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New research shows insider trading is everywhere. So far, no one seems to care.
Jimmy Filler made his considerable wealth buying and selling scrap metal in Birmingham, Ala. Now approaching 80 and mostly retired from business, he has dabbled as a collector of antique cars and casino memorabilia, acquired a 20,000-square-foot mansion in the hills outside the city, and donated $1 million to help build a practice facility for the University of Alabama at Birmingham football team. This largesse has made Filler a big name in his hometown—but he’s an even bigger deal among a certain class of stock trader.
That’s because Filler has an incredible track record buying shares in the companies he advises and invests in. Of the 496 trades he’s made since 2014 in Alabama’s ServisFirst Bancshares Inc., where he sits on the board of directors, and Century Bancorp Inc. of Massachusetts, where he’s the largest shareholder, 372 of them, or 75%, have shown a profit three months later. That’s the kind of run the world’s best stockpickers dream of, the financial equivalent of making the final table of the World Series of Poker main event in consecutive years.
Filler is the most successful corporate insider in the U.S., according to TipRanks, a data company that rates executives by how good they are at timing trades. As a result of this status, every time Filler buys a share in ServisFirst or Century, 2,699 TipRanks subscribers get an alert. Some of them, assuming Filler’s past performance will continue, follow suit and buy some stock for themselves.
In the U.S., an insider is defined as a senior executive, board member, or any shareholder who owns 10% or more of a company. There are about 82,000 of them, and every time they trade they’re required by law to file a disclosure, known as a Form 4, within two days. These filings can be viewed on the U.S. Securities and Exchange Commission’s website, but scores are added each day, and most don’t offer much insight. “You have to know where to look,” says TipRanks Chief Executive Officer Uri Gruenbaum. Directors typically receive a proportion of their compensation in stock options, giving them the right to buy shares at a set price before a certain date, so if an executive is simply exercising an expiring option, it probably doesn’t reveal a great deal about how he views the company’s prospects. Selling may not tell you much either, because there are all sorts of reasons an insider might want to cash out—to buy a boat, for instance. It’s when insiders use their own funds to buy stock on the open market that it’s most worth paying attention.
TipRanks uses an algorithm to sort through the torrent of SEC filings, filter out what it calls “uninformed” transactions—that is, those that don’t seem to have predictive value—and come up with a rolling list of the top 25 insiders. As well as looking at win rate, the service factors in how much, as a percentage, insiders are making per trade. Those with long track records, such as Filler, also score better. “Someone might pick heads five times in a row, but to do it 20 times or 50 times is really hard,” Gruenbaum says.
Besides Filler, other TipRanks stars include Steve Mihaylo, the CEO of telephone services company Crexendo Inc., where he owns a $60 million stake. Mihaylo has turned a three-month profit on 83% of his trades over the past five years even as Crexendo’s shares have seesawed. His 1,985 followers understand that when the CEO is buying, there’s a decent chance the stock is about to go up. Then there’s Snehal Patel, CEO of pharmaceutical company Greenwich LifeSciences Inc., who’s made only five purchases but has earned an average 488% return on them, because four of the trades preceded the announcement of promising results from a cancer drug trial. Filler says he’s a long-term investor in Century and has never been affiliated with the company; he also says he’s never sold a share in either Century or ServisFirst. Patel points out that the success of the Greenwich LifeSciences trial was referenced on the company’s website and IPO prospectus before he traded. Mihaylo declined to comment.
It’s not just those at the top of the rankings who constantly beat the market. Purchases made by U.S. executives outperformed the S&P 500 over the ensuing 12 months by an average of five percentage points between 2015 and 2020, according to a TipRanks analysis. The gap might seem scandalous to those with only a passing acquaintance with U.S. insider trading rules, which make it illegal for insiders to trade using material—or financially significant—nonpublic information. And yet on Wall Street it’s long been an open secret that insiders trade on what they know. In 1962, Perry Wysong, a bow-tie-sporting investor from Florida, started a newsletter identifying opportunities based on insider trades. Years later, a young stockbroker in Florida, George Muzea, set up a consulting firm to advise George Soros, Stanley Druckenmiller, and other hedge fund managers, often over games of tennis. “We used to call the best prospects studs,” he recalls. In 2008 a group of quants from Citigroup Inc. published a paper that found a portfolio mirroring insiders’ trades could yield an astonishing 23.5% a year, more than all but the most profitable hedge funds.
