Insider Trading (with Dan Taylor)

[0:00:00 Speaker 0] from

[0:00:00 Speaker 1] the Salem Center for Policy at the University of Texas at Austin. Welcome to an episode of Policy and Pieces. I’m your host, Scott bogus.

[0:00:12 Speaker 0] I think the first thing to disabuse people of is this notion that there’s a law that says, Thou shalt not insider trade. Unfortunately, such a law doesn’t exist, so the existing laws on insider trading are built up over case laws. Uh, and that just means over a series of court cases. There have been precedents set, and those precedents effectively define what it means to engage in insider trading.

[0:00:38 Speaker 1] That was Dan Taylor. He’s an accounting professor at the Wharton School and is the director of the Wharton Forensic Analytics Lab. In recent years, he has focused his attention on illegal insider trading and the challenges around defining it, detecting it and doing something about it, including potential policy changes for the SEC to consider. He also talks what it’s like to be an academic at a preeminent institution, mining data for market misconduct and the challenges he faces with his peers and explaining the relevance of his pursuit to the pedagogy of academic research. We hope you enjoyed today’s episode, okay, Dan Dan Taylor from Warton. Welcome to our show.

[0:01:19 Speaker 0] Thanks for having me, Scott. It’s a pleasure to pleasure to be here and and to see you again.

[0:01:24 Speaker 1] So our topic today is insider trading. It’s something that, in your recent work, you have become, I think passionate about it’s a practice that has long held the interest of regulators. And the potential wrongdoing by market participants in this area never really seems to go away. And I’m pretty sure that if we how to talk about this 20 years from now, many of the topics that we’re going to discuss today are still gonna be prevalent then. And I definitely want to get into those details. But before we do, I was hoping we could explore a little bit about your background and figure out how an accounting professor at Wharton is so focused on this topic. We do that?

[0:02:03 Speaker 0] Yeah, absolutely.

[0:02:04 Speaker 1] So let’s just start with an easy question. That why did you get a PhD and how did you do it and why Accounting.

[0:02:11 Speaker 0] Okay, so the those are both easy, easy questions. The PhD, I think, was I was I was an undergrad. I did my undergrad at University Delaware, and without naming names of companies, I did some internships, and I did, you know, some some work in the private sector out of undergrad, and it didn’t really suit me. I was in a cubicle doing some work, and and I didn’t really feel like there was an opportunity for advancement and and whatnot. And and so I thought, Well, what am I good at? What can I do better than other people? And how can I leverage that compared to advantage? And I was always really good in school, in college, specifically in my in my economics classes. And so I said, Well, okay, why don’t I sort of, you know, move up the academic food chain from Delaware to a different school, And so I went back and I got a master’s degree in accounting. Uh, excuse me. In economics, actually not accounting. And so my accounting expertise is, you know, pretty actually pretty small. So my undergrads and economy and finance and my master’s degree is in Yukon. So I had taken, like, two accounting classes, accounting one on one and accounting one or two. And then when I was in the master’s degree at at Duke. It’s a terminal program I thought about. Should I go on and get a PhD? I really like this a lot. You know, I’m good at this academic stuff. Doing research was really a passion of mine. So, you know, my parents actually weren’t happy in their corporate jobs. And they always said, You know, son, you know, try and find something you really like and pursue that. And so I really like doing research. And so I thought about what I should do a PhD in. And at the time, you know, I was considering accounting finance. And then I stumbled across an accounting academic journal, and what I started doing is I started reading accounting academic journals and finance academic journals, Journal of Finance and Econ journals, and I realized that the topics that the accounting journals were addressing to me were actually more interesting. I think that you know, when I say things like insider trading or earnings announcements or analystsforecasts, most people think on the street Well, that’s that’s academic finance, right? And I think that may be true, but it’s a very small sliver of academic finance, whereas it’s a massive chunk of the accounting literature. And so just by looking at the topics that was getting published in the academic journals, I decided, Hey, this accounting thing, you know, it’s not debits and credits. They’re not doing research on debits and credits. They’re actually doing research on how people use information, predicting the information and accounting fraud, that kind of stuff. And I found that interesting. And so that’s why one account

[0:04:53 Speaker 1] I want to point out to people who may be listening to this, that I can see you because we’re operating over Zoom. You said you didn’t like working in a cubicle, but I see you’re now working in the basement. Was that a fair trade?

[0:05:04 Speaker 0] Yes, we renovated the basement one year before covid, and it’s a very nice basement. I’ve got two white boards. Uh, I’ll take the basement, the renovated basement, any day over cubicle, absolutely

[0:05:16 Speaker 1] so in your in your work and your research that you’ve done on issues that are interesting or of interest to regulators. Have you developed a worldview? And is that influence the way you do your research and write papers?

[0:05:28 Speaker 0] It has, I would say that I had when I started, you know, in the PhD program in the beginning, As a junior faculty member, I think academics trains you in a certain way sort of like this view that everything is optimal. So if you observe behavior, it’s the result of the cost benefit tradeoff that and everyone is optimized and as a consequence, sort of. If you document patterns in the data that seemed to be sort of evidence of illicit activity, either it means that it’s not illicit activity because everything is optimal. The SEC, the regulator’s know about it and have chosen not to enforce it. Or it means that, you know, it’s, you know, there’s very little benefit there or if you’re just documenting optimal bad behavior because you know, some amount of bad behavior is potentially optimal. There’s an optimal amount of of illicit activity. And so there was really sort of really no point. It was very much of a Okay, well, you document this because it’s optimal. We assume that everybody knows about it and nothing has happened. So, you know, no big deal. And then I had some, you know, something into it. Accidentally, I was a junior faculty member, and I worked on a paper on political connections and insider trading around TARP. And I got a call out of the blue from a gentleman, that Treasury. And he says, uh, Scott, you might actually remember this paper. I think I might have met you when I presented a paper at the SEC. He says, Professor Taylor, you know, we’d like to come talk to you about this research that you’re doing on political connections and form for trading. So that’s fantastic. I’m teaching right now. Let’s schedule it in three weeks. No, Professor Taylor, we’re going to be coincidentally in Philadelphia at 9 a.m. tomorrow and unrelated business. And so we’re going to see you at 9 a.m. And so that experience, I would say, opened my eyes to a different perspective, more realistic perspective on how things are actually done in, in practice, around regulation and around enforcement.

