Presentation on theme: "The Strategic Trading Around News Announcements"— Presentation transcript:
1The Strategic Trading Around News Announcements To Trade or not to TradeThe Strategic Trading Around News AnnouncementsMeziane LasferProfessor of FinanceWeb page:
2Roadmap Introduction Definitions of insider trading Who has access to insider informationDifficulties in identifying insider tradingReasons for trading by insidersInsider trading regulationCan insiders trade strategically?Empirical evidence of trading around news announcementsConclusions
3IntroductionDiploma (1982), MBA (1985) and PhD (1987) from London School of Economics and University of BathWorked in investment bank and water companyStarted at Cass in1990Research in corporate finance, asset management and corporate governanceEmpirical research, publications and consultancy for BP, FLA, NAPF, ICAEW, Trillium (Goldman Sachs/Land Securities), Donaldson and Morley Asset ManagementTeachingCass: MBA, MSc, PhD Corporate Finance and Asset ManagementExecutives: Goldman Sachs, KPMG, Thales, Deloitte, Lloyds-TSB, Bank of China, PT Commicacoes (Portugal), Global Aviation Underwriting Managers , Swedish CFOs …Details are in
4DefinitionsInsider trading is the trading activity before “price sensitive” (material in US) information is announced.TimeTRADING? News announcementIssues:Who could be an insider?What type of news?How long is the period before news announcements?
5Who has access to insider information Who has access to insider information? The case of Mergers and Acquisitions (by order of importance)First meetingFinancingLawyers/advisor to discussLarge investor meetingMeeting pension trusteesOthersBidder CEO and CFO meet advisers to discuss strategy options Meetings with financiers/advisers to negotiate funding of deal To seek support for the dealTargetPreliminary talks possibility of takeover; Board meeting CEO, CFO and advisersResponsibilities under takeover codeTo explain proposals for pension deficitPR firms, IT, printers, cleaning staff may have access to (discover) confidential information as the deal nears conclusion.
6How details of a deal can leak? Discussions overheard in city restaurants/ pubs/wine bars (tube?)Junior banker brags about big deal to friendsCEO’s PA leaves confidential information on photocopier (or at home on a dinning table!!)“Fat finger” errors on s, letters and faxesCode names for bidder and target easily decipheredStaff may leave to another firm in the middle of a deal negotiationsInsecure IT systems lead to information being vulnerable to outside hackersLoss of laptops and Blackberrys containing key dataSensitive information left out on untidy desksSource: FSA November 2006
7Why do Insiders Trade Private Information: Other reasons: Illegal, unethical, market inefficiencyBut difficulties in enforcing the legal system becauseTypically, several hundred individuals will be aware of a deal, rising to over a thousand in the case of large deals.Thus, many insiders may trade strategically to take advantage of the loopholes.“We suggested that insider trading may have taken place before about one-third of takeover announcements in 2004”. FSA Market Watch Dec 2006Other reasons:Market miss-pricing/inefficiencyUndervaluation: BuyOver-valuation: SellMimicry by non-informed investorsThus insider trading may lead to increase in efficiencyLiquidityCash needsDiversification (don’t put all your eggs in one basket!)