No one is claiming to know if Filler or any of the other TipRanks stars are taking advantage of nonpublic information. Poker legend Doyle “Texas Dolly” Brunson made five final tables in his career, after all, and it’s possible to get lucky enough to flip a coin and hit heads a bunch of times in a row. Plus, insiders will always have a better general sense than others about how their company is doing. But a growing body of research suggests that many insiders are trading well thanks to something more than luck or judgment. It indicates that insider trading by executives is pervasive and that nobody—not the regulators, not the Department of Justice, not the companies themselves—is doing anything to stop it. “There is a lack of appreciation for the amount of opportunistic abuse that exists under the current system, the amount of egregiousness,” says Daniel Taylor, a professor at the Wharton School and the head of the Wharton Forensic Analytics Lab. “Most Americans today believe the stock market is rigged, and they’re right.”
In many ways, insider trading is the exemplar white-collar transgression. It’s what drives Bobby Axelrod’s nefarious profits in the Showtime series Billions and what Wall Street’s Gordon Gekko was engaged in when he said, “Greed is good.” In the real world, too, the crime captures, almost perfectly, the sense that the market is biased in favor of a corporate elite—a sentiment that undergirds both the recent meme-stock explosion and the rise of cryptocurrencies. When an executive learns his company is about to lose its well-regarded CEO and offloads shares to an unwitting pension fund, or a board member hears about a potential takeover on the distant horizon and sets up a plan to start buying, they’re profiting at the expense of regular people. Prosecuting insider trading is “a manifestation of America’s basic bargain,” wrote Preet Bharara, the former U.S. attorney for the Southern District of New York, in a 2018 op-ed article for the New York Times. “The well-connected should not have unfair advantages over the everyday citizen,” he wrote.
In theory, the law governing insider trading is clear-cut: Under the Securities Exchange Act of 1934, executives who abuse their access to nonpublic information, either by trading on it themselves or passing it along to someone else, can be charged with fraud and sent to jail. But regulators and lawyers say identifying and prosecuting the offense is deceptively difficult, and lawmakers as diverse as Democratic Senator Elizabeth Warren of Massachusetts and Republican Representative Elise Stefanik of New York, prodded on by Taylor and other researchers, have been calling for reform.
Taylor’s focus on the topic dates to 2016, a few years after he arrived at Wharton, when he co-authored a draft paper showing that employees at banks who previously worked at the Federal Reserve, the U.S. Department of the Treasury, or some other regulator significantly outperformed the market during the 2008 financial crisis, as the government was handing out bailouts. Not long after, a member of one of the enforcement agencies asked to meet up to discuss Taylor’s methodology.
Working with colleagues at Stanford and other institutions, Taylor has since put out a half-dozen papers that apply statistical analysis to SEC disclosures and other large datasets to look for evidence of potential insider trading. “Hopefully, we can help highlight what’s happening, and our collective institutions will start to tackle this behavior,” he says.https://imasdk.googleapis.com/js/core/bridge3.483.2_en.html#goog_862939832Is the Stock Market Rigged?Is the Stock Market Rigged?
One area of Taylor’s research is how insiders respond when their employers are facing difficulties. Each year the SEC opens probes into hundreds of companies, but not all of them go anywhere, and there’s no obligation to disclose anything about the investigations to shareholders. It’s also up to companies to decide whether their staff must abstain from trading. Most implement blackout windows in the runup to earnings reports, but beyond that they can be laid-back about letting their executives trade. After a lengthy negotiation, Taylor persuaded the SEC to give him a 300-page list of probes opened from 2000 to 2017, which he cross-referenced with Form 4 disclosures. It demonstrated that, as a group, insiders consistently avoided losses by selling shares before their companies’ legal problems were reflected in the stock price.
