SOX and Insider Trades

This post comes from Francois Brochet of Harvard Business School.

In my paper, Information Content of Insider Trades before and after the Sarbanes-Oxley Act, which was recently accepted for publication in the Accounting Review, I examine whether Section 403 of SOX has resulted in the provision of more timely and relevant information to market participants in the United States. SOX Section 403 addresses the issue of insider trading disclosure, by requiring insiders to report their trades to the Securities and Exchange Commission (SEC) on a Form 4 within two business days. Until August 2002, the requirement had only been to file Form 4 with the SEC within ten days after the close of the calendar month in which the transaction had occurred.

Using stock returns adjusted for book-to-market and size and abnormal trading volumes as proxies for information content, I find evidence that filings of insider purchases are significantly more informative after SOX. Over a three-day window beginning with the receipt of the form by the SEC, the pre- and post-SOX mean cumulative abnormal returns are 0.59 percent and 1.89 percent, respectively, while the pre- and post-SOX average daily trading volumes are 1.03 percent and 12.03 percent higher than normal, respectively. These differences are all statistically significant. In the case of insider sales, mean daily trading volumes around post-SOX filings are significantly higher than normal (1.15 percent over a three-day window) and greater than they were pre-SOX. In contrast, mean abnormal returns are more negative around pre-SOX filings than around post-SOX filings (-0.28 percent and -0.11 percent, respectively, over a three-day window). All results except for stock returns around filings of insider sales suggest that SOX has increased the information content of Form 4’s. However, additional findings indicate that, after controlling for confounding factors such as preplanned trades and litigation risk, stock returns around filings of sales are also significantly more negative after SOX.

I also find that, after SOX, insiders are less likely to sell shares immediately prior to negative stock returns and ahead of earnings news that falls short of analyst forecasts. This finding suggests that there is a decrease in informed insider selling around SOX. In the remainder of the paper, I use a variety of supplemental tests to provide further support to my causal attribution of the increase in information content of Form 4 filings to Section 403 of SOX.

The full paper is available for download here.

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