Watch the watchmen on insider trading

Singapore

WHEN it comes to insider trading, the watchmen need to be watched as well, says a paper published in a recent edition of the Journal of Law and Economics.

Supervised industries in the United States showed more signs of insider trading when regulators possessed undisclosed information, according to the study.

"We interpret these findings to suggest that regulatory oversight results in an unintended consequence, namely greater leakage of material non-public information," wrote co-authors David M Reeb of the National University of Singapore Business School; Yuzhao Zhang of Oklahoma State University and Rutgers University; and Wanli Zhao of Southern Illinois University. The paper looked at the price movements of financial services pharmaceuticals and utilities in the United States between 1996 and 2009. Companies in these sectors typically have to submit certain information to regulators such as the Federal Reserve or the Food and Drug Administration before disclosing to the public.

Symptoms of insider trading among banks spiked in the first 10 days after they provided detailed financial data to regulators, and decayed over the next 30 days, suggesting that "information flows to regulators lead to greater insider trading", the paper said.

Drugmakers' shares also showed greater signs of insider trading while regulators were deliberating on product applications, seeming to correctly anticipate the outcome of application decisions, the study found.

Professor Reeb told The Business Times that he was surprised by the findings.

"I was absolutely stunned, because I really bought into this idea that regulators were this additional governance device," he said.

While regulators still play an important role and in many instances will still require confidential disclosures, the key takeaway is that rules governing insider trading need to account for the regulators themselves as well, instead of just focusing on officers and directors, Prof Reeb said.

Regulators who have more to lose from being caught - reputation and pay, for example - may be less likely to be tempted to trade on insider information. Reducing the amount of time that regulators possess private information can also reduce the problem, he added.