Taylor says he got the idea from seeing shares of Under Armour Inc. fall by 18% on Nov. 4, 2019, after the Wall Street Journal reported that its accounting practices were being looked into. Before that, filings show, executives had been selling stock to unsuspecting buyers. It’s a surprisingly common story. At CBS, shareholders are suing board members for offloading shares before the media company disclosed CEO Les Moonves was under investigation for sexual harassment. An executive at Boeing Co. sold $5 million of stock after managers were reportedly briefed that a software problem may have been responsible for downing Lion Air Flight 610 over the Java Sea in October 2018—an issue the company didn’t share with the public until five months later, after a second crash. A spokesperson for Boeing said corporate officers are “only allowed to trade during an open trading window.” Under Armour didn’t return a request for comment. CBS said in a statement that all its executives’ transactions were either preplanned or approved internally.
In another paper, Taylor looked into insiders’ activity when their companies were being audited. He found elevated buying and selling that accelerated in the crucial weeks after the audit report had been relayed to the board of directors but before it had been made public. The insiders who traded were able to avoid significant losses, particularly in instances when a company’s results ended up having to be restated. Time and time again, “insiders appear to exploit private information” for “opportunistic gain,” Taylor and his co-authors wrote. Cheating, they’d discovered, seemed to be everywhere.
At the heart of these findings are the U.S.’s somewhat woolly disclosure rules. Under something known as “disclose or abstain,” U.S. insiders in receipt of material nonpublic information are forbidden from trading unless they release it first. But unlike in the U.K. and the European Union, companies in the U.S. have a lot of discretion over what is considered material, and a gray area exists between what a company deems worthy of disclosure and what its directors might wish to trade on. Legal advisers face a constant flow of judgment calls, such as when, if ever, to tell the world about merger talks, a fraud investigation, or a cyberattack. “If something is material enough to move the share price, then insiders should be restricted from trading on it,” Taylor says. “Unfortunately, that’s not how some lawyers see it.”
Early in the pandemic, several pharmaceutical company executives were criticized for making trades that seemed to be designed to profit from positive vaccine developments, highlighting another flaw in the regime. The transactions were made through so-called 10b5-1 plans—trading schedules that lay out the timing and size of trades in advance and are then executed by third parties. These plans were introduced in 2000 as a way for executives to sell shares without being accused of wrongdoing, no matter how fortuitous their trades turned out to be.
But 10b5-1 plans are vulnerable to abuse, Taylor says, because there is no requirement for insiders to wait after establishing a plan to place their first trade. Three days before Moderna Inc. announced that its Covid-19 vaccine was ready for human testing, its then chief medical officer, Tal Zaks, implemented a plan to sell 10,000 shares a week for 10 weeks. The program coincided with Moderna’s share price more than doubling, and Zaks netted $3.4 million. Moderna told the health-care news website Stat that the sales were part of “SEC-compliant plans” set up “well in advance.” Zaks, who didn’t respond to requests for comment, is far from alone. A recent paper by the Rock Center for Corporate Governance at Stanford, which collaborated with Taylor on the research, showed that 14% of executives set up plans to transact within 30 days and 39% within 60 days, making it likely they were in receipt of some nonpublic information. Another issue is that about half of all U.S. plans involve a single transaction as opposed to a series of trades, as the SEC originally envisioned. These single trades collectively avoided losses of as much as 4%, according to the Rock Center report, suggesting some executives use them to offload shares before bad news.
Perhaps the biggest flaw in the 10b5-1 framework is that executives don’t have to stick to their plans. They can cancel and reinstate sales whenever they choose, meaning that an insider could set up a new plan every quarter then decide whether to stick with it depending on how the next earnings report is shaping up. In a speech in June, Gary Gensler, the new chair of the SEC, said his staff would look into forcing companies to implement a “cooling off” period between when executives set up 10b5-1 plans and when they place their first trades. He also said he’d consider preventing insiders from canceling planned sales to capture profits. “In my view these plans have led to real cracks in our insider trading regime,” Gensler said.
