A research paper on insider trading by experts at Wharton and New York University has set the stage for a bill that seeks to reform disclosure requirements by insiders at foreign firms listed in the U.S. The paper, titled “Holding Foreign Insiders Accountable,” published in April, prompted Sen. John Kennedy (R-La.) in early May to push for a law with the same title. A loophole in the law allowed insiders at foreign firms listed in the U.S., especially those from China and Russia, to avoid losses totaling $11.9 billion over five years at the cost of U.S. investors, the research found.
“Insiders at foreign companies listed on U.S. exchanges have a weaker set of insider trading rules than U.S. companies — we need to change that,” Wharton accounting professor and Wharton Forensic Analytics Lab founder Daniel Taylor recently said on the Wharton Business Daily radio show that airs on SiriusXM (listen to the full podcast here). “That’s what the bill is proposing to do – to treat everybody on the same playing field if their company is listed in the U.S.” Taylor co-authored the paper with New York University School of Law professor Robert J. Jackson Jr. and Wharton doctoral candidate Bradford Lynch. Taylor and Jackson recently testified before the Senate Banking Committee, which was the impetus for the bill.
What the Researchers Found
Essentially, the Securities and Exchange Commission (SEC) requires insiders at U.S. listed companies to disclose their trades electronically within two days. But insiders at foreign companies listed in the U.S. are allowed to disclose their trades using regular mail “within 10 days of the close of each calendar month.” The SEC does not publicly post those mail-filed disclosures.
Insiders at U.S. firms electronically file Form 4 to report their trades, while those at foreign companies paper-file reports on their trades on Form 144. The lack of public disclosure provides insiders at foreign companies with a bigger opportunity to profit from material, price-sensitive insider information before other investors receive that information.
In the absence of public disclosure, corporate executives at foreign firms listed in the U.S. avoid significant losses. “And the evidence suggests that there’s a high level of insider trading within those companies,” Taylor said.
“Insiders at foreign companies listed on U.S. exchanges have a weaker set of insider trading rules than U.S. companies – we need to change that.” Daniel Taylor
“The lag this system creates means that foreign executives can keep trades private for a longer period of time, which promotes insider trading at the expense of everyday American investors,” a press note on Sen. Kennedy’s website stated.
The paper begins with an account of insider trading activity around the high-profile October 2020 IPO plans of the Ant Group, an affiliate of the Nasdaq-listed Chinese firm Alibaba. The IPO was suspended after Alibaba CEO Jack Ma publicly criticized Chinese regulators and Communist Party officials. That led to a sharp 8% fall in Alibaba’s stock price.
But a day before the announcement of the IPO cancellation, an entity controlled by Alibaba insiders called Skyscraper sold more than $150 million worth of Alibaba shares, “avoiding millions in losses,” the paper noted, citing prior research. “Disclosure of that transaction was provided not in the widely watched form that U.S. insiders must provide, but rather on a little-known paper filing stored in file cabinets in the SEC’s reference room known as Form 144,” it added.
“If we know that Jack Ma is dumping shares in Alibaba, that’s very useful for U.S. investors to know because it suggests that maybe he has private information that he’s trading on, independent of any enforcement action that the Department of Justice or the SEC may seek,” Taylor said.
The Paper Trail
The authors covered a digitized dataset of more than 147,000 paper filings over five years, which documented foreign-firm insider sales exceeding $77 billion annually. The median 12-month returns following insider sales were -23% for Chinese firms listed in the U.S. and -21% for those based in Russia. In other words, those insiders avoided negative returns by selling their stocks before precipitous stock price declines.
The study found that insiders at companies based in eight countries avoided losses in excess of $11.9 billion. Insiders at Chinese firms accounted for $10 billion of those avoided losses, and 53% of all foreign insider trades by volume. Chinese firms dominated that league for two reasons: China has more U.S.-listed companies than any other foreign country, and “Chinese insiders trade much more aggressively than their American counterparts,” the paper stated. The average sale by insiders at American companies is about $3 million, but that number is six times larger at more than $18 million for insiders at Chinese firms, the authors noted.
The authors found that officers and directors at U.S. companies “generally do not” sell shares they hold in their companies before stock-price declines, and they noted that this was consistent with what prior researchers have found. “In contrast, foreign-firm insiders often sell prior to significant declines in stock prices, whether measured over the subsequent three, six, or 12 months,” they stated. Specifically, they found such “opportunistic trading and loss avoidance” concentrated in firms based in China, Russian, the Cayman Islands, India, and the Netherlands.
“The fact that SEC continues to accept disclosures by mail and not post these disclosures publicly is an embarrassment to the agency.” Daniel Taylor
Gathering the data for the study called for some unusual means. The SEC received more than 700,000 Form 144s on paper from 2002 to 2020. Those paper filings are retained in the SEC’s public reference room for 90 days. Prior to the COVID-19 pandemic, a commercial vendor called The Washington Service would send a daily courier to the SEC reference room to scan and digitize those forms. The authors tapped that digitized database for their study, which covers sales of securities between January 2016 and July 2021. The database covered sales of more than $495 billion by 37,514 insiders at 4,193 U.S.-listed companies.
Fixing the Loophole
The SEC recognizes the loophole in its rules. Last November, it proposed a change in its rules to mandate electronic filing of several documents including Form 144. “Our findings provide support for the SEC’s proposal,” the authors stated. The SEC’s move is consistent with the explosion in the availability of real-time data, especially with high frequency trading. “The soft underbelly of the SEC is [its] information plumbing system,” Taylor said. “The fact that SEC continues to accept disclosures by mail and not post these disclosures publicly is an embarrassment to the agency.”
Leveling the playing field between insiders at U.S. and foreign companies would also challenge the notion that the latter are “law-proof,” where they escape “market scrutiny,” the paper noted. “For example, while executives at Pfizer and Moderna faced considerable scrutiny over their stock sales at the height of the COVID-19 pandemic, their counterparts at [U.K.-based] AstraZeneca largely avoided such scrutiny,” it pointed out. Why? “AstraZeneca’s insiders are not subject to Form 4 reporting requirements, and thus their trades largely eluded public scrutiny.”
Requiring electronic reporting of insider trades by executives at foreign firms listed in the U.S. would not be a cure-all, the authors noted. But they do want the rules “[to allow] market forces to meaningfully discipline insider-trading activity at foreign firms — just as they do for insiders at American public companies,” the researchers wrote. “For markets to play that role, however, regulators must provide meaningful transparency into the insider trading activity of insiders at foreign firms that list in the U.S.”