[0:07:30 Speaker 1] Are you saying that the world doesn’t operate around the academic clock?

[0:07:35 Speaker 0] I don’t think it operates around the academic clock, and I don’t think that just because you document a pattern in the data that you should assume that everyone else is aware of that pattern. You know, I think that academics tend to because it’s convenient in our models. We model agents, as you know, infinitely patient with no bureaucratic constraints, no budget constraints. And so there’s a cost benefit trade offs, whereas, you know the truth couldn’t be farther from that, especially when it comes to regulatory regulatory agencies.

[0:08:06 Speaker 1] So you’re meeting with the Treasury officials? What impact that have on you? And did that shape your research program after that meeting?

[0:08:14 Speaker 0] Yeah, I would say that it was probably one of the few academic experiences where meaningfully altered what I was doing. I may actually get in trouble for this, but I doubt that my colleagues will actually be listening to the podcast. But it will be. It’s informative, I think, for future scholars and for regulators to realize what happens. And so I had actually written in my tenure packet that I had done this work and it had been used or referenced somehow relevant to some investigations. And I wrote that in my tenure pack and going to pretend I’m thinking, this is fantastic. This is great. And, um, I sent my tenure packet around two senior factory in my department for advice. What do you think they said about that section of the tenure back?

[0:08:56 Speaker 1] They said, Good job, Dan. Really good to see your academic research having an impact on real real world issues.

[0:09:03 Speaker 0] Well, it actually said no, you should take it out. No one cares. And so I decided, uh, in my rebellious nature at the time, I wasn’t going to take it out because, you know what can it hurt? Leave it in. So I left it in and go for tenure, and then awarding the process is interesting because there’s, you know, personnel Committee and one member from each department, and we have interestingly work. We have a legal studies department, and so after I made 10 years and I went up for tenure, one of the legal studies professors came up to me afterwards at the faculty and said, Hey, you know, I was the reader on your case. I was the one shepherding it through, and this was probably the most interesting case that I’ve seen coming out of. You know, your department. We really the whole committee was really in love with the fact that you actually had, you know, impact on practice.

[0:09:50 Speaker 1] So it seems to me that what you’ve just described as mixed feelings within the academic community and particularly working, I think is considered one of the top schools research schools about how academic research should be shaped by real world events or its potential impact on policy or regulation. Is that a fair statement?

[0:10:12 Speaker 0] Yeah, I think that’s fair. And I would generalize beyond Warden, So I don’t I think that conversation could have easily occurred at MIT at Chicago, at Stanford and other schools, at least an accounting where I’m familiar with their with their departments. Because if you if you look at what the incentives are for junior faculty, I mean at top schools it’s pretty clear that it’s a publisher parish game and note that relevance doesn’t necessarily factor into the publisher Parish parish game.

[0:10:38 Speaker 1] Is that a fair statement? Or is it relevant to the real world versus relevance to their academics? I mean, what do you what is measured by

[0:10:43 Speaker 0] relevance? Academic right when I say relevance, you know, like I mean relevance to the real world. My view on research is that eventually not every paper has to be relevant to the real world. But it should be eventually like there should be a stream. And so, by maybe the third or the fourth paper on the topic, it should become relevant to the real world. Other people have used that. It should be like the 100th paper on the topic becomes relevant to the real world. And so I don’t know, I’ve kind of that took me down a rabbit hole. That experience and subsequent experiences where, you know, I’ve become much more interested in having an impact in the real world. I think one reason why academics don’t prize that more is because they haven’t actually tried to do it or they’ve tried and failed, but sort of when I sort of tell people about, you know, sort of impact that I’m having everybody you know, you know, congratulates the impact on the back. Um, but, you know, that was very different as a junior faculty than versus a senior faculty them

[0:11:43 Speaker 1] We still have talked about insider trading yet or 10 minutes, and I don’t have one more question for you before we do. And you are the director of the Word and Forensic Analytics lab. Can you tell us a little bit about that. Why? You’re the director of it. What It does.

[0:11:59 Speaker 0] Yeah. So, you know, the lab is really designed to generate research and do translation activities between research and practitioners and research and regulators surrounding accounting fraud, corporate transparency and an insider trading. Um, I think that, you know, I was inculcated in my PhD program when we would write a paper, and we study like, the effect of a particular act, like the effect of the Jobs Act on capital markets or the effect of some other act on capital markets. You know, you would right the paper and you have a probably a paragraph for two at the end of the introduction that says something like this is relevant for regulators for the following reasons. And you know, dear A likes those papers and occasionally uses and insights those papers. But when I started to realize this is that kind of wasn’t enough for me in terms of influencing practice and influencing regulators in this sense that you know how many of those academics that write those papers actually read comment letters to the SEC supporting or or you know, supporting what the analysis or not supporting the analysis. How many of those, uh, you know, academics actually show up that sort of conferences hosted by the regulators. And so what I realized is those activities, while useful, clearly very useful, aren’t really rewarded in the PMT process and aren’t subsidized, um, as a result, So the lab is trying to subsidize those activities. You know, we have research assistance. And so, you know, people interested in writing comment letters on one SEC rules. They need some research support, you know, definitely send me an email. Um, so it’s really designed to foster this translation between what we do in academics and what regulators and enforcers, you know, need and want.

[0:13:51 Speaker 1] So how many academics do you get interested in doing this? Is there a large community of academics like yourself who want to do this and who’s willing to fund it? And how do you get sponsorship?

