There was a rather breathless report last week on the frequency with which insider trading occurs:
Insider trading of public companies that are bought through mergers or acquisitions occurs very frequently according to a study conducted by Measuredmarkets for the New York Times.
The researchers conducted the study by analyzing historical trading behavior. Surprisingly, 41 percent of all stocks that were bought with a market value greater than $1 billion showed suspicious trading activity just before buyout bids were made public. In these cases huge spikes in trading volume in the stocks and options on the stocks were identified. For example, in the days before bidders announced offers for Amegy Bancorp trading volume in the stock soared by 400 percent. The study’s findings indicate that insider trading is much more prevalent than ever thought.
More prevalent than who thought? In my insider trading scholarship, I've frequently noted that insider trading is rampant, is detected and prosecuted in a tiny fraction of cases, and probably is the most commonly committed violation of the securities laws. In any event, the report prompted my friend Henry Manne (the leading contrarian scholar of insider trading) to send along this email, which he kindly authorized me to reproduce here:
There are several problems with this approach. Of course, there is a vast amount of trading going on in advance of important announcements. Who but a nit-wit – or someone who has not read the academic literature for fifty years - could be surprised at that? Anyone who even casually watches stock price movements can observe that occurrence. However, that is a long way from establishing that illegal insider trading is occurring, though undoubtedly that is part of it. Probably, as enforcement has improved over the years, so have the techniques of hiding or obfuscating or sanitizing what would constitute illegal insider trading.
But the problem with the kind of approach taken in the instant study is that the same stock price effect can be had with gamblers and partially informed traders, not one of whom has specific, total information about a forthcoming event, trading on their assumed information. Some of the trading, for example, may be by employees of the traded company, or even mere standers by, who notice increased phone and courier business with lawyers and bankers and “bet” on this information though they do not know anything else. Is that a “significant” bit of information? Would we want to stop all such trading? Wouldn’t competitors and suppliers and customers often be in positions to infer that something “tradable” was up with a company even though they did not know what it might be?
There are always going to be lots of folks good at ferreting out trading signals from what may be perfectly innocuous activities to the rest of us, and it will remain forever impossible to totally isolate every observable aspect of a major corporate event. Who could do business that way? And how much of the observed trading, even of large blocs, is “derivative” (and therefore not actionable) of a small amount of informed trading. And how much input from people with low-probability, partial information is required before the “correct” price emerges via a “wisdom-of-crowds” mechanism? No one has even a clue to the answers to these questions.
All of this fits into the category of reasons why IT laws are generally not enforceable. But far too little interest has been shown in the problem of fractional enforcement of laws, a source of myriad unforeseen consequences. It seems that the more we learn about insider trading, the more we realize that we do not know enough abut what is going on to regulate it intelligently. And this certainly supports Larry Ribstein’s counsel that if we really do not know what the untoward consequences of a regulation are, we are probably better off without it, especially when we do know that the status quo has some real benefits.
