The US Securities and Exchange Commission prosecutes approximately 50 insider trading cases per year, with penalties ranging up to 20 years in prison.
But researchers from the University of Technology Sydney believe there is four times more insider trading happening in the US stock markets than regulators are detecting.
The researchers created a new model predicting the extent of insider trading, based on details from all prosecuted insider trading cases in the US over the last 21 years. The model has also used data on daily price and trading activity on US stock markets.
The study has estimated that insider trading occurs in one in five mergers and acquisitions and in one in five quarterly earnings announcements – implying there is at least four times more insider trading occurring than there are prosecution cases.
“Therefore, what we see in prosecutions is the tip of the iceberg. We further estimate that the probability of detection/prosecution of insider trading in both M&A and earnings announcements is approximately 15 per cent,” the authors noted.
Finance professor Talis Putnins from UTS Business School has said while it is generally agreed that prosecution cases reflect only a fraction of all illegal insider trading, opinions about the total amount of illegal insider trading had varied widely.
“Given the substantial penalties for convicted insider trading violations including financial, reputational, and potential jail time, and smaller potential profits, the probability of detection and prosecution has to be relatively low otherwise no one would attempt it,” Professor Putnins said.
The study had focused on mergers and acquisitions, and quarterly earnings announcements, because the events are the most frequent of the major price sensitive announcements made by companies and the most likely to result in successful prosecutions.
“The prevalence of insider trading ahead of mergers and acquisitions is approximately four times higher than for earnings announcements,” research co-author Vinay Patel, senior lecturer in finance at UTS Business School added.
The research also ruled that insider trading is more likely when there is more liquidity, which “allow insiders to conceal their trades and earn higher profits”, Dr Patel said, as well as when the value of information is larger, as measured by market reactions.
“So, more volatile stocks that see greater share price movements, and popular stocks that attract a high volume of trading, are more frequent targets for insider trading,” Dr Patel said.