[0:14:02 Speaker 0] Well, so that’s a good question. We haven’t really figured out the funding model other than warden funding so far. I would like to obviously get external funding because then we could do it to scale. I have found that academics a generally aren’t aware of the comment periods, so they’re not even aware what’s going on. But I’ve submitted to comment letters so far. I’m gonna right in the middle of writing a third. And generally, when I send the comment letters to other academics or when I talk to co authors about it, they’re like, Yep, sign us up. You know we’ll help you with the comment letter. Absolutely, but they’re really not willing to do the coordination or or or be the primary person to bear the effort. But, you know, once you say Okay, I’ll take 50% of the effort or I’ll take 75% of the effort. Then you know a lot more. A lot more dominoes fall,

[0:14:53 Speaker 1] so you’re so for people who may not be familiar. Anytime the SEC proposes an action regulatory action, there’s something under the Administrative Procedures Act that says you need to put the action out. Proposed action out for comment. Maybe 30 days, 60 days, 90 days. And that’s when the public has an opportunity to write in issue something called the comment letter, and the regulator, at their own peril, needs to listen to it or may be challenged in the court. And so what you’re saying is you identify the issues. This is solving the search cost issue with academics. They may have spent 10 years working on something and have no idea that it’s active policy debate in D. C. You identify it, you flag it. And even if an academic does, no, that’s something they know about is important to regulators. They generally don’t know how to do anything about it. And so you’re solving that coordination problem. You’re telling them about it. And also you’re providing the effort and labor and help for them to share their expert views on important issue. Is that a fair summary?

[0:15:51 Speaker 0] I think that’s a fair. So me, I would add one additional thing, which I didn’t quite value until, you know, I I started the lab and I got to where I’m at. We also provide branding, so that is actually turns out to be a really big deal, because when you see our comment, letters get covered. I originally authored some comment letters without outside of the lab before we had the lab, and it was with some some individuals outside of sort of like what’s called the top five, and it would say, Oh, Professor, you know, Professor Blank, Blank and Blank And it would have my affiliation with Warden, but it wouldn’t list the co authors affiliation with the different schools. Or it would say a comment letter from, you know, the Wharton School. And then it would ignore the schools of my other of my other co authors. And so what I realized was, Is that for better or worse? Probably actually, for worse, there was a lot of attention to the brand being associated with the comment letter, as opposed to the substance, at least in terms of media coverage.

[0:16:51 Speaker 1] So that’s that’s an interesting point that you bring up and may be partly due to the fact that some rules could have thousands of comment letters and how do you sort through them? And people look for signals. And if you see a primitive institution like warned that, get somebody’s attention and so either by good fortune, hard work or luck you at that institution, and so you get that attention the same. I suppose it’s true with media that when they see you writing, they’re more likely to pick it up then somebody from Southwest directional State. So let’s talk about insider trading. That’s our topic today. And just start with the caveat that neither one of us are lawyers. And a lot of this is legal centric in terms of definitional properties of insider trading. But let’s do our best imitation or or have you do your best imitation? Can you just start off by telling us what insider trading is?

[0:17:42 Speaker 0] Great question. I think the first thing to disabuse people of is this notion that there is a law that says Thou shalt not insider trade and then defines what insider trading actually is. That would actually be really helpful and convenient. It would make a lot of people’s jobs a lot easier, but unfortunately, such a law doesn’t exist. So the existing laws on insider trading are built up over case laws. Uh, and that just means over a series of court cases. There’s been precedent set, and those precedents effectively define what it means to engage in insider trading and that

[0:18:19 Speaker 1] Does that mean that can you say insider trading? If there is no law prohibiting it, does that mean that it exists? It’s principle in some cases and not in other cases is that of

[0:18:29 Speaker 0] absolutely, absolutely. It has to, because there’s no, you know, like Red Line law or or bright line laws. The case might be that has two consequences. The first consequences. You can hire a white collar defense lawyer to basically say, Well, the existing precedents don’t really cover this case and try and argue that this is unique and therefore not covered by existing case law. And so that creates a really rich opportunity for, uh, you know, for consultants and defense defense experts. The second is that it may make some prosecutors reluctant to bring a case for fear that if they lose the case, it actually sets precedent that that sort of activity becomes permissible. And and that’s that’s a concern and increasingly concerned that I’m seeing where you know for. You know, economists are PhD students listening to this, you know, we can look at trading behavior and we can say Okay, this is clearly trading on material nonpublic information, But that’s not necessarily something that would be illegal because there’s this potential need for C enter or or intent or benefit. Um, and then there’s a sensor so center would be, you know, the the intent, intent to deceive or intent to defraud. And so that takes us to sort of like these legal theories, right? So instead of trading, legal theories are not built. The unfairness the classical theory of insider trading governs typically corporate insider trading, where you have an executive or officer breach of fiduciary duty or a duty of care oh, to shareholders. And they trade on information that they shouldn’t be trading one that gives rise to this phrase disclosure of state. So if the executive has private information, maybe they know earnings is going to be poor before the earnings announcement, they should either disclose the information, maybe issue some guidance or don’t trade until the information. Because public. The other theory is misappropriation that typically is used to govern outside corporate insiders like hedge funds. Um, incidental. You know, M and A deals the lawyers, the printers, where you have a situation in which you come by information and you owe a duty of confidence to your employer or to whoever provided you with the information. You may violate that beauty of that duty of confidence, you know. So for example, the classical case. Capital One. Where to credit card analysts all data in real time on this is all public on retailers like Abercrombie and American Eagle. And they can see the credit card sales were coming through Capital One, and they decided to take that information and front runner earnings based on generating a sales forecast from the real time credit card data. So that would be misappropriating the capital one data for their own personal case. So those are kind of like the two rules that govern the governor. Insider trading.

[0:21:34 Speaker 1] Okay, so that that reminds me I’ve got a couple of questions. I’ll start with one that’s been interesting for a long time. But say, for example, Goldman Sachs is partnering with Apple and offering a credit card. The Apple card. Now Goldman Sachs can see all the same things that these capital one traders saw and make trade decisions on. Is there a difference when we think about Goldman Sachs having access to all of Apple customer information in terms of the decisions they make versus an employee that’s observing it and trading on their own account

[0:22:08 Speaker 0] so legally, is there a distinction or economically is there economically,

[0:22:13 Speaker 1] Morally, legally.

[0:22:14 Speaker 0] How should we? Well, we shouldn’t get too far a field, but I mean, that’s effectively what happened here. The difference is that the employees used it for their own personal gain, whereas it would have been perfectly acceptable. I shouldn’t say Perfectly acceptable, depending on how Goldman contracted with Apple, Goldman could use that information to, uh, potentially enrich themselves. But the individual employees are not allowed to use the information to to enrich themselves.

