IRRC Reveals 25% of US Public M&A Deals Involve Insider Trading

A groundbreaking new study has revealed that around a quarter of all public company deals have at some point involved insider trading.

The Investor Responsibility Research Center Institute (IRRC) study, conducted by two professors at the Stern School of Business at New York University and one professor from McGill University, is the first of its kind because it sifted through hundreds of public company transactions from 1996 through the end of 2012.

The study found that there was unusual stock market activity around 30 days before 25% of public firm deals were announced, leading to suggestions that many transactions may have fallen foul of insider trading rules.

"A study of all Securities and Exchange Commission (SEC) litigations involving options trading ahead of M&A announcements show that the characteristics of insider trading closely resemble the patterns of pervasive and unusual option trading volume," said Stern's Menachem Brenner and Marti Subrahmanyam and McGill's Patrick Augustin.

"Historically, the SEC has been more likely to investigate cases where the acquirer is headquartered outside the US, the target is relatively large, and the target has experienced substantial positive abnormal returns after the announcement."

Inside trading occurs when an investor attempts to execute a transaction on the basis of market-moving, non-public information they have received as part of their role.

Findings vs Litigation

While the professors found "extensive evidence" through their data of public company transactions that resemble that of insider trading, they say that those that coincidently emulate illegal activity through their data findings are "about three in a trillion".

Moreover, they add that the SEC only litigated "about 4.7% of the 1,859 merger & acquisition (M&A) deals included in our sample."

"Completed deals are strong predictors of options litigation, as a withdrawn or rumoured deal is about 22 times less likely to be investigated," said the professors.

"The SEC, being resource-constrained, pursues larger-sized cases that provide the biggest 'bang for the buck' from a regulatory perspective."

However, the professors noted that there are several reasons for the lack of insider trading related litigations on record.

"Some prominent cases of insider trading, such as JPM Chase-Bank One, do not appear in the SEC database," they said.

"We have three potential explanations for these discrepancies. First, the SEC only reports civil litigations. If a case is deemed criminal, then the Justice Department will handle it and it will not appear in the SEC records. Second, the SEC may refrain from divulging the details of a case to protect the identity of a whistleblower.

"In these instances, if the case is settled out of court, it will not appear in the public record. Third, the SEC will not even bother to litigate if there is little chance of indictment, which will depend on the availability of clear evidence of insider activity."