A regulatory loophole has created an opportunity for corporate insiders to make “meaningful” profits by trading in a public company’s stock before it discloses a significant event, a new study warns.
Researchers at Columbia and Harvard universities analyzed nearly 43,000 insider purchases and sales between 2004 and 2014 that occurred during the four-day window that the U.S. Securities and Exchange Commission gives companies to file a Form 8-K reporting a significant development.
The rules, the researchers concluded, have created an “8-K trading gap” during which corporate insiders have “earn[ed] economically and statistically meaningful profits” from stock trades.
On average, insiders netted about 0.4 percentage point over a broad market index between the time of their trades and the market close after the 8-K disclosure. Those gains, realized over the span of a few days, would be much larger on an annualized basis, The Wall Street Journal noted.
When insiders bought shares outright — rather than by exercising options received as compensation — the gains were about 1.6 percentage points over the index, and when companies used the full four-day window, the average excess profit rose to 1.95 percentage points.
Insiders aren’t explicitly banned from trading ahead of 8-K announcements but, as with other times, can’t do so if they possess market-moving information unknown to other investors.
The researchers cautioned that their evidence “in no way establishes the existence of illegal or improper conduct” and that the “mere occurrence of an insider’s transaction during the 8-K gap is insufficient to establish liability of any kind under the securities laws.”
“We simply document that insiders do, in fact, trade profitably during the gap — not that the gap causes greater levels of insider profits,” they wrote.
But the study recommends that firms should consider extending trading “blackout” periods to significant reportable events and “policymakers currently considering choices regarding the design of information-forcing rules — such as those that govern Form 8-K — should consider the effects of those choices on the opportunities for trading by insiders.”
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