A new study, reported in the WSJ, showed that corporate insiders consistently beat the market in their companies’ shares in the four days preceding 8-K filings, the period that the researchers called the “8-K trading gap.” The study also showed that, when insiders engage in open market purchases –relatively unusual transactions for insiders—during that trading gap, insiders “are correct about the directional impact of the 8-K filing more often than not — and that the probability that this finding is the product of random chance is virtually zero.”
The study, conducted by researchers at Columbia and Harvard, analyzed over 15,000 8-K filings as well as almost 43,000 reported insider transactions between 2004 and 2014 that occurred within the four business days between the 8-K event and the 8-K filing. The results showed that the insiders could have realized gains (absent the Section 16 prohibitions on short-swing trading) that were about 0.4 of a percentage point over a broad market index. Direct stock purchases (as opposed to option exercises) during the 8-K trading gap could have resulted in estimated gains that were about 1.6 percentage points over the index. In addition, the greater the time lapse between the event and the filing, the better the insiders’ estimated returns, rising to an average excess profit over the index of 1.95 percentage points.
The study determined that open market purchases in the 8-K trading gap were the most profitable types of transactions; open-market purchases by insiders preceded stock price increases in approximately 57% of the transactions. Interestingly, the study showed that trades by insiders in the 8-K trading gap were profitable to a statistically significant extent when the 8-K reflected information about changes in corporate documents or capital structure, M&A transactions, key customer and supplier agreements, exchange listing violations and changes in accountants, but were unprofitable to a statistically significant extent only when the subject of the 8-K was related to a legal issue.
The study also examined instances where insiders knew only about the specific 8-K event, focusing in particular on material customer or supplier agreements. The authors posit that entry into these types of agreements can be expected to be associated with positive returns. After reviewing a sample of almost 4,700 8-Ks, the authors concluded that simply buying on the date the company entered into the new agreement would earn statistically significant returns within the 8-K trading gap. In addition, the authors found that, as compared to other randomly chosen periods of equal duration, insiders were over 20% more likely to engage in open-market purchases during the periods between the times of entry into the major agreements with customers or suppliers and when those agreements were disclosed. And it turns out, according to the study, that these transactions would yield significant abnormal profits.
The study excluded 8-K filings that announced 10b5-1 plans, but apparently did not exclude trades under those plans. (The authors did not believe that the failure to exclude 10b5-1 trades would have much impact because, among other things, they primarily provide for sales and the most profitable transactions they studied were purchases. In addition, they cite previous work that has cast doubt on the idea that 10b5-1 plan transactions are completely uninformed. See this news brief .) Also, if the information disclosed in the 8-K was made public earlier through a press release, the study took that into account, but did not address the possibility that the information may have been disclosed on a website or otherwise.
The authors suggest that Congress and the SEC should consider accelerating the 8-K filing deadline and that companies should consider imposing “blackout” periods around 8-K filings. In addition, the authors contend that design choices associated with mandatory disclosure rules could have insider-trading implications and that a “single disclosure rule governing all information types may be inadvisable. Instead, policymakers should consider whether the nature of the underlying information itself should shape the disclosure rule that governs whether and when that information will be revealed to the market.” The WSJ article reports that, after reviewing the study, Representative Carolyn Maloney, D., N.Y., a member of the House Financial Services Committee, characterized the results as “’troubling’ and said she was preparing legislation to address the issue. Her office is considering several options, including a bill preventing executives from trading their own company’s shares ahead of an 8-K filing.”