Directors and associates of some of Australia’s public companies are regular users of insider trading tactics, according to a new study by the Australian National University which reviewed a decade of trades on the ASX since 2005.
Finance professor and lead researcher Dean Katselas found “contrary trades” were being made with non-public knowledge about the future performance of a firm, giving rise to the notion that insider trading is alive and kicking within the nation’s corporate sector.
In his paper, Dr Katselas addresses the idea that insiders, endowed with superior information about their firm, are “contrarian” and reflect disagreement with the market’s current perception of the firm’s value.
He says they use this knowledge by trading in advance of future performance indicators not known to the market.
“I find that insiders – directors in particular – are contrarian traders; they buy when their firm is in the bottom tercile according to prior returns (losers), and sell if their firm is a prior winner,” he said.
“This most certainly amounts to insider trading under the law [and] is exacerbated if the firm is a value or glamour stock.”
Dr Katselas said trading during the period of review was contrary to the sentiment of the news – good news meant the directors sold their shares and if it was bad news, they bought.
“It was the exact opposite of what you would expect to see after either kind of news,” he said.
“If the news had the potential to boost the share price, I found the directors were selling their shares when normally, this is the time you would expect them to be buying.”
He said when he looked at the profits made by these seemingly inverse trades, the companies with the “more dire sounding future” showed the greatest profitability.
The Australian Securities and Investment Commission (ASIC) has watered down Dr Katselas’ allegations, suggesting that the market is “cleaner” than the study implies and that ASIC “actively monitors trading for misconduct” including market manipulation and insider activities.
In a clean market, prices react immediately after new information is released through the proper channels.
Abnormal price movements and unusual trading patterns ahead of material announcements may indicate an “unclean market”.
In its July review of market cleanliness, ASIC found Australia’s equity markets continued to operate with a high degree of integrity during the three years from November 2015 to November 2018.
The findings built on a similar review for the 10 years to November 2015, which found an overall improvement in market cleanliness during the period.
“Markets cannot operate with a high degree of integrity if people trade with inside information,” said ASIC commissioner Cathie Armour.
“We expect all parties involved in mergers and acquisitions to put in place meaningful confidentiality controls at the start of a transaction – and make sure the controls are rigorously followed.
“Controls for some small cap companies are clearly lacking and need to be tightened.”
Insider trading refers to the illegal practice of buying or selling the shares of a listed company based on non-public material information.
When carried out ahead of major announcements, it can create false markets and affect market integrity.
Reduced confidence in market integrity, in turn, discourages investors from risking their savings by investing in an unfair market which can lead to lower turnover for companies, a higher cost of trading and inefficient allocation of capital.
Under Australian law, directors are required to inform the market about every share transaction they make in their company and strict penalties exist for engaging in insider trading.
For individuals, it can include up to 10 years jail time and the greater of $495,000 or three times the profit gained or loss avoided.
For companies, the maximum penalty is the greater of $4.95 million, three times the profit gained or loss avoided, or 10% of the body corporate’s annual turnover in the relevant period.
Dr Katselas said cases of insider trading prosecuted by ASIC were predominantly made ahead of public announcements; trading after financial news about a company had been made public meant the activity could fly under the radar.
“The practice is both creative and criminal,” he said.
“In the safe knowledge of what is coming in the future for their firms, these company directors and many of their associates, are confidently trading in the opposite direction, which ultimately helps tip [their] share price back again.”