Enforcement of insider trading: empirical results and one practical case Guillermo Larrain Superintendente Superintendencia de Valores y Seguros, Chile Presidente, Comité de Mercados Emergentes, IOSCO Conferencia “Foro sobre Modelos de Supervisión” Organizada por la CNMV y el IIMV Madrid, September, 2008 Insider trading : old phenomena, adult regulation, young enforcement Figure 1. Insider Trading Regulations in the Twentieth Century 200 Countries in the world 180 160 140 120 100 Countries with Stock Markets 80 60 40 20 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 Source: Utpal Bhattacharya (2008): “When No Law is Better than a Good Law” Insider trading : old phenomena, adult regulation, young enforcement Figure 1. Insider Trading Regulations in the Twentieth Century 200 Countries in the world 180 160 140 120 Countries with Stock Markets 100 80 … with Insider Trading regulation 60 40 … which enforce IT regulations 20 0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 • Increasingly countries consider IT a bad practice, but few of them do something about it. • As no law could be preferable to a law not enforced regulators must take actions How much IT takes place? From the perspective of the announcement date, there is clearly an anomaly. Pricet Anomalies can be or cannot be due to insider trading activities. Alternative explanations include • issuers keep a good flow of information to markets so market participants can foresee price movements, • research by brokers is good enough so as to anticipate official announcement effects Announcement Time How much IT takes place? Juan J. Cruces: “Anticipation and Impact of Corporate Announcements in the Americas”, SVS Research report How much IT takes place? Results from the Abnormal returns model Results from the Abnormal volatility model Results from the Total returns model Conclusion: IT exists, it is significant and we are far away from tackling it properly • Enforcement of IT is still a process in the making: – Locally, regulators must learn how to face it and market participants must realize the damage they cause on markets – Internationally, regulators must improve their coordination and cooperation • LA countries, Chile among them, do not appear particularly bad, but – poor previous enforcement compared with the US, – better information from issuers available in the US – better research available in the US suggest that anomalies in prices in LA and Chile are more probably linked to IT activities The approach taken by the SVS to enforce insider trading regulation • Regulation concerning IT dates back to 1981 • First case enforced in 1988. Since then, until 2006, there were 19 cases. • Enforcement division created in 2001 – From 2 to 12 – Material improvement: software, databases, knowledge [critical exchange of experiences: IIMV, SEC, CFTC, AMF, CVM…] – Investigation of price anomalies: exchanges, issuers, attorneys • Monitoring division created in 2007 – Continuum supervision of transactions. Daily report. – Updated follow up of national and international financial affairs – Transaction analysis to detect price anomalies • In 2007-08, 17 cases • Reform of the SVS into a real Commission : the CVS The D&S – Falabella merger case • There had been rumors concerning this merger (or other ones in this area) for long time. • The merger would have been created one of the largest retailers in Latin America (lately refused by Tribunal de Defensa de la Libre Competencia) The D&S – Falabella merger case • Early april 2007. First warnings. The issuer answered SVS requirements officially saying (through an essential fact) that they had business plans concerning their credit card business (association with a bank) • May 9th prices started abnormal behaviour. Monitoring division warned the respective areas at SVS. Press versions mentioned this particular merger. • May 14th, both companies announced the merger • May 14th, SVS asked both issuers to describe the merger process: timing, people involved (over time, insiders and outsiders,…) • Simultaneously, – – – – Abnormal price movements of both companies started to be analyzed SVS defined the critical period of privileged information based on issuers description Databases were constructed (data from companies, brokers, civil register, 585 circ) Suspicious transactions identified: abnormal previous investment behaviour (around 600 cases) plus eventual links with potential sources of privileged information • Formal administrative procedures were open under reserve • One year later the SVS announced several sanctions • Critical role of assumptions: according to Chilean law, only one assumption can be used to establish a case. Three general cases were sanctioned. The D&S – Falabella merger case Breach of duty of confidentiality Use of privileged information Board member of firm 1 Fellow board members of a third firm (recognized a telephone conversation to justify not to attend board in a third company) (after communication: massive debt, portfolio concentration, opportunistic acquisition of firm 1 shares) Member of controlling group of firm 2 Recognized couple for several years (asked to sign final agreement in the morning) (acquisition of shares of firm 1 hours later, benefiting him and also her) Advisor to the merger process Husband (informed two days before announcement) (acquisition of shares of firm 1 the day after) The role of assumptions FACT 1 Someone provenly has a given knowledge that can be considered “privileged information” if made public This person breached the confidentiality duty FACT 2 Assumption Someone provenly acquired shares of a company and does so in a suspicious way: increasing indebtedness, changing portfolios, buying only after some critical decision was taken… This person used priveleged information Thought 1: to prevent or not to prevent, what is the optimal? Sanction-based regulator avoids black out type of regulation, excessive info disclosures, Optimal Preventive regulator: request information, set rules, transparency … (sanctions are preventive…) • Sanction based regulator: the regulator believes that maket intervention may harm liquidity and therefore inhibits itself to act. This regulator acts expost, once the damage has been done. • Preventive regulator: in order to prevent abuses and to avoid undesired and unfair wealth transfers,rules are set so as to induce insiders to behave properly. This may however reduce liquidity if a significant proportion of liquidity is provided by insiders. Thought 2: Trade-off between efficiency, liquidity and enforcement? • Meulbroek (1992): El mercado detecta insider trading y el efecto se ve rápidamente reflejado en los precios. – Si esta hipótesis es correcta, la prohibición de insider trading sólo afectaría la liquidez del mercado y haría los precios menos informativos. – La no intervención del regulador permitiría alcanzar mayor eficiencia de mercado pero el costo sería el no evitar la redistribución de riqueza no equitativa (se entiendo equitativo como “en igualdad de condiciones”). En e0 Ab 1 r-0 1 Ju l-0 O 1 ct -0 En 1 e0 Ab 2 r-0 2 Ju l-0 O 2 ct -0 En 2 e0 Ab 3 r-0 3 Ju l-0 O 3 ct -0 En 3 e0 Ab 4 r-0 4 Ju l-0 O 4 ct -0 En 4 e0 Ab 5 r-0 5 Ju l-0 O 5 ct -0 En 5 e0 Ab 6 r-0 6 Ju l-0 O 6 ct -0 En 6 e0 Ab 7 r-0 7 Ju l-0 O 7 ct -0 En 7 e0 Ab 8 r-0 8 Ju l-0 8 Thought 2: Trade-off between efficiency, liquidity and enforcement? Overall Market Liquidity vs Liquidity provided by Insiders 18% 12% 6% 0% 3,0% 16% 2,5% 14% 2,0% 10% 1,5% 8% 1,0% 4% 0,5% 2% 0,0% Thought 3: Do participants prefer markets where enforcement is stronger? • Hay quienes confunden flexibilidad del mercado con laxitud del regulador. – El enforcement reduce el costo de capital del emisor, mejora la liquidez del mercado y aclara las “reglas del juego”. – Se atribuye lo contrario a la ausencia de enforcement. No hay literatura que demuestre claramente que la “ausencia de enforcement” pueda ser percibida como beneficiosa, especialmente a nivel de bienestar social. Enforcement of insider trading: empirical results and one practical case Guillermo Larrain Superintendente Superintendencia de Valores y Seguros, Chile Presidente, Comité de Mercados Emergentes, IOSCO Conferencia “Foro sobre Modelos de Supervisión” Organizada por la CNMV y el IIMV Madrid, September, 2008