[0:22:41 Speaker 1] Okay, so let’s let’s go back to the beginning and wine a little bit where you started. So corporate insiders, you know, one subject of insider trading, they have shares of their stock. They need to sell them at some point to consume, and we shouldn’t prohibit them from selling stock. But the point is the manner in how they sell that stock, and they need to disclose non material public information to trade on it, or wait until it’s disclosed to some typical disclosure path.

[0:23:10 Speaker 0] And I think that’s right. Um and you know, 11 great question is, you know why? Why study corporate insiders as opposed to the trading of other parties and you know, the pragmatic answer is that’s what academics have data on. You know, if I if I was sitting in your you know, your former shoes at the SEC, maybe a future years Hence, when I had the consolidated audit trail or I had, you know, blue Sheep data, you know, from other market participants, I think there would be a lot of studies done on. But what we have is trading of corporate executives and so that that that really gets us to focus on them.

[0:23:44 Speaker 1] Yeah, so we’ll talk about that in a minute. And I do think that’s that. There’s a funny joke about looking for your keys on the lamppost cause that’s where the light is and so I think a little bit that applies here. But I do have one economic question for you, and it’s something that often comes up and we teach students and respective universities about market efficiency versus fairness, and we would take a teach about market efficiency. Uh, the idea that information is impounded into prices faster. If you were to allow insiders to trade on the nonpublic information, that seems wholly unfair. But is there any argument to suggest that why not just let insiders trade on any piece of information they have, because then prices would be more efficient. Like, where does that argument breakdown, or does it break down?

[0:24:31 Speaker 0] Yeah. I mean, I think that is the I’ll call it like the classics. 1970 1980 Chicago View of, you know, just allow for insider trading because the desire is price efficiency, trying not to reveal just how scathing I want to get. But you know, that view breaks down pretty fast in more recent rational expectation models. When you have, you know, liquidity and discretionary liquidity and you have these noise traders and you have endogenous information acquisition. It certainly might be true in the models from the 19 seventies, where they didn’t sort of have, like the Grossman Stiglitz paradigm and whatnot. But you know it. Suppose we allow for everyone. There are no insider trading laws at all. Insider trading becomes legal. Do we think that there is going to be as much participation in the equity market? That there’s going to be people willing to provide liquidity if they know that there’s no laws governing, uh, insider trading? And so I would expect that you would see US capital markets dry up pretty fast if, you know, insider trading became legal and it was well documented that it was it was rampant. One interesting academic study. I don’t can’t remember the year for the author. I want to say Bhattacharya looked at insider trading around the world, and I think, you know, I’m probably abusing. The finding has been a while since I’ve done the study or read the study. He actually looks in Mexico and finds that in Mexico they have very weak enforcement of insider trading laws. Very period. And I’m very few laws. And there there’s the earnings news. There isn’t any. Do you have an earnings announcement? Nothing happens. And he basically tries to show that it’s because the insiders already impounded the information enterprises. Uh, that’s what I would expect to happen if we got rid of insider trading,

[0:26:28 Speaker 1] I suppose would also create incentives for executive to potentially profit by manipulating corporate actions if they could know that their actions would affect prices in a way that would benefit them.

[0:26:42 Speaker 0] Yeah, I mean, I think that’s right. We typically think of, I mean the two ways, at least the academic literature proceeds is we either hold the trades of executives fixed, and then we look at whether they had discretion over the timing of disclosure and discretion over the corporate activity, or we hold the activity fixed. And then we look at the timing of the timing of the trades. But as you point out, if you know if insider trading is legalized and that way, I would expect that to have meaningful changes in in reporting practices.

[0:27:11 Speaker 1] So let’s talk about reporting. You mentioned data and there’s information sources like form for where insiders of publicly traded corporations, if you’re a non executive officer director, has to report their trading activity. The SEC, as you mentioned something called Blue Sheets, has an ability to requisition trading information from broker dealers that allows them to see who traded around one event. So we have all this information, both private and public, available to regulators. We can scrutinize insiders, so why do they engage in insider trading illegal insider trading?

[0:27:49 Speaker 0] So I think we need to back up and we actually need to take a look at the enforcement practices of of the SEC, and we need to think about the procedures that they’re using for enforcement. So before I started down this path, I had always envisioned government as being similar to, like the enemy of the state, this omniscient entity that had every piece of data on you and was sifting through the data in real time and spitting out red flags. And then immediately you get a you get a request for documents or a subpoena from the from the regulator who you know very efficiently, uh, you know, processed information and, uh, and followed up on an enforcement lead. But as you know, that’s not actually how it operates in practice. And when you introduce a human element and you’re not doing things in real time, that’s that’s where things I would say breakdown. So you know, this is, you know, public how how some of these leads get generated. But the way the system works and this is all, and I think use of AI and governments. A report out there is put out by Stanford. Is there be an analyst human analyst that will have some intuition or some suspicion? Um, that some potentially illicit trading occurred around an event, maybe a vaccine trial or some sort of, you know, public information event, no earnings announced. And then they’ll submit a request for what’s known as Blue Sheet data. And the blue sheet data is the data that I’d like to have but can’t have, which is, you know, data from everybody, all the trades, all the instruments, all the broken dealer activity. And then they send that through some algorithms. And then the algorithms sort of look for suspicious correlations and suspicious relationships because they have the account members, they have the individuals, you know. They have all kinds of information out there. And then that’s how the enforcement lead gets generated. It could come in. It could also come in from finra, as opposed to somebody just being curious. The weakness with that approach is that it is not proactive. It is reactive in the sense that if he’s in on the human having a suspicion, a human analyst having a suspicion or saying, Okay, looks blue, sheet this FDA vaccine trial or let’s blue sheet this earnings announcement as opposed to doing it in real time. So it starts. So we talk about big data versus, you know, sort of economic data analysis. It starts with a hypothesis that something is happening around an event and then works backward to look as opposed to starting with the data first and saying, Here’s the mound of trading data. Let’s sift through the mound of trading data and work back to see if there was any event. The important thing with the latter approach is it allows you to detect private events that the human analysts would not be privy to. So, for example, board meetings are not publicly disclosed. You have to disclose when the board meeting is you don’t have to disclose who’s there. And so there’s been some evidence of spikes and informed for volume trading of corporate insiders around board meetings before share buybacks or before, you know, bad audit reports. That would be something that would not have been flagged by a human analysts unless the trading was incidentally, caught up in flagging an earnings announcement. Foreign flagging, some other, some other public events.

