More Policing Needed?

However, their results also suggest that there may be more avenues
for conflicts of interest with regard to insider trading than
previously thought. Regulators may need to go further than the
traditional policing of the Chinese Wall between research analysts and
bankers who work for the same institution.

This could be a game-changing result of the findings, especially at
a time of intense regulatory scrutiny in the wake of the failures of
all five U.S. investment banks in 2008 and the financial meltdown of
equities markets around the world. Asked what the most direct result of
the researchers' work might be, Yan says: "Disclosure." After
Regulation FD, "the window for piggybacking [got] shorter."

Before and after Regulation FD, Géczy adds, "you see a change, and
that may be generally correlated with the associated greater disclosure
statement. Potential advantages that arise from anomalous behavior are
obviated by disclosure."

The authors present two hypotheses. Their "Information Hypothesis"
is that insider-affiliated brokers' clients or traders, possessing
privileged knowledge that the stock price may fall after insider sales,
could place limit sell orders with lower limit prices. The "Market
Stabilization Hypothesis" refers to instances when insiders trade in
large quantities, and affiliated market makers then greatly influence
the stability of the market -- by the more frequent and more aggressive
nature of their quotes.

The authors acknowledge a few significant limitations to the sample
selection of more than a half-million trades between March 1999 and
November 2003, but they could be offset by conservative assumptions.
For example, the exact time of day when insider trades took place is
not known (many regulatory filings aggregate several trades from the
same day, or even over a period of several days, usually when volume is
large).

Also, information on inventory positions for each broker, or the
daily volume of any given stock traded by a particular broker on any
given day, is not known. However, as footnoted in the report, insider
trades may be completed by more than one broker at the same company on
the same day, but the authors record them as "independent events" -- a
conservative assumption which they assert could reduce their test power
but, at the same time, increase the significance of their results.