Insider Trading Isn’t What You See in the Movies
Insider trading has long captured the public imagination, featuring in headlines, television and movies ranging from Wall Street in 1987 to the more recent TV series Billions. It's thus worth asking: To what extent does all the drama correspond to what insider traders actually do?
Judging from new research, the reality is a lot pettier and less glamorous -- and provides some troubling insight into the nature of trust in our society.
Kenneth R. Ahern, a professor at the University of Southern California's Marshall School of Business, examined hundreds of Department of Justice and the Securities and Exchange Commission cases from 2009 to 2013, with an associated 5,423 pages of documentation. What emerged was some fascinating detail on the crime and its practitioners (both alleged and convicted).
Some aspects come pretty close to what we see in the movies. The average insider trader is 43 years old, and nine out of 10 are male. The practice also seems correlated with some features of recklessness: Insider traders are younger than their associates, less likely to own real estate, and have fewer family members on average. More than half have criminal records, with almost all charges stemming from traffic violations.
To my eye, the most striking data involve personal connections: Insider traders appear to be pretty careful in choosing their accomplices. Of the known pairs of people who provide and act upon private information ("tipper and tippee"), 64 percent met before college, and 16 percent met in college or graduate school. Another 23 percent are family relations -- more siblings and parents than aunts and uncles, despite the added capital that the latter might have provided. Tips are also commonly shared among people with ethnically similar surnames: Of 24 tips coming from people with Celtic surnames, for example, 14 went to individuals who also had Celtic surnames.
The choice of accomplices demonstrates how hard it is to trust people you haven’t known very long, especially if you're not all that trustworthy yourself. It also implies that modern corporations are, in some ways, more honest places than one might think. Not that people are always so law-abiding; rather, many workplace relationships may be too superficial and too transient to develop the trust and cooperation typically required for villainy and law-breaking.
The tight circle of trust -- and the associated lack of capital -- appears to limit perpetrators' ability to take full advantage of a highly profitable activity. Returns averaged about 35 percent, realized over an average holding period of 21 days. Yet despite the nearly certain gains available, the median insider trader invested only about $200,000 per tip and received $136,000 in profit. That's hardly enough to retire on. Granted, the much higher average profit of $2.3 million indicates that some investors hit it big -- and maybe the smartest, wealthiest and best-connected insider traders aren’t included in the data because they don’t get caught.
The insider traders in the sample are hardly rich. The median value of their homes is $656,300, not a lot given that they tend to live in relatively expensive metropolitan areas. Arguably many of them are upwardly mobile enough to have seen real wealth, without quite yet having it themselves.
The average source waits about 12 days between receiving valuable information and providing a tip. This could reflect either indecision about breaking the law or the difficulty of finding a trustworthy tippee. Nearly half, though, pass on the information the same day they receive it, suggesting that a significant group has greater experience and preparation. Repeat offending is also common: The average source gives 2.36 tips, and those who both give and receive tips do even more.
Overall, I'm struck by the sordid and petty nature of the crime as it is practiced -- and by how a lack of trust manages to place constraints on even such a relatively reckless group. Easy as it may be to call the perpetrators criminals, perhaps they are reflecting back some broader features of the innocent as well.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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