[0:31:22 Speaker 1] So you make a good you make a good point that the SEC, I don’t think there’s any secret about this. They look at price dislocations, big example, merger and acquisition, a big price change and they’ll go and look and they see who traded around that event and was there any insider trading? But what you don’t see is potential gains for events that don’t necessarily have a big price dislocation but are nonetheless informative about the direction of the future prices. And for that, you need to have a more systematic approach that looks at algorithms that reverse engineers. And here in academia, um, there’s a general belief that you shouldn’t date of mine, right? I mean, if you write a paper because you found a result and you look for hypothesis, you would be shunned by your colleagues. But in government, if you find a pattern and you look back and you say, Well, why is this pattern exist? You issue a subpoena and you find out that oh, they engaged in insider trading. In that case, there’s nothing wrong with that. Is that a fair statement?

[0:32:24 Speaker 0] Yeah, I I would agree with that. And I would also say that the academic research and say the form for trading at least the stuff that I do is pretty close to data money. Um, in the sense that we’re not seeking to estimate an average treatment effect to an exogenous shock. Uh, we’re not seeking to provide evidence of General Izabal inferences that are generalized outside of a setting. We’re simply seeking to provide robust evidence of a pattern that seems to be you know, let’s call it at best bad corporate hygiene and at worse evidence of illicit activity. And you know, occasionally that gets into the top journals. But, you know, as you outlined earlier, you know, it won’t be surprising to any academics to to view that sort of approach. As with a little bit of, you know, more skepticism than the traditional approach

[0:33:13 Speaker 1] you mentioned. I think a few minutes ago, if I heard right something called the Consolidated Audit Trail or the Cat, did you mention that

[0:33:20 Speaker 0] I did? Yes.

[0:33:21 Speaker 1] Okay, so that that’s interesting. You say that you mentioned it because the consolidated audit trail was something that was born out of a release almost a decade ago that said, Hey, why don’t we have a single repository of all trade data? Why should the SEC have to go off and requisition from 400 different brokers, trade information and piece it together to see if there was wrongdoing. And it just so happens that as of December of last year, in fact, December 13th of last year, that repository now exists. All broker dealers report in all trade information. Not yet. The count attributes, I

[0:33:55 Speaker 0] don’t think, but

[0:33:56 Speaker 1] in one place, all the trade information. So are you saying that is now the Holy

[0:34:00 Speaker 0] Grail

[0:34:01 Speaker 1] for regulators to look for insider trading?

[0:34:04 Speaker 0] Uh, you know, maybe a Holy Grail. Version two point. Oh, I’m not sure if I would go that far, but I would definitely say that that’s the first place they should look, you know, they have these algorithms that they run on blue sheets and you know, it’s no secret. Maybe it’s somewhat of a secret what they use, but those algorithms could be run on the entire consolidated audit trail. They don’t have to potentially do Lucy requests anymore. They can be running in real time.

[0:34:28 Speaker 1] So would you offer your help to effect regulators like the SEC to mine data like that?

[0:34:32 Speaker 0] I would love to help them. I’m willing to serve if it called upon for or it asks.

[0:34:40 Speaker 1] Okay, so we’ve We’ve talked about data and availability of data, and I have a few more questions that all loopy brown back to a little later. But I was hoping we could add some contextual information to insider trading. Uh, they kind of make it more tangible to somebody might be listening. And do you have any examples of the type of illicit activities that are occurring? Particularly, Let’s talk about coded. Are there any examples of things that are suspicious that fall into this crack of potentially illegal? But maybe not necessarily given the current rules?

[0:35:10 Speaker 0] That’s that’s a good question, because I think nicely highlight the distinction between the legal definition of insider trading that you could prosecute on and what I interpret as an economist. And I would say most people would think that would be cool. You know, consider trading on material nonpublic information, you know, So it’s come out that you know, Modern and and Pfizer obviously successfully to develop their vaccines. But in the process of that vaccine development at both firms, there was a lot of insider stock sales and those stocks sales tended to correspond in time in calendar time, very close to major vaccine announcements. So at Moderna, it’s been reported by NPR that, you know, I think one of the chief scientist, the chief medical officer, unloaded a substantial fraction of his shares the business day before they released, You know, the vaccine trial results quoting that very officer in the vaccine trial result announcement. And so we can think at this point we can say Okay, Was the executive the officer aware of the vaccine trial results before the public and aware that they were probably going to be quoted in the press release? Let’s take Let’s just suppose that the answer is yes. And Madonna was questioned on this, and they did not deny that that he was aware of the results. So now the next question is okay. We know that they knew the vaccine trial results, and we know that they knew that they were going to get quoted, and we know they unloaded a lot of shares right before the announcement. As an economist, I would say that that is trading on material nonpublic information, especially when one considers that that announcement shot up the stock price by over 20%. So there’s no argument here that it wasn’t economically material to stop for US one up by 20% and the company’s not denying that he had knowledge of it. Although I think they did technically say it wasn’t until nonpublic information. How would you prosecute that individual? Well, they sold before the stock price went up. So what losses did they avoid? What benefit did they accrue from selling before the announcement? And the answer is, it’s not clear they accrued any. They probably would have been better off to wait until after the announcement and then sold if, since it was good news. So that’s an example where I would as an economist, I would say that that would be considered economically. You know, we have nodules where agents get private information, they trade on that information. And then it’s a legal question on whether that is against the law. And, you know, I think the jury’s still out aware that against the law. But I would I would be surprised if that was ruled to be

[0:37:57 Speaker 1] so. You bring up a really good point, and I wonder if a clever prosecutor could make the point that well, this individual thought the price would go down because maybe he expected the public to think the results would be better than they were. He just didn’t get it that went the wrong way.

