Shining a Light on Corporate Black Box Meetings: How Private In-House Meetings Flirt With Insider Trading
For Americans who aren’t entrenched in the day-to-day dealings of the stock market, books and films like the 1987 movie “Wall Street” and the best-selling memoir “The Wolf of Wall Street” have provided a window into how insider trading works. In stories like these, stockbrokers and finance executives catch wind of confidential information on upcoming business deals and exploit that information for personal financial gain.
While these narratives are often set in the hectic stock market of the 1980s, insider trading remains a prevalent issue today. In 2018, CNBC noted that insider trading was still a “rampant problem” on the street, citing political connections as a major source of these illicit transactions. But insider trading isn’t the only problematic issue facing the financial industry — some private, in-house meetings exist in an ethical gray area as well, blurring the line between legal and illegal trading.
Current Regulations
An act of insider trading — where individuals make stock purchases or sales based on private information — is deemed illegal if it breaches specific regulations set out by government authorities, such as the Securities and Exchange Commission. These regulations include the Securities Exchange Act of 1934, the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988. Individuals found to be in violation of statutes such as these can face civil penalties and jail time.
China has similar laws, such as the Corporate Law and the Securities Law, which help to establish certain protocols for stock buying and selling. China’s laws even go so far as to provide specific date ranges in which a trade must occur to abide by federal regulations.
As for insider trading, there is a lack of federal regulations in both countries addressing the legality of private meetings where valuable information is shared among a group of privileged and powerful attendees. Government authorities have the ability to question and potentially prosecute a trader who, for example, earns a profit of $1 million after suspiciously purchasing 10,000 shares in a small startup right before it announced its acquisition by a larger corporation. What doesn’t exist are rules governing the meetings where that trader got the information about the startup in the first place.
Looking Into the Loophole
This legislative gap prompted Dr. Robert Bowen and Dr. Pengcheng Zhu, professors at the University of San Diego Knauss School of Business, to analyze information from meetings in the Shenzhen Stock Exchange (SZSE).
Unlike many financial organizations, the SZSE makes information about private meetings available to the public. Dr. Bowen and Dr. Zhu gathered all of the summaries from private meetings held by SZSE-listed firms between July 2012 and December 2014 for an initial sample size of 17,631 reports from 1,316 firms. They also examined the names of attendees listed in the reports and cross-referenced them with their titles at other companies.
From there, they used the standard market model to look for possible connections between abnormal stock returns and private meetings.
The Findings
Unsurprisingly, the research showed that insiders used information discussed in legal private meetings to inform their trade decisions as well as to anticipate how other investors would react when the information became publicly available.
The professors also found that investors were more likely to sell shares before negative events and postpone sales in anticipation of good news. Conversely, investors were more likely to purchase shares after hearing good news in a private meeting, while holding off on purchases if insiders predicted bad news.
Another key insight Dr. Bowen and Dr. Zhu gleaned from the research was regarding overall trade activity within a two-day window after private meetings. If stock sales after a private meeting went up, it indicated to other investors that they should follow suit. In other words, insiders were able to use the information learned in the meeting itself — such as Company A’s plan to acquire Company B — to influence their trading activity. Consequently, outside traders could note that a meeting took place at Company A on January 1 and there was a flurry of purchases of Company A stock between January 2 and 3, and those traders could then make similar buys before the information announced in the meeting became available to the public.
These trades based on market reaction to the meeting, not information revealed within the meeting itself, are not necessarily illegal. Insider trading only occurs when traders buy or sell stock based on information they have gleaned from private sources.
This type of outsider trading discussed in Dr. Bowen and Dr. Zhu’s research occurs as a reaction to the potential insider trades taking place. The outsiders are not breaking insider trading laws and regulations since they are not privy to the information being discussed in the private meetings; they are responding to what happens after the conversation takes place.
Making the Case for Increased Regulation
Dr. Bowen and Dr. Zhu’s research relied on regulations ensuring public access to private meetings within companies listed on the Shenzhen Stock Exchange. But in the United States, private meetings are unregulated. American laws and regulations that restrict insider trading have historically focused on reprimanding the individuals who participate in or profit from private information, but not on the accessibility of the information itself or the forum in which it was discussed.
Dr. Bowen and Dr. Zhu’s research demonstrates the importance of increasing public awareness of these meetings as a first step. While regulations may help limit illegal activity, this legal gray area requires more research before real action is taken.
In the United States, if corporations had to make their meeting information available to the public, it might encourage them not to share sensitive information in legal private meetings in the first place, potentially spurring increased insider trading. There could also be overly harsh judgments and actions taken against outside traders, considering the government has not yet established the legal implications of buying or selling stocks based on the trends after these meetings.
Learn More About the Future of Business
Dr. Bowen and Dr. Zhu’s findings unveiled how not only private information but the reaction to private information can spur stock market activity, both of an illegal and legal nature. While their findings were made possible thanks to SZSE-listed firms making their meeting summaries publicly available, a similar correlation between meeting dates and trade activity still can’t be determined in the United States as that data is not immediately available. More research is necessary to determine if that relationship is present in the United States, and, if so, what steps can and and should be taken.
Dr. Bowen and Dr. Zhu’s research is indicative of the groundbreaking work being conducted at the University of San Diego Knauss School of Business. Discover the ways University of San Diego professors are pulling new insights from today’s business world and providing students with a sharp and holistic perspective on modern industry and commerce.
Sources
CNBC, “Insider trading is still rampant on Wall Street, two new studies suggest”
Investopedia, “How the SEC Tracks Insider Trading”’
University of San Diego, “Pengcheng Zhu”
University of San Diego, “Robert Bowen”
Phil Zhu teaches courses in corporate finance, international finance, and financial reporting and analysis. His research focuses on mergers and acquisitions, top executives and corporate strategy, and the financial market in China.