Gensler’s assessment may greatly understate the problem. In two decades the SEC hasn’t brought a single insider trading case involving trades made under a 10b5-1 plan. In recent years it hasn’t charged many individuals or companies with the violation at all. In 2019 the agency brought only 32 insider trading actions, the fewest in more than 20 years. Last year that number edged up slightly, to 33. What cases the government does bring tend to involve insiders passing along tips to co-conspirators—referred to as “tipper-tippee” cases, such as the one that sent Martha Stewart to prison for five months—as opposed to the opportunistic trading by executives that Taylor’s work highlights. “It’s a huge blind spot,” he says. The SEC declined to comment or make anyone available for an interview.
It’s Nice on the Inside
Why, then, isn’t the government doing more? Part of the answer has to do with how insider trading law has developed. Unusually for a federal crime, there’s no standalone offense for insider trading. Instead, the notion that it’s illegal came into widespread acceptance only in 1961, when the SEC charged a stockbroker, Robert Gintel, with securities fraud for selling shares in an aviation company after getting wind of an impending dividend cut.
The Gintel case set a difficult precedent. To prove securities fraud, it’s not enough for prosecutors to simply show that someone profited from nonpublic information; prosecutors have to demonstrate that the defendant knew they had such information and intended to cheat. This helps to make it among the most difficult white-collar crimes to prosecute. “Insider trading is hard to prove without some kind of smoking gun,” says Russ Ryan, a former assistant director in the SEC’s enforcement division who now works in private practice at the law firm King & Spalding. “And because there’s no statute, the law is vague and unpredictable. Jurors don’t like convicting people of crimes where the law is not clearly defined.”
Ankush Khardori, who worked as a prosecutor in the Fraud Section of the Justice Department until 2020, says it’s even tougher in cases in which the alleged tipper and the tippee are the same person. “In these insider cases, most of the crime is taking place within the executive’s mind,” he says. “There’s unlikely to be the kind of evidence you might hope to see in a tipper-tippee case, like an email or a phone call.” Another hurdle, he explains, is that insiders have some legitimate advantage over everyone else. “Insiders have experience and expertise that allows them to put public information into context in a way others cannot. That allows a defense lawyer to say, ‘This wasn’t inside information. They were just better at reading what was already out there.’ ”
The widespread adoption of trading plans creates a further hurdle for prosecutors. “There’s this whole set of rules and conventions that has built up—10b5-1 plans, trading windows, compliance programs—that executives can use to say, ‘Look, I did everything by the book. I relied on the lawyers!’ ” Khardori says. Prosecutors can theoretically argue that a plan wasn’t entered into in good faith, but that’s an additional burden to meet in court, and in practice they almost never do so. As Lisa Braganca, another former regulator at the SEC, says, “Nobody wants to be on the front page of the New York Times for losing.”
Nor do they want to go through the ignominy of seeing their convictions overturned. Bharara, the former U.S. attorney, built up a fearsome reputation targeting insider traders, including a number of high-profile hedge fund managers. But in 2014 several of his office’s convictions and guilty pleas were quashed after judges on an appeals court acquitted two hedge fund employees in a ruling that made it even harder for prosecutors to win cases. On leaving the government, Bharara set up a task force of academics and lawyers to consider how to fix things. Last year it issued a report that proposed creating an entirely new statute defining insider trading as its own offense and severing the link to fraud. The group also suggested strengthening the government’s hand by making insiders liable in criminal cases in which they should have known they were trading on material information—when they acted “recklessly”—even if there is no evidence that they actually did know.
Such drastic changes seem unlikely to make it into law, though a watered-down set of proposals, put forward by Connecticut Democrat Jim Himes, passed the House of Representatives by 350 votes to 75 in May. Himes’s Insider Trading Prohibition Act falls short of Bharara’s call to create a new offense, but it would at least define insider trading, going some way to clarifying and simplifying the rules. “It’s time to take it out of the courts,” Himes says. “If we’re going to send people to prison for 20 years, then it’s important that we know exactly what for.” The next step is getting the bill through the Senate—something that’s scuppered prior insider trading bills over the years.