[0:38:13 Speaker 0] It could be that it could also be another clever prosecutor could make an argument, and this is occasionally occurring again. We’re not lawyers. Look occasionally seen this argument recklessness. So there’s potentially a lower bar for center, which is intent to defraud, which is just recklessness. Wasn’t reckless to execute a train right before announcing a you know, vaccine results. I would, Yeah, in my opinion, Yeah, that’s that’s I would consider that reckless. But you know, again, you know, there are differences of opinion on the on the matter. But, you know, suffice it to say for your listeners what we just described. I would say undercurrent like you need a prosecutor who was willing to take prosecutorial risk to do that because I’m not sure what the president is there. And I would think, if anything, the president would would be in favor of letting letting the executive off because there weren’t any clear benefits.

[0:39:08 Speaker 1] You know, another point of view, and I know this well because it’s a senior officer in government. For many years. There’s so many rules around what you can do and what you can do at some point to stop owning stocks. It was just too hard. And you just don’t engage in certain behavior because you can’t figure out the rules are too complex. You can always go and ask an attorney or an ethics officer what you should do. And some things if in your mind, you think they’re okay. Like maybe this executive thought, Well, the price is probably going to go up and I need to sell My kid’s college tuition is due, and I don’t want to be accused of taking advantage of information I’m gonna sell right now. And, you know, in their mind they’re doing the right thing. But in the mind of somebody else, it might be, Well, that’s just reckless. You should have gone and talked to, uh, an attorney general counsel’s office at the company before you did that.

[0:39:55 Speaker 0] Yeah, so to you know, two points. The first point is, is sort of simple because you brought up the general counsel. What if the forum for is signed by the general counsel? So many companies have insider trading policies that require the trade to be approved by the general counsel before it can be made, um, so that they would require the executive to run the trade by the general counsel. I have an academic paper on that, and we actually find that that has a more meaningful effect on trading behavior than trading blackout windows. And so there’s, you know, that that avenue is you know, they may have asked the lawyers permission and he gave it. You know what? I’m describing that pattern. I suspect the lawyer would say, There’s no problem with that, to be honest with you because I do think there’s been a normalization, right? Like what I described that we would say, Well, it’s not illegal, you know? So go ahead. So there’s a distinction between is someone violating the law versus what should should normative What should the law be? Should it be based on economics as opposed to sort of case law? You know, the second point there is. Executives have things known as 10 B 51 plans and you know it’s, you know, no surprise. Executives have lots of equity ownership in the firm, and they need to sell to send you know, their kids to college to buy the yacht to buy the house. And so they have diversification. Liquidity needs. Rule 10 B 51 provides them with the ability to submit a schedule for trades. So for the academics listening, imagine submitting a writing down on paper. You’re Kyle 85 Demand Order and then giving it to a broker, basically a sequence of limit orders or date orders. And then the broker just executes those you know for the contract. And so there are methods that they can use for these things. And the question is, is that Are they being used properly within the letter of the law? And then the second is is, you know, Are we comfortable with what the law allows? And should we tighten the law or rules?

[0:41:54 Speaker 1] So do the non academic crowd. Uh, your your Colony five model equivalence is commit to a schedule of trades in the future and irrespective what information is released. And therefore we know it’s not going to be trained on material nonpublic information because who knows the world is going to be six months from now. Okay, so is that the Is that the Is that the intent of a 10 B five planner rule?

[0:42:19 Speaker 0] Let me shave that a little bit because the word commit is the sticking point. So you basically submit a nonbinding schedule of trades, either at certain amounts of shares to sell a certain prices or certain amounts of share on certain dates in advance. Recognize while you have while you don’t have any nonpublic information, recognizing that in the future you will have nonpublic information.

[0:42:42 Speaker 1] So what is non binding means

[0:42:44 Speaker 0] so non binding? That’s a good question. So non binding means that you can cancel the plan at any time, even while you are in possession of material nonpublic information. And it means that you can cancel traits while in possession of material nonpublic information. But you cannot add additional trades or change the details of the trades while in possession of material nonpublic information. So this comes back to the legal distinction. It is illegal to trade on material nonpublic information, but it is not illegal to not trade well material nonpublic information. So there the president is. If you cancel a trade based on material nonpublic information, you are not trading based on material nonpublic information that’s permissible.

[0:43:31 Speaker 1] So lawyers like to use double negatives a lot that can be confusing.

[0:43:35 Speaker 0] Yeah, so here’s a let’s let’s set a setting. Suppose that we set a plan now to sell before every earnings announcement for the next four quarters. We’re going to set a plan now to sell two days before the earnings announcement. Okay, I don’t have any private information about the future earnings announcements. Yeah, but I know that five days before the earnings announcement, I will get private information about the earnings announcement. So if the earnings announcements going to be bad, you know, I’m perfectly willing to let my cell order execute and sell right, because I’m selling in advance of bad news so I can sell the elevated price. But if I learned that the earnings announcement is going to be good, I can cancel my cell trait, even though I have material nonpublic information. So that allows me to basically trade either after the good news is disclosed, and and so after the price goes up at the Max Price or sell in advance of the bad news disclosure. So in either case, I can time the market because I’m allowed to cancel these trades while in possession of material nonpublic information.

[0:44:45 Speaker 1] Do you see any abuse Have you seen are documented abuse in this area, and if so, can you describe it?

[0:44:50 Speaker 0] So, yes, we’ve documented abuse in 75 1 plant. We have not documented abuse on 10 B 51 cancellations. And the reason we haven’t documented abuse on 10 B 51 cancellations is because they are not required disclosure. And I have yet to see a firm that actually discloses they canceled 10 B 51 trade. So as academics not having access to, you know, some of the data the SEC has or or you know, since they don’t have the data, I would say I’m not having access to document request or subpoena power. We can only observe or document trends based on public data. So what is public data on these plants? The public data. It’s not mandatory disclosure. Nothing on these things is mandatory. Disclosure executives have to document or file their trades with the SEC within two business days. They can voluntarily disclosed that their trade was pursuant to one of these 10 B 51 plants. They can voluntarily disclose the adoption date of the plan, and they can voluntarily disclose when they adopted. So some companies disclose in an eight K Hey, are executives adopted this plan? Here’s the details, but those are very few and far between. So there is a form form 144 which took me down a rabbit hole. And there’s a current open comment period at the SEC on Form one for four. If you get excited about this after hearing me talk and want to write a comment, please do so. 4144 is still accepted paper filing by the SEC, and so the proposed rule would require for 144 to be filed electronically. What is 41444144 It has to be filed for any sale of restricted shares over 50,000. And it’s not just corporate officers and directors will be hedge funds. It would be VCs Anybody that has unregistered restricted shares, you know they’re going to be selling on the open market has to file form 144 You can file electronically. You can file it via paper and in proposing the rule, uh, era and we’ve confirmed this analysis ourselves found out that over the past three years, 90,000 for one for force have been filed on paper, which is 99% of all form one for force.

