INSIDER trading is alive and well, concludes a new University of Michigan study.
It is ironic that just as a new updated paperback version of "Den of Thieves" is about to be released, the Michigan study is published. Den of Thieves (Simon & Schuster), by James B. Stewart, is the controversial account of the insider trading scandals of the 1980s that has won widespread news media attention.
Mr. Stewart, front-page editor for The Wall Street Journal, received a Pulitzer Prize in 1988, in part for his investigative stories on illegal insider trading.
But most insider trading is not illegal. Trading in a company's stock by executives or other insiders of that company is only illegal if it is based on "material" information about the company before that information is released to the public. Through its prosecutions, the Securities and Exchange Commission (SEC) has determined what is "material."
A new study by H. Nejat Seyhun, a professor at the University of Michigan Graduate School of Business Administration, finds that trading by insiders (undoubtedly mostly legal) as reported to the SEC "is very profitable."
Professor Seyhun examined close to a million stock market transactions between 1975 and 1989. His conclusions are startling:
Congress trebled damages on insider trading in 1984, hiked fines to $1 million in 1988 (up from $100,000), and extended prison sentences from five years to 10 years.
Since then the number of insider trading transactions, mostly legal, has increased.
What has happened, Seyhun says, is that insider traders have merely shifted their practices.
Court case law, he says, has lead to convictions largely based on insiders acting on information about earnings and takeover announcements.
But insiders have changed their focus to other areas of action, "such as gaining access to privileged corporate information," Seyhun says.
Thus, insiders obtain news about upcoming corporate announcements, new products, company goals, and what competitors are doing. Moreover, insiders now seek to act on their information "long before the privileged information is made public."
According to Seyhun's study, "increased statutory sanctions in the 1980s did not produce an additional deterrent effect either on the profitability or volume of insider trading.
"In fact, the volume of insider trading increased by a factor of four while the profitability increased by a factor of two in the period after 1984 as compared with the period before 1980."
Corporate insiders, Seyhun reckons, have "earned an average of about 5.1 percent [on a dollar-weighted basis, in] abnormal profits over a one-year holding period between 1980 and 1984, increasing further to 7.0 percent after 1984, as compared with 3.5 percent before 1980."
Seyhun says that he must be considered "sort of an agnostic" on the insider trading issue. He sees "two schools of thought:"
* That insider trading is "immoral," because it is based on such practices as privilege and dishonesty.
* That it is part of the natural functioning of the stock market.
Case in point: In October, 1987, following the market crash, "when everyone in sight was selling stocks like mad, insider traders were quietly buying," he says. "They knew what the public didn't know, that their individual firms were not really in bad [shape.]"
But by buying, insiders helped shore up the market, preventing a deeper decline in stock prices.
While opposed to dishonesty, such as manipulating prices, Seyhun says that Congress should be wary about imposing a "blanket ban" on insider trading; such a ban, he says, might work against market efficiency.