Scholar
Liman, L.“Second Circuit Rules on Short-Swing Profit.” White Paper, Harvard Law School Forum on Corporate Governance and Financial Regulation (2013).Google Scholar
Lowenfels, L. D.“Section 16(b) a New Trend in Regulating Insider Trading.” Cornell Law Review, 54 (1968), 45–64.Google Scholar
Lowenfels, L. D.“Scienter or Negligence Required for SEC Injunctions under Section 10(b) and Rule 10b-5: A Fascinating Paradox.” Business Lawyer, 33 (1978), 789–809.Google Scholar
Macchiarola, M. C.“Tilting at Insider Trading Windmills.” University of Pennsylvania Law Review Online, 163 (2014), 61–74.Google Scholar
Manne, H. G.Insider Trading and the Stock Market. New York, NY: Free Press (1966).Google Scholar
Manne, H. G.“Keynote Address.” Journal of Law, Economics & Policy, 4 (2008), 225–232.Google Scholar
Maug, E. G.; Van Halteren, J.; and Ackerman, A.. “Insider Trading Legislation and Acquisition Announcements: Do Laws Matter?” Working Paper, University of Mannheim (2008).Google Scholar
Munter, J. E.“Section 16(b) of the Securities Exchange Act of 1934: An Alternative to ‘Burning Down the Barn in Order to Kill the Rats.” Cornell Law Review, 52 (1966), 69–101.Google Scholar
Muth, K. T.“With Avarice Aforethought: Insider Trading and 10b5-1 Plans.” U.C. Davis Business Law Journal, 10 (2009), 65–82.Google Scholar
O’Connor, M. A.“Toward a More Efficient Deterrence of Insider Trading: The Repeal of Section 16(b).” Fordham Law Review, 58 (1989), 309–381.Google Scholar
Richardson, S.; Teoh, S. H.; and Wysocki, P. D.. “The Walk-Down to Beatable Analyst Forecasts: The Role of Equity Issuance and Insider Trading Incentives.” Contemporary Accounting Research, 21 (2004), 885–924.Google Scholar
Romeo, P. J., and Dye, A. L.. “Developments Under Section 16 (Part I of Two Parts).” Review of Securities and Commodities Regulation, 33 (2000), 1–12.Google Scholar
Roulstone, D. T.“The Relation between Insider-Trading Restrictions and Executive Compensation.” Journal of Accounting Research, 41 (2003), 525–551.Google Scholar
Seligman, J.The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance. 3rd ed.New York, NY: Aspen Publishers (2003).Google Scholar
Seyhun, H. N.“Insiders’ Profits, Costs of Trading, and Market Efficiency.” Journal of Financial Economics, 16 (1986), 189–212.Google Scholar
Seyhun, H. N.“The Effectiveness of the Insider-Trading Sanctions.” Journal of Law and Economics, 35 (1992), 149–182.Google Scholar
Sharpe, W. F.“Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance, 19 (1964), 425–442.Google Scholar
Shleifer, A., and Vishny, R.. “A Survey of Corporate Governance.” Journal of Finance, 52 (1997), 737–783.Google Scholar
Smolowe v. Delendo Corporation. 136 F.2d 231 (2d Cir. 1943).Google Scholar
Sokenuai, C. O.; Baskin, S. J.; Craner, M. L.; Dunogué, A.; Fishbein, S.; Fortinsky, J. S.; Frank, J. J.; Hakki, A. S.; Laguardia, D. H. R.; LaVigne, C. L.; Nathanson, J. A.; Resetarits, J. J.; Lanpher, M. D.; Urofsky, P.; Hibbard, S. D.; Robbins, P. D.; and Burke, B. G.. Securities Enforcement 2014 Year-End Review. New York, NY: Shearman & Sterling LLP (2015).Google Scholar
Swanson, C. B.“Insider Trading Madness: Rule 10b5-1 and the Death of Scienter.” University of Kansas Law Review, 52 (2003), 147–206.Google Scholar
Talesnick, A. L.“Corporate Silence and Rule 10b-5: Does a Publicly Held Corporation Have an Affirmative Obligation to Disclose?” Denver Law Journal, 49 (1972), 369–412.Google Scholar
Tamersoy, A.; Khalil, E.; Xie, B.; Lenkey, S. L.; Routledge, B. R.; Chau, D. H.; and Navathe, S. B.. “Large-Scale Insider Trading Analysis: Patterns and Discoveries.” Social Network Analysis and Mining, 4 (2014), 1–17.Google Scholar
Taylor, E.“Teaching an Old Law New Tricks: Rethinking Section 16.” Arizona Law Review, 39 (1997), 1315–1359.Google Scholar
Wang, W.; Shin, Y.; and Francis, B. B.. “Are CFOs’ Trades More Informative Than CEOs’ Trades?” Journal of Financial and Quantitative Analysis, 47 (2012), 743–762.Google Scholar