FSA might act on insider trading

The FSA seems to be finally accepting that London has a serious insider trading problem. The increasing proportion of informed price movements (IPM) ahead of announcements certainly shows, not only that there is a problem, but also that it is getting worse. In spite of this the FSA seems inclined to play down the amount of insider trading taking place. This is worrying.

Their comments and my responses:

1. Some of the IPMs we observe may be the direct result of trades by insiders.

I agree, except that “some” is an understatement.

2. Some IPMs will indirectly result from trades by ‘informed’ traders who picked up on and derive information from insiders' trades.

So that is not insider trading, but it encourages traders to rely on rumour which makes markets easier to manipulate, and less stable

3. [...] a) IPMs triggered by legitimate (non abusive) trading due to: financial analysts or the media doing a good job at assessing which companies are likely takeover targets., or investors betting on a likely outcome.[...] non abusive trades, for which there is a perfectly rational explanation, that just happen to fall before an announcement.

Given that such speculation happens constantly, that is really a cause of the statistical uncertainties that are discussed below. It does not, therefore, need to be corrected for separately. It also appears to me very unlikely that such analysis would reach the right conclusion a few days before an announcement.

b) IPMs triggered by a deliberate ‘strategic’ leak of information by a company or its advisers

Again this encourages traders to rely on rumours, makes manipulation easier, and destabilises the market. Furthermore leaks to the press are not available to all investors equally at the same time in the way that properly made announcements are. I also have some doubts about how often the bidder in a takeover will have a motive to leak.

4. Due to the statistical thresholds we use when computing IPMs, even if there is no insider or other (legitimate) abnormal trading, we would not expect the results to be zero but on average, 3% for the FTSE 350 data set and 10% for takeovers. Thus, taking the 2007 takeover figure as an example, of the 28.7%, we estimate that approximately 18.7% of announcements are preceded by some form of abnormal price movement

That works the other way as well. The usual fluctuations in price could also disguise abnormal movements, causing some IPMs to be missed. There are a lot of uncertainties in working with a small data set, all the more so given that a key quantity being measured (prices) is subject to constant fluctuations.

Some cases of insider trading will not cause a large enough price movement to be detectable, in any case. Many others will not be occur sufficiently close to the announcement to be picked up by the FSA's methodology

The problem has existed for years. With some companies it was not even necessary to do a statistical analysis to see the evidence, simply looking at price movements prior to announcements has been enough. The FSA has now done a proper analysis two years running, and has promised to act. I hope we will now see a lot of criminal prosecutions. A lot of insider trading is clearly going on, and one or two prosecutions will not be enough to demonstrate that insider traders face a significant chance of being caught. Given the FSA's past inaction, and the intrinsic difficulty of finding proof, I am not optimistic.