The U.S. Securities and Exchange Commission (SEC) brings hundreds of civil enforcement actions against violators of federal securities laws every year. One of the most common actions is for insider trading; the SEC brought 58 of them in FY 2012 alone, and more in the last three years than in any three-year period ever.
Not everyone regards insider trading as a bad thing, but the SEC prioritizes enforcement on the basis that it “undermin[es] the level playing field that is fundamental to the integrity and fair functioning of the capital markets.”
Insider trading occurs when someone with non-public information about a company buys or sells stock in that company. Many recall when Martha Stewart was caught in the act, selling her shares of ImClone stock in 2004 after receiving an inside tip that the CEO was selling his own shares.
Before a landmark Supreme Court decision and ensuing regulatory action, some federal circuit courts let those kinds of transactions slide if the security trader could convince a jury that, while he may have possessed material non-public information about the company, he would have made the trade anyway. But as of 2000, after the SEC enacted Rule 10b5-1, trading stock with mere possession of such information is against the law.
Yet, the very enforcers of that law have been trading in securities they investigate as part of their job at the SEC. Emory University business school professor Shivaram Rajgopal points out in his draft study that the SEC “undoubtedly come[s] across a substantial amount of non-public information about publicly traded companies.”
No one has proven misconduct, but Rajgopal’s survey of security trades by 3,500 SEC employees from 2009 to 2011 found that in the 30 days before stock was subjected to an SEC enforcement action, 74% of SEC employee trades in that stock were sells (as opposed to buys), significantly higher than the 51% sell-rate in the total market. “They do manage to get out before bad news hits the market,” Rajgopal observed.
New York Times columnist and soon-to-be Berkeley Law faculty member Steven Davidoff has doubts about the insider trading speculation. “The likely truth . . . is that not only is no insider trading going on, but that the SEC staff members are just as bad as the rest of us at picking stocks,” he wrote in a recent column. He points out that a misreading of Rajgopal’s study may overlook the fact that suspicious-looking sale-timing trends could be a result of employees’ having to sell a stock when the SEC is about to investigate the company. “[M]ost of the sales were required by SEC policy. Staff had no choice. They were required to sell,” SEC spokesman John Nester explained.
While Davidoff made a point to rebuff any conclusions of insider trading in the SEC, he praised Rajgopal’s study, noting that its findings could ultimately compel the SEC “to rethink its sale rules for when investigations are initiated” and “to revisit its stock holding rules.