[0:47:17 Speaker 1] Okay, let me pause there for a second. So you say 99% of all disclosures about insider sales are filed in paper versus an electronic filing, which covers most other forms and violence at this point on Egger.

[0:47:35 Speaker 0] So let me let me shape. Let me put a little comment on that. So there’s a form for the form for filing covers Section 16 officers and directors that is required disclosure. It’s electronic. There is a secondary requirement for the sale of restricted securities that’s form 1 40 for that has to be filed by anybody who’s selling more than 50,000 in restricted securities. Those forms are filed on paper, so there will be instances in which you see a paper 1 44 filed and a paired electronic form for filing. Why the form 1 44 is important is that Form 1 44 contains required disclosure on the adoption date of 25 1 plans. So if you sell over 50,000 and restricted shares. Using a 10 B 51 plan, you will be filing a form 1 44 and on that form, you will be required to put the date that you’re Kennedy. 51 plan was adopted.

[0:48:48 Speaker 1] Why does that matter?

[0:48:50 Speaker 0] That matters? Because with the 10 B 51 plans, we can then see the date at which that non binding contract was entered into. And so, for example, we could find the non binding contract now to execute a trade in three days. Right? That would be, we would say, that would be highly suspicious and not consistent with the intent of the Rule 10 B 51 which allows for preplant trades. The intent behind that role was a series of trades spaced out throughout calendar time. And while you were not in possession of material nonpublic information, but there is no data other than on these form 1 40 four’s. There’s no mandatory disclosure other than these 41 40 four’s that would allow for the policing of those plants. And so I offered an academic

[0:49:41 Speaker 1] piece,

[0:49:43 Speaker 0] you know shouldn’t surprise anybody given the disclosure regimes on paper. Um, the first piece to look at over 20,000 of the details of the plans when the plan is adopted, when the train when the train is executed in the timing, Um, and so we have data and over 20,000 of these plants, and we do find, you know, pretty compelling evidence of abuse.

[0:50:06 Speaker 1] So how did you get the data? If it’s filed on paper,

[0:50:11 Speaker 0] we had to do a lot of digging. So it turns out that there is a data provider shout out to the Washington service that sends a courier for lack of a better term to the SEC reading room on a routine daily or every two day basis to scan the form 1 44 and then digitizes them and then sells the form 1 40 four’s to data providers like Thompson Reuters. So if you go on to more research data services or if you have access to the Thompson Reuters definitive terminal, you can see the Form 1 44. You can see at least a database of the form 1 44. You can see that those forms are not on Endor. They are paying the Washington service to get access to the Washington services data, which is generated by this person going into the reading room. So the form 1 44 gets mailed to the FCC. It gets stored in the reading room for 90 days, and then it gets taken off site and disposed of.

[0:51:15 Speaker 1] Okay, so now I’m curious. So you have a courier who spends all the time and effort, which I’m assuming is quite laborious to collect this data. That must mean that there’s somebody paying them to collect this data. Why is there a market for this data?

[0:51:33 Speaker 0] I mean, yes, they’re making the Washington service makes you know millions of dollars, right? Like they’re in business. It’s a corporation. Uh, they’re not doing this for charity. The market for the data exists because of the failure of the SEC to scan these paper filings and post them whatever. So there are two solutions One scan the paper filings and post them whatever. And the SEC has that capability because we see that with uploads and comment letters. And the second is require form 1 44 to be filed electronically. And that is the proposal that is currently before the SEC and is open for comment period.

[0:52:16 Speaker 1] Okay, so let’s pause there for a second. It was proposed by whom

[0:52:19 Speaker 0] it was proposed, I think, December 22nd by the commission. I think it was one of the last rules that was put out under Clayton’s.

[0:52:27 Speaker 1] Okay, so we have a we have a We have an administration change, and a lot of people are looking at the administration change as being a reversal of past policies. Is this a case where the last administration did something that was needed was good and the new administration should actually carry forward the previous administration’s plan?

[0:52:47 Speaker 0] So I have. You know, there are some things that I should say so many things that the previous SEC administration did that I would say it was not industrial protection friendly by my view, rolling back disclosure requirements and whatnot. This is, frankly, the most compelling rule. I think that the previous administration’s proposed and absolutely the new administration should should adopt it and actually expand on it. But I would say in this one case, like it’s the year 2021 and the SEC is getting 30,000 paper filings a year. It’s pretty clear that that should be electronic. And I think you know that should be a bipartisan issue. You know, we’re not changing the reporting burden for companies here. We’re just making disclosures. Electronics.

[0:53:37 Speaker 1] Okay, so let’s So this is one. Make it electronic. That seems to be really low hanging fruit, given that it has been around since 1990 for, um, and this has been part of the plan for three decades. Just to make things information accessible, important, information accessible. We know it’s important information because somebody is actually collecting it by hand and reselling it. So we know there’s value to the data. Must be market participants out there probably trading on this information or data or hedge funds are purchasing who’s purchasing it, and in what way is it valuable other than finding misconduct potentially

[0:54:11 Speaker 0] well, so the first way is potentially. I have not spoken with the market participants trading on it, but potentially in trading on it. The reason for that is because oftentimes VCs are hedge funds will be granted restricted shares. If they do not have a board seat or they are not a 10% beneficial owner, you will not see their transactions in the shares appear on form four, but you will see it appear on form 144 The second thing is, is that foreign entities who trade on U. S exchanges are still required to file these for one for force. They’re not required to file form force. So there are some entities who never have that File 20 s their foreign registrants trading on the NYSE e, for example. You know, maybe from various countries throughout the world, Asia, Europe, where you do not see form four trades with the SEC. But you do see form 144 So there’s information in in the trading activities individuals. The other reason that people pay for this information at least talking to the data provider. And this was I had this had never occurred to me is that on the form 144 it must list the broker who conducted the transaction So you can imagine Goldman Sachs wanting to know, you know, potential prospecting clients. Who is using Morgan Stanley? Morgan Stanley wants to know who’s using J. P. Morgan so that they can get a sense of what the market is for managing the money of high net worth individuals. And so that is my understanding is that’s a considerable source of information for the firms in potential prospect

[0:55:52 Speaker 1] for regulatory purposes. Is knowing the broker dealer important?

