Watching the watchdog: Serious questions have been raised about insider trading by employees at the US Securities and Exchange Commission

Watching the watchdog: Insider trading allegations against US Securities and Exchange Commission employees

March 5, 2014 – 5:33PM

Bianca Hartge-Hazelman

Serious questions have been raised about insider trading by employees at the US Securities and Exchange Commission with academic research pointing to a long history of profitable deals ahead of off limit trading periods.

A new report by academics in the United States suggests that employees working at the US Securities and Exchange Commission, are trading on inside information relating to investigations and upcoming enforcement actions.

Australian economist Tim Harcourt, from the University of New South Wales’ Australian School of Business and author of The Airport Economist said the research recalls the infamous bet taken by Australian cricketers Dennis Lilly and Rob Marsh in 1981 at Headingley in Yorkshire.

“It is not a good look for the integrity of the SEC and that is one thing we have learnt from the global financial crisis,” he said

In the report titled The Stock Picking Skills of SEC Employees, researchers found that SEC employees’ stock purchases look harmless enough, but when they go to sell their stocks, they have an uncanny ability to beat the market.

“These results suggest that SEC employees potentially trade profitably under the new rules, and that at least some of their profits potentially stem from trading ahead of costly SEC sanctions and on privileged non-public information,” write Shivaram Rajgopal, a professor of accounting at Emory University, and Roger M. White, a doctoral student in accounting at Georgia State University.

“In short, it appears that SEC employees continue to take advantage of non-public information to trade profitably in stocks under their regulatory purview.”

The Washington Post reported that a spokesperson for the SEC, which has made crackdowns on insider trading a priority in its enforcement division, declined to immediately comment.

The report’s authors obtained the information on the SEC under a Freedom of Information Act request, but they did not have access to the portfolios of the employees and could not tell the extent of the profits or the positions held by the employees.

Instead, the researchers built hedge fund portfolios where they went long on stocks that SEC employees buy and short on stocks they sell.

In doing so they found that out of the 56 enforcement actions against publicly traded companies during the time period analysed, SEC employees traded ahead of six – and were far more likely to sell rather than buy. “This fact pattern indicates that the monitoring mechanisms the SEC planned to impose to discourage such practice are either weak or nonexistent,” the researchers said in the report.

The six enforcement actions were against Bank of America on February 4, 2010, General Electric on July 27, 2010 and December 23, 2011, Citigroup on July 29, 2010, Johnson & Johnson on April 8, 2011 and JPMorgan on July 7, 2011.

In these cases where trades were made ahead of an announcement, the vast majority were sales, versus just half in the total market.

The researchers said that while the SEC introduced new rules in 2009 for all employees to obtain approval before trading, there was still no way of knowing whether the agency is auditing the reported trades to verify their accuracy.