Just to revive any anger you have left from the 2008 financial crisis and its aftermath, a new academic paper found evidence of insider trading among corporate insiders at leading financial institutions during the Financial Crisis. That’s on top of other research that brokers leak information or front run trades.
One research paper on political connections comes from the private meetings between government officials and financial institutions during the financial crisis which eventually lead to the Troubled Asset Relief Program.
Any corporate insiders with knowledge of those discussion could have known how much money was involved and which financial institution would get it. With financial institutions staring into a pit on destruction and some being dangled a rope to safety, one could have made a good chunk of cash if you knew which company to bet on and which ones to avoid. The government was making hundreds of billions of dollars available.
The paper examines conduct at 497 financial institutions between 2005 and 2011. The researchers focused on individuals who had previously worked in the federal government. In the two years prior to the TARP, these people’s trading gave no evidence of unusual insight. But in the nine months after the TARP was announced, they achieved particularly good results. The paper concludes that “politically connected insiders had a significant information advantage during the crisis and traded to exploit this advantage.”
The other research paper on order flow leakage uses data from 1999 to 2014 from Abel Noser, a firm used by institutional investors to track trading transaction costs. The data covered 300 brokers, but the researched focused on the 30 biggest. 80-85% of the trading volume flowed through those 30.
The researchers found evidence that large investors tended to trade more in periods ahead of important announcements. That would be hard to explain, unless they have access to inside information.
The most innocent access to information would be brokers that “spread the news” of a particular client’s desire to buy or sell large amounts of shares. That helps with market-making. A less innocent explanation is that they give this information to favored clients to boost their own business.
Of course, large institutions can be both beneficiaries and victims of this information leakage. But in general they are net gainers to the lowly retail investor who does not have access to this information. It further leads to a conclusion that the markets are rigged and they should not participate at all.
One common theme to these papers is the use of big-data and analytics to find these trends and identify weaknesses in the systems. We have seen cases from the SEC’s Division of Economic and Risk Analysis attacking frauds. It may be useful for the SEC to focus on these systemic problems.
Sources:
- Insider trading has been rife on Wall Street, academics conclude in The Economist
- Political connections and the informativeness of insider trades by Alan D. Jagolinzer, Judge Business School, University of Cambridge; David F. Larcker, Graduate School of Business, Rock Center for Corporate Governance, Stanford University; Gaizka Ormazabal, IESE Business School, University of Navarra; Daniel J. Taylor, the Wharton School, University of Pennsylvania. Rock Center for Corporate Governance at Stanford University, Working Paper No. 222.
- Brokers and order flow leakage: evidence from fire sales by Andrea Barbon, Marco Di Maggio, Francesco Franzoni, Augustin Landler. National Bureau of Economist Research, Working Paper 24089, December, 2017; and “The Relevance of Broker Networks for Information Diffusion in the Stock Market” by Marco Di Maggio, Francesco Franzoni, Amir Kermani and Carlo Summavilla. NBER Working Paper, No 23522, June, 2017