[0:55:55 Speaker 0] Potentially Because it can. It can lead you to potential weak internal controls or failings at the appropriate dealer level. Um, one thing we have not done because it wasn’t in the data that I have digitized was looking at whether there are systematic abuses based on which broker dealer you’re using, you know. So that’s obviously a possibility that there is a failure at the broker dealer level. Or that you know, there’s a selection issue that certain brokers select certain clients or certain clients select select progress.

[0:56:27 Speaker 1] Okay, so we’ve talked a lot about insider trading, the murkiness of it, understanding what’s right and wrong and permissible versus not, and we’ve talked about some of the data limitations and highlighted a very potentially big one with respect to form 144 What should we do about all this if you were king for a day at the SEC or whispering into future Chairman Gansler’s here? If he’s confirmed, what should we do with 4144 Any other disclosures besides making them electronics? Is there anything that needs to be done beyond that?

[0:57:02 Speaker 0] So I will be so I think there are two. There’s really three things that need to be done. Three separate areas and the one is on the disclosure of the you know the form one for it obviously needs to be electronic. As part of revising that disclosure, the proposal before the SEC that’s open for comment period also proposes putting a check box on Form four for whether the trade was made as a result of 10 b 51 And to give you a preview of what I will be urging the commission to do is to make that check box of mandatory. It was proposed currently as being voluntary, and I will also propose to require the date of 10 B 51 plan adoption be added to form for so that will bring the reporting requirements, reform 144 and put them in parody with the reporting requirements Reform for So if you have to disclose its 10 B 51 trade and the adoption for 144 do the same thing. One for four so that, I think, is pretty much cut and truck, or at least relatively straightforward

[0:58:09 Speaker 1] now in the proposal, This is important from the EPA Perspective Administrative Procedures Act. Did they ask questions about the issues that you think are important to address? Did they acknowledge you may want to do this and you’re writing in saying Yes, you should do it like you should make it voluntary. You should make it mandatory to check that box.

[0:58:29 Speaker 0] I am not sure about the voluntary versus mandatory, to be honest with you, but I I do know that the others are sort of open questions. As you know, many of the times, the questions are very broad and sufficiently broad that often time you can construe. The question is as being open on a particular topic. And so you know, that’s what I take the point that you know,

[0:58:55 Speaker 1] we’ve covered a lot and we appreciate all your time joining us here today. But before we let you go, I wanted to ask you a question about what you think the future is in this area with insider trading. If if we make these changes, will they have material impact or we’re just going to be here 20 years from now, talking about all the same abuses. Notwithstanding all these disclosures.

[0:59:21 Speaker 0] Great question. I mean, in watering down. You know, you said what would you do? And I told you what I would do. That was the water down version, because that I think, is politically feasible. Uh, and it doesn’t impose a burden on companies, but really, everything starts with enforcement. You know, if I was to whisper in the chairman councillors here, I would say the top three priorities for the SEC should be enforcement enforcement enforcement. They have algorithms. They have data analytics. They are not currently applying those to the form for violence. I would very much like to see a more robust enforcement regime applied. The existing algorithms that are applied to the blue sheet data applied to form for violence. There are over. I think we calculated $13 billion in lake form for filings filed every year because it doesn’t make sense to put it SEC lawyer on a firm for filing there for four or five days late. Fine is very small. Cost of the lawyers. Time is very high. But if there is an enforcement of of sort of these, let’s call them smaller dollar issues. You know, even insider trading is not typically $100 million case. It creates a bad culture and can lead to rampant abuses. So do I think we’ll be here still talking about this 10 years from now? I think that depends on whether they’re going to be changes in the enforcement division, because as long as there are changes in the enforcement division, I think that’s that’s what we will be. You know we’ll be having this conversation.

[1:00:54 Speaker 1] Okay, My last question for you. Do you have any advice for academics who may want to apply their general knowledge to the practice in areas of regulation enforcement?

[1:01:08 Speaker 0] Yes, I would say that what is relevant, at least in my experience, what I have found to be the most relevant for regulation enforcement is not necessarily the most the most relevant for what’s going to get you through a top journal. And so I think it would be nice if you don’t have to choose between those two. I’ve been trying to thread the middle ground, Um, and so I would recommend that you get out of the ivory tower that you talk with Scott or others who actually have experience with enforcement and with regulators and actually listen to what they say is valuable and then sort of work well knows as distinct from what academics think that regulators want to hear. So, you know, I know for a fact that when I was an academic and Scott was Aguirre, my academic colleagues would tell me all the time what people like Scott want to know, you know? But if you actually ask Scott what he wants to know, you know, you’ll probably get a very different, very different answer. And oftentimes that relies on descriptive data as opposed to, uh, causing sites. Um, so I would say, if you want to do it, you know, look me up, send me an email. Since I got an email, we can put you in touch with the people. Scott definitely has a much thicker roller, Dex, than I do right. Some comment letters. Get out. You know, talk to media. I think you know there’s a world of people who want an enforcement and regulators who actually want to do evidence based policy making evidence based enforcement. It’s just a question of making those connections

[1:02:43 Speaker 1] great. Dan, thank you so much for joining us today.

[1:02:47 Speaker 0] My pleasure. Thanks for having me, Scott.

[1:02:49 Speaker 1] We hope you enjoyed this episode, and if so, please rate. It’s that others can find it. The production is brought to you by the Salem Center for Policy Housing, the McCombs School of Business at the University of Texas at Austin. If you’d like to learn more about the center, but at Salem center dot org, our student executive producers from the Moody’s College of Communication or Abby Sawyer and Zoe Tar