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E-MailShivaram Rajgopal is the Roy Bernard Kester and T.W. Byrnes Professor of Accounting and Auditing at Columbia Business School; Roger M. White is an Assistant Professor of accounting at Arizona State University W.P. Carey School of Business. This post is based on a recent article by Professor Rajgopal and Professor White, forthcoming in the Journal of Law and Economics.
In March 2009, H. David Kotz, then Inspector General (IG) of the SEC, released a report outlining the questionable trading activity of two lawyers employed by the SEC’s enforcement division. IG Kotz admitted in subsequent testimony before Congress that the SEC lacked a compliance system capable of tracking and auditing employees’ trades [1]. This report and testimony, as well as the accompanying public outrage, spurred Mary Shapiro, then SEC Chairman, to impose new, stricter internal rules, beginning in August of 2010, whereby SEC employees must (i) refrain from buying or selling stocks of firms under SEC investigation; (ii) have their transactions pre-approved, and; (iii) order their brokers to provide transaction-level information to the SEC. [2]
In our article, Stock Trades of SEC Employees, we investigate the efficacy of this new regime in restricting informed trading in the SEC workforce. This investigation began with a Freedom of Information Act request we filed to collect all the SEC’s data on trades executed by the SEC workforce (collected under the new regime). In response to privacy concerns, the responding data included tickers, dates, direction (buy/sell), and dollar amount, but no information on the employee (name, position, tenure, etc.).
The responding data included about 7,000 trades for $65 million in exchange traded securities from August 2009 to December 2011. This amounts to less than one trade per employee per year, and about $7,000 in