Read the article below.It would point to the recent buying of...

Read the article below.It would point to the recent buying of shares pointing toward a good indication and possibly a signal to the market that should probably be heeded.

Crossing the line
By Stephen Bartholomeusz
August 6, 2005

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A perverse feature of the insider trading by Steve Vizard and Rene Rivkin is that they risked, and lost, so much for so little.

Rivkin bought 50,000 Qantas shares after being told it was about to acquire Impulse Airways. His profit on the trading that saw him disgraced, sentenced to nine months of weekend detention and which was a factor in his suicide was a paltry $335.

Vizard, while a director of Telstra, traded heavily in shares in Computershare, Sausage Software and Keycorp. He was banned from acting as a director or manager for a decade, fined $390,000, and his reputation was destroyed as a result of that trading, which actually lost him $335,000.

The fact that even as astute a sharemarket trader as Rivkin barely profited from his use of inside information underscores the difficulty of predicting the market's response to a particular corporate event.

Possession of market-sensitive information and trading on the basis of it doesn't guarantee a profit. Routinely, the market's response to a price-sensitive announcement is counter-intuitive, which means insider traders are running a lot of risk for a very uncertain reward.

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AdvertisementHad Vizard, in particular, been smarter, there was a much safer and more lucrative option for exploiting his privileged position as a Telstra insider for personal gain. Instead of being an insider trader he could have been an insider who trades.

The distinction might appear fine but it is profound. Insider trading is illegal; trading by insiders isn't necessarily so. Insider trading involves buying or selling shares on the basis of price-sensitive information not generally available. Trading by insiders, to be lawful, isn't reliant on specific information but rather on the privileged insight directors and executives have of their company's position.

Such insight can be valuable. Goldman Sachs JBWere analyst Rob Pinnuck produced an analysis of trading by insiders earlier this year, looking at the publicly disclosed trading of directors in their own companies. Directors' trading usually occurs within "windows" of opportunity framed to ensure they aren't buying or selling shares while possessing undisclosed price-sensitive information.

The analysis was a complex statistical exercise using probability theory. The probability of the outcomes was otherwise so low that the only explanation for them was that the trading was informed by superior insight.

The broad conclusions reached by the research was that directors who bought their own companies' shares generated excess returns of about 8 per cent over 12 months. Directors who sold seem to have exquisite timing - in the six months leading up to the sale, their average excess return was 8 per cent while, after their sales, the average underperformance by their companies was minus 3 per cent and as much as minus 11 per cent where there was more than one director selling.

For buyers, about two-thirds of the companies outperform after the trading; for sellers about 60 per cent of the companies subsequently underperform.

GIVEN that the research is based on disclosures that are not only public but that directors know will be made public, it seems reasonable to assume that the directors aren't trading on the basis of specific non-public information but rather on their superior knowledge of the companies' broad prospects and strategies.

The findings of the research are consistent with academic studies and, as Pinnuck says, suggest that implicit in the signal sent by trading by insiders is that there is information asymmetry.

The findings demonstrate that even non-specific non-sensitive information is valuable - the market is structurally tilted towards the insiders and away from ordinary investors.

One of the peculiarities of the public response to the Vizard case was the emotion generated by the insider trading that underpinned his prosecution for breaches of directors' duties. Trading by insiders, whether legal or illegal, is pervasive.

Directors, executives, institutions and other market participants - the system's insiders - do have privileged access to information and insights and therefore a superior ability to make money from the market even without using the undisclosed price-sensitive information that often swirls around the market. It is the "outsiders" for whom inside information ought to be seductive because it appears to offset their disadvantage.

The Vizard case was unusual because it was a director of a large public company who was caught up in an insider trading scandal. At an anecdotal level, the stereotypical insider trader is a friend or relative of a loose-lipped director or executive or an employee of an intermediary with a relationship with the company.

The market's privileged inner circle doesn't need to risk jail, fines, loss of position and very public humiliation to make money from the market. Either Vizard was the exception, or the law and its enforcement are regarded as so irrelevant to market practice and so ineffective that they can be ignored.

If it were the latter - if insider trading was so rife and accepted as to be a form of civil disobedience by even the most privileged of market insiders - either the legislators and regulators would need to completely rethink their approach to such trading or abandon the effort altogether.

If, however, Vizard was the exception, the Australian Securities and Investments Commission's apparent targeting of only high-profile insider traders would send the disturbing message that it prosecutes insider trading purely for the demonstration effect rather than to stamp it out. That is, it has largely accepted that the trading is so pervasive a feature of the market that it is a fight not worth more than a token effort.

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