Executive Insider Trading Isn’t Really a Big Problem

Weak US Earnings Cast Shadow Over Risk Appetite
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The Wall Street Journal'slengthy article detailing well-timed trades by corporate executivesmay spur regulators and lawmakers to attempt to crack down on insider trading. But it's far from clear that anything illegal is going on here.

Felix Salmon has a very good takedown of the WSJ piece. The basic problem with the article is that Journal's methodology seems bound to produce the suspicious results. It takes a look at trades made around the time a company released potentially market-moving news and finds that gains of 10 percent were twice as likely than losses at that level. But since most of these trades were probably sales (because many executives are compensated in stock and rationally seek to diversify their portfolio by reducing their exposure to their own company), that's exactly what you would expect. Large, sudden moves in a stock are more likely to be to the downside than the up. As Salmon puts it — stocks take the stairs up and the elevator down.

But, for the sake of argument, let's say there really is something at least a bit nefarious going on. Let's say that executives are using their access to material, non-public information to sell their stock prior to the announcement of bad news for their companies.

It certainly is not impossible for this to be the case.

Let's say you are an executive with a 10b5-1 plan under which you sell some shares of your stock at regular intervals. Under the rules, you are allowed to suspend your plan. So if you were in possession of market-moving positive news about your company during a particular quarter, you could change your plan to avoid a stock sale prior to the release of the information. When you had bad news, you'd simply keep to the old scheduled sales. You'd avoid a lot of losses and preserve a lot of upside if you carried out such a scheme.

This is also very likely completely legal. There's no legal prohibition on corporate insiders using non-public information not to trade. In fact, to run afoul of the insider-trading rules, you actually have to trade. There has to be a transaction coupled with the possession of non-public information.

No doubt there are some corporate insiders who buy stock while in possession of non-public good news or sell while in possession of non-public bad news. But I suspect that by far the most common use of non-public information is simply to refrain from trading. And that just isn't against the rules.

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