Study released on insider leaks
Many recall the highly publicized Martha Stewart case in 2001: Stewart dodged hefty losses by selling her stocks after receiving insider information from her broker which, in turn, landed her in prison for just over a year.
While scandals like this appear to be rare, a new study by three Wilfrid Laurier University professors indicates that in Canada it is common practice for brokerage firms to leak insider information to their clients.
The study was conducted by WLU professors of finance Andriy Shkilko, Brian Smith and William McNally, who used data provided by the Toronto Stock Exchange about a set of brokers who handled insider transactions between 2004 and 2006. The particular data they looked at documented the amount of activity brokers engaged in with their other clients after they handled the trades of these insiders; the study revealed that their activity spiked.
“What we found is that it looks like brokers who execute these insiders’ transactions tell a few other people about these transactions right away — literally within the half hour,” Shkilko explained.
“Those people who are told mimic insiders’ positions, presumably making money by doing so.”
According to Shkilko and Smith, this practice is unethical. At the time of the study, regulators stipulated that brokers must wait ten days before the market is notified of an insider’s transaction.
Therefore, if certain clients are privy to information before others, it’s unfair and inequitable. However, there are currently no explicit rules done by this.
The three profs’ study confirms that this tipping is practiced, and Smith mentioned a number of measures that could be implemented in an attempt to mitigate this.
However, he emphasized the nature of their study “isn’t to prescribe the regulations or what enforcement they should do, it’s to make the public aware that this is happening.”
The study was recently awarded the 2012 Canadian Investment Research Award, sponsored by Hilldale Investment Management and the Toronto Chartered Financial Analyst Society. Shkilko and Smith were enthused at being recognized. Shkilko explained that being in an academic research profession means that papers take a significant amount of time to write and get published, which is often the most recognition a researcher will receive.
“The gratification here is rare and when you get an award on a relatively fresh paper that hasn’t been published yet, it’s definitely nice,” he continued.
Shkilko, Smith and McNally came to work on the study together due to, as Smith put it, “a convergence of interests.”
Shkilko conducted a similar study in the United States, but due to the nature of the data, was only able to establish the link between the broker and the insider and not between the broker and their other clients. Smith and McNally have been doing insider trader studies using Canadian data since 2000. Together, they were able to bring Shkilko’s study to Canada and fill the missing link with Smith and McNally’s work.
According to Smith, their success is a testament to the research culture at Laurier where “[they’re] not stuck in this box that other schools are.” Other schools, he explained, strive to be like top American schools, and use mainly American data.
“Some departments in other schools often have toxic environments just because of the competitive nature of the profession,” Shkilko added. “But here, it is amazingly collaborative.”