Study: Corporate Mergers Overrun By Insider Trading

June 17, 2014

On Wall Street, winning trades often come down to who has the most information — who has the most “edge.” The question is, just how often does edge cross the line into insider trading?

A jaw-dropping new study of mergers and acquisitions (M&A) suggests the problem is not only pervasive, but also rarely enforced.

According to the study, as much as 25 percent of all M&A deals from 1996 through 2012 may have involved some degree of insider trading. The typical “rogue trade,” the authors found, reaped an average profit of $1.6 million.

The authors — Patrick Augustin of McGill University and Menachem Brenner and Marti Subrahmanyam of New York University — focused on movements in the price of stock options in the 30 days before an M&A deal was announced. Options allow investors to acquire a stock at a future date at a set price.

M&A deals are supposed to be secret, so “we should not be able to distinguish options trading activity before an announcement … on any randomly chosen date,” the authors wrote.

That’s not what they found, however. The trades flagged in the study as suspicious were so well-timed, the authors say, that “the probability of the unusual volume in the sample arising out of chance” is approximately “three in a trillion.”

In addition to the sheer extent of insider trading, the authors found that regulators at the Securities and Exchange Commission are often overmatched in their efforts to keep pace with such activity. Out of 1,859 deals examined in the study, fewer than 5 percent resulted in any form of litigation by the SEC.

In recent years, the government’s most successful actions against insider trading have originated at the Department of Justice. Since 2009, prosecutors in the U.S. Attorney’s Office for the Southern District of New York have won 81 convictions or guilty pleas for insider trading in the hedge fund industry. The historic crackdown was the focus of the recent FRONTLINE investigation, To Catch a Trader.

One problem at the SEC, say the authors, is that regulators appear overly focused on insider trading with stocks, rather than on trading in options. From 1990 to 2013, they note, the SEC investigated 207 M&A transactions for insider trading in stocks only, but only 102 cases involving options.

“The modest number of civil lawsuits for insider trading in options made by the SEC appears small in comparison to the pervasive evidence we document,” they conclude.

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