1. The Strategic Trading Around News Announcements
To Trade or not to Trade
The Strategic Trading Around News Announcements
Meziane Lasfer
Professor of Finance
Web page:

2. Roadmap Introduction Definitions of insider trading
Who has access to insider information
Difficulties in identifying insider trading
Reasons for trading by insiders
Insider trading regulation
Can insiders trade strategically?
Empirical evidence of trading around news announcements
Conclusions

3. Introduction
Diploma (1982), MBA (1985) and PhD (1987) from London School of Economics and University of Bath
Worked in investment bank and water company
Started at Cass in1990
Research in corporate finance, asset management and corporate governance
Empirical research, publications and consultancy for BP, FLA, NAPF, ICAEW, Trillium (Goldman Sachs/Land Securities), Donaldson and Morley Asset Management
Teaching
Cass: MBA, MSc, PhD Corporate Finance and Asset Management
Executives: Goldman Sachs, KPMG, Thales, Deloitte, Lloyds-TSB, Bank of China, PT Commicacoes (Portugal), Global Aviation Underwriting Managers , Swedish CFOs …
Details are in

4. Definitions
Insider trading is the trading activity before “price sensitive” (material in US) information is announced.
Time
TRADING? News announcement
Issues:
Who could be an insider?
What type of news?
How long is the period before news announcements?

5. Who has access to insider information
Who has access to insider information? The case of Mergers and Acquisitions (by order of importance)
First meeting
Financing
Lawyers/advisor to discuss
Large investor meeting
Meeting pension trustees
Others
Bidder CEO and CFO meet advisers to discuss strategy options Meetings with financiers/advisers to negotiate funding of deal To seek support for the deal
Target
Preliminary talks possibility of takeover; Board meeting CEO, CFO and advisers
Responsibilities under takeover code
To explain proposals for pension deficit
PR firms, IT, printers, cleaning staff may have access to (discover) confidential information as the deal nears conclusion.

6. How details of a deal can leak?
Discussions overheard in city restaurants/ pubs/wine bars (tube?)
Junior banker brags about big deal to friends
CEO’s PA leaves confidential information on photocopier (or at home on a dinning table!!)
“Fat finger” errors on s, letters and faxes
Code names for bidder and target easily deciphered
Staff may leave to another firm in the middle of a deal negotiations
Insecure IT systems lead to information being vulnerable to outside hackers
Loss of laptops and Blackberrys containing key data
Sensitive information left out on untidy desks
Source: FSA November 2006

7. Why do Insiders Trade Private Information: Other reasons:
Illegal, unethical, market inefficiency
But difficulties in enforcing the legal system because
Typically, 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 2006
Other reasons:
Market miss-pricing/inefficiency
Undervaluation: Buy
Over-valuation: Sell
Mimicry by non-informed investors
Thus insider trading may lead to increase in efficiency
Liquidity
Cash needs
Diversification (don’t put all your eggs in one basket!)

8. UK insider trading regulations (1)
Outlined in the Model Code of the LSE/FSA
Trading bans
60 days before the preliminary annual results
60 days before the half-yearly results
30 days before quarterly results
Any periods when there exists ‘any matter which constitutes inside information in relation to the company’
‘Clearance to deal’
Granted by the chairman or designated director
Possibility to get a permission to sell in the ban period
See FSA Market Watch June 2008

9. Insider 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 enforced
BUT
Under 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 Economist
IT 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 Economist
IT 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...

10. Costs and benefits of trading on information
Benefits: Capitalize on foreknowledge of the information
Financial Rewards
Increase prestige
Costs: Regulatory scrutiny
Subsequent civil and criminal
penalties under the insider trading laws,
Potential loss of job,
Reduction in future career prospects
Reputation damage
Cont .. Insider trading in Hong Kong
An 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.

11. Can insiders trade strategically?
Many studies report abnormal returns earned by insiders on trades in their companies’ shares
Early seminal contributions by Jaffe (1974), Finnerty (1976) and Seyhun (1986)
Wide later evidence from different countries
Such evidence is related to trading on private information
Superior knowledge about the firm’s prospects

12. Insider trading before corporate events (1)
Long run – Yes
Corporate 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)

13. Insider trading before corporate events (2)
Short run – No/Little
Earnings 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?

14. Empirical Findings
Source: 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)

15. Research question When do insiders trade?
A universe of corporate news announcements
Trading vs. No trading
Decision to trade before good vs. bad news
Decision conditional on the information content of the disclosure (proxied by stock price reaction)
Hypothesis: strategic decision to trade driven by a trade-off
Incentive to capitalise on private information
Disincentive – regulatory scrutiny
Hence non-linear relation

16. Hypothesis – illustration
Probability of trading
Abs value of the market reaction (CAR)

17. Data
All 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 categories
Banned – Earnings announcements with bans
Not Banned – Other Results & Dividends, Capital Structure, Restructuring, Ownership, Board Changes, General Business Info, Miscellaneous
Total 119,179 announcements, 78,251 with a unique company-date
Open-market directors’ trades in the sample period (obtained from Directors Deals Ltd)
Total 8,086 trades
Stock market data from Datastream

18. Methodology (1) Good/bad news Total 39,617 good news, 38,634 bad news
Non-negative/negative CAR(0,1)
CARs market model adjusted
Estimation window: 260 trading days ending 30 calendar days before the disclosure
FTSE All Share index as proxy for market portfolio
Total 39,617 good news, 38,634 bad news

19. Methodology (2)
Net insider trading in the firm’s shares before each news announcement
Total no. of shares purchased less sold
30 calendar days
News Preceded by Insider Trading
If the direction of trading consistent with the content of the news
News without Insider Trading
Otherwise
Total 10.31% of good news, 16.09% of bad news preceded by insider trading

20. Good news

21. Good news

24. Logit results – Good news
Prob(Trading=1) = logit(α1 + β1Size + β2Market-to-Book + β3Buy-and-Hold 120 pre + β4Multiple News + β5 |CAR| + β6 CAR2 + ε)

25. Logit results – Bad news
Prob(Trading=1) = logit(α1 + β1Size + β2Market-to-Book + β3Buy-and-Hold 120 pre + β4Multiple News + β5 |CAR| + β6 CAR2 + ε)

26. Logit results – Specific news categories

27. Summary More insider trading before good than before bad news
Trading is concentrated before less price sensitive releases
Probability of trading before bad news decreases with the information content of news releases
Other results:
Amount of trading before good news increases with the information content of the news, but is reduced when the news is extreme
Next work:
Expand data to cover new rules by FSA
Trading in options (data problem?)
International evidence to assess effectiveness of legal settings.