8UK insider trading regulations (1) Outlined in the Model Code of the LSE/FSATrading bans60 days before the preliminary annual results60 days before the half-yearly results30 days before quarterly resultsAny periods when there exists ‘any matter which constitutes inside information in relation to the company’‘Clearance to deal’Granted by the chairman or designated directorPossibility to get a permission to sell in the ban periodSee FSA Market Watch June 2008
9Insider trading laws around the world Battacharyan and Daoud, JF, 2003, find that even though the laws across different countries in the world are strict, they are not enforcedBUTUnder Hong Kong’s stock-exchange rules, listed companies need to report results twice a year but can disclose them three months after the end of the period for the half-year report, and four months for the year-end (Vs. US 40 days of a quarter-end and 60 days of a year-end).Directors and managers are permitted to trade shares until a month before results are announced, giving them months of proprietary access to information that could be invaluable in knowing whether to buy or sell shares. (Economist Jan 2009)SEC disclosed on 6 Feb 2008 that insider-trading charges had been settled by David Li, a man at the centre of almost everything that matters in Hong Kong.New legislation in 2009.A good lesson for Hong Kong, Feb 7th 2008, The EconomistIT WOULD be hard to find a better time to bury bad news in Hong Kong than the early hours of February 6th. The presses had already rolled for almost all of the newspapers coming out the next morning—the last before the Chinese New Year when Hong Kong in effect shuts down for a few days, and the talk around the dinner table turns for once to family matters as well as business.In this atmosphere America's Securities and Exchange Commission (SEC) disclosed that insider-trading charges had been settled by David Li, a man at the centre of almost everything that matters in Hong Kong, who effortlessly straddles both the British and the Chinese establishments. Mr Li heads the largest locally owned financial institution, the Bank of East Asia, led the election campaign for the territory's current chief executive and has better access to powerbrokers in the legislative chamber than almost any other businessman. He also serves, or has served, on the board of numerous local and global companies including—until its recent acquisition by News Corp—Dow Jones, owner of the Wall Street Journal. …Insider trading in Hong Kong - To the dungeon, Sep 17th 2009 The EconomistIT HAS long been considered a paradise for investors who have a juicy bit of inside knowledge. Insider trading was not even a criminal offence in Hong Kong until Earlier this year local tycoons banded together to block proposed changes to disclosure rules that, in effect, allow executives to front-run earnings announcements. So a striking change in regulatory approach has come as a shock to many.Over the past year Hong Kong’s Securities and Futures Commission (SFC) has initiated ten prosecutions for insider trading, resulting in ten guilty verdicts, dozens of convictions and five jail sentences. This month the SFC claimed its biggest scalp yet with the conviction of Du Jun, a former Morgan Stanley banker, who was expected to receive a hefty jail term at his sentencing on September 18th. The SFC’s harder line came about in a peculiar way, after what initially appeared to be a devastating setback. In 2008 an appeals court rejected two key powers of the government’s insider-trading tribunals: their right to compel evidence and their right to assess fines beyond the repayment of ill-gotten profits. The ruling was part of a legal battle over the conviction of Koon Wing-yee, chairman of a firm called Easy Concepts, who was found guilty of tipping off a friend in 2000 about a takeover. Cont...
10Costs and benefits of trading on information Benefits: Capitalize on foreknowledge of the informationFinancial RewardsIncrease prestigeCosts: Regulatory scrutinySubsequent civil and criminalpenalties under the insider trading laws,Potential loss of job,Reduction in future career prospectsReputation damageCont .. Insider trading in Hong KongAn initial consequence of the government’s failure in the Koon Wing-yee case was to call into question the fines in 21 other cases (although ultimately no decisions were reopened). But the real significance of the appeal court’s ruling was its opinion that punishment was rightly the prerogative of the criminal courts. Rather than be dismayed about this blow to its traditional legal venue, the SFC interpreted the ruling as a green light to skip the tribunals, where charges were heard as civil cases, and bring far tougher prosecutions. “Before, potential penalties were merely a fine and could be considered a cost of doing business,” says Martin Wheatley, the SFC’s boss. “Now they are a loss of freedom.”A series of cases, many of which had already been in the works, was quickly filed in criminal courts. Most involved small-time traders operating in tiny firms, but not all. One case involved leaks about a takeover by a vice-president at BNP Paribas (sentence: 26 months in prison for the employee, 12 months for his girlfriend); another involved tip-offs about a takeover from a director at CLSA, a regional stockbroking firm (sentence: six months in jail for the CLSA employee, 12 months for a fund manager). Mr Du was found guilty of buying shares in a firm at the same time as he was advising it on an acquisition. Even these cases may pale in comparison with an ongoing investigation into Tiger Asia Management, an asset manager based in New York, some details of which were disclosed in a court filing last month. The SFC alleges that on January 6th Tiger was asked if it wanted to be among the buyers of shares in China Construction Bank (CCB). The shares were going to be sold by Bank of America, one of CCB’s largest investors. The placement had obvious implications: a huge block of shares on the market would push prices down.According to the court filing, Tiger responded to the invitation by quickly shorting CCB’s shares before the offering was announced, and then covering its short position by participating in the placement. The transaction allegedly earned Tiger a rapid profit of HK$30m ($3.9m). Tiger could not have been the only firm notified about the share placement—Bank of America’s stake in CCB was too large for a single firm to absorb, particularly at that crisis-infused time. Given broader price movements before that share sale and other placements, suspicions are rife that many hedge funds were using privileged information to front-run such offerings.So far insider trading is not considered a serious enough offence to support extradition. Mr Du, who lives in Beijing, was arrested only when he was passing through Hong Kong’s airport. But as a result of the Tiger filing, Hong Kong’s regulators have sought to freeze the firm’s assets in several (as yet undisclosed) foreign jurisdictions. Unlikely as it sounds, Hong Kong is gradually turning itself from a haven for insider trading into its scourge.
11Can insiders trade strategically? Many studies report abnormal returns earned by insiders on trades in their companies’ sharesEarly seminal contributions by Jaffe (1974), Finnerty (1976) and Seyhun (1986)Wide later evidence from different countriesSuch evidence is related to trading on private informationSuperior knowledge about the firm’s prospects
12Insider trading before corporate events (1) Long run – YesCorporate sell-offs (Hirschey and Zaima 1989)Takeover bids (Seyhun 1990b)Dividend initiations (John and Lang 1991)Seasoned equity offerings (Karpoff and Lee 1991)Stock repurchases (Lee et al. 1992)Bankruptcies (Seyhun and Bradley 1997)Earnings downturns (Ke et al. 2003)
13Insider trading before corporate events (2) Short run – No/LittleEarnings downturns (Ke et al. 2003)Earnings announcements (Huddart et al. 2006)Management earnings forecasts (Noe 1999)Non-earnings announcements (Givoly and Palmon 1985)The impact of regulations?
14Empirical FindingsSource: Korczak, A., Korczak, P. and Lasfer, M., 2009, To Trade or not to Trade: The Strategic Trading Around News Announcements, Journal of Business Finance and Accounting (forthcoming)
15Research question When do insiders trade? A universe of corporate news announcementsTrading vs. No tradingDecision to trade before good vs. bad newsDecision conditional on the information content of the disclosure (proxied by stock price reaction)Hypothesis: strategic decision to trade driven by a trade-offIncentive to capitalise on private informationDisincentive – regulatory scrutinyHence non-linear relation
16Hypothesis – illustration Probability of tradingAbs value of the market reaction (CAR)
17DataAll regulatory news releases by FTSE All Share firms published in the RNS between 01/1999 and 12/2002 (retrieved from Perfect Information)Hand-coded into 2 and 8 categoriesBanned – Earnings announcements with bansNot Banned – Other Results & Dividends, Capital Structure, Restructuring, Ownership, Board Changes, General Business Info, MiscellaneousTotal 119,179 announcements, 78,251 with a unique company-dateOpen-market directors’ trades in the sample period (obtained from Directors Deals Ltd)Total 8,086 tradesStock market data from Datastream
18Methodology (1) Good/bad news Total 39,617 good news, 38,634 bad news Non-negative/negative CAR(0,1)CARs market model adjustedEstimation window: 260 trading days ending 30 calendar days before the disclosureFTSE All Share index as proxy for market portfolioTotal 39,617 good news, 38,634 bad news
19Methodology (2)Net insider trading in the firm’s shares before each news announcementTotal no. of shares purchased less sold30 calendar daysNews Preceded by Insider TradingIf the direction of trading consistent with the content of the newsNews without Insider TradingOtherwiseTotal 10.31% of good news, 16.09% of bad news preceded by insider trading
27Summary More insider trading before good than before bad news Trading is concentrated before less price sensitive releasesProbability of trading before bad news decreases with the information content of news releasesOther results:Amount of trading before good news increases with the information content of the news, but is reduced when the news is extremeNext work:Expand data to cover new rules by FSATrading in options (data problem?)International evidence to assess effectiveness of legal settings.