Apart from amending the law itself, Taylor says, the government would benefit from adopting a more sophisticated approach to both identifying and prosecuting insider trading. He gives the example of an insider who’s made unusually high returns over many years. The government has some circumstantial evidence that the executive is cheating, but he attributes his performance to a mix of skill and good fortune. “We can now model exactly how much he would have made had he placed each of those trades on other random days,” Taylor says. “Being able to say there’s literally no other sequence of trades that would have netted him more money could be incredibly useful.” Taylor has been sharing his insights with regulators, and the SEC recently set up a small analytics unit to explore this kind of data-led approach. Persuading judges to embrace new forms of evidence, however, has proved challenging so far. In 2019 a judge refused to allow a suit that relied on data to allege insider trading and accounting irregularities at Under Armour to proceed.
Of course there’s another possible reason the government isn’t charging scores of executives with insider dealing, which is that, deep down, many prosecutors don’t see it as much of a problem. Before the Gintel case, trading on sensitive information was widely considered a perk of being an executive at a publicly traded company, and that thinking seems to persist, even among those who are supposed to prosecute the crime.
Several former government lawyers interviewed for this story questioned how much damage well-timed trading by executives really causes when compared with, say, a Ponzi scheme that takes elderly investors for their savings or an Enron-style accounting fraud that causes a company to collapse when exposed. Anyone unlucky enough to sell stock to a company CEO right before the share price bounces will probably miss out on a few dollars per share at most.
One former government prosecutor recounted how, during his job interview, he was asked by his soon-to-be boss what he thought of the libertarian argument that regards insider trading as good because it helps disseminate information more quickly, making markets efficient. “I will prosecute the laws as they currently stand to the best of my ability,” he replied, stone-faced, declining to mention his sympathy for the idea.
That some government officials are ambivalent about the laws they’re charged with enforcing doesn’t come as a surprise to Mississippi College School of Law professor John Anderson, who’s written dozens of papers defending insider trading. “It’s really easy to say that our markets should be a level playing field, but the reality is that they never have been,” he says. “The whole reason people come to the market is because they think they have better information, better understanding than their counterparties.”
Anderson, who started his career as a white-collar defense attorney, says it should be up to companies and not the government to decide whether to allow their employees to trade on what is, he argues, the organization’s intellectual property. Under this approach it would still be fraudulent to take information and pass it along to others without permission from one’s employer. But insiders, once approved, could buy and sell freely, happy in the knowledge they were making markets function better. “If investors object to a company having loose controls, they can take their capital elsewhere,” Anderson says. As with the legalization of drugs, the government would be released of the burden of fighting an expensive losing battle.
Viewed through this lens, services such as TipRanks’ can be seen as providing a benefit to society, helping information pass from the informed few to the masses more quickly and efficiently. You don’t have to be an Alabama scrap metal tycoon to trade like Jimmy Filler—you just have to pay $29.95 a month for a TipRanks subscription. In April, TipRanks raised $80 million from investors; it’s started collecting filings from Canada and the U.K. Eliot Spitzer, the onetime New York attorney general and scourge of Wall Street, is on the board. “The appetite from retail traders is huge,” CEO Gruenbaum says.
Reforming insider trading rules is a difficult prospect. As a society, we want our executives to have a stake in the businesses they run; but if they receive shares, they have to be able to sell them. When they do, they’ll always be at an advantage. “No one really believes that corporate insiders are ever truly cleansed of material nonpublic information,” says Philip Moustakis, who left the SEC in 2019 to join Seward & Kissel, a law firm focused on Wall Street. “Trading windows, 10b5-1 plans—they’re all part of this useful fiction that society engages in. If you really wanted to stamp out insiders trading on superior knowledge, you’d have to reassess our entire approach to corporate governance. Insiders would become more like trustees with no skin in the game, and that’s not going to happen.”
Taylor refuses to accept that idea, pointing to a slew of proposals currently under consideration, from tweaking 10b5-1 plans to ripping up the insider trading rulebook altogether and starting again. “Nothing in society worth fixing is easy,” he says. “The fact it’s not easy is not a reason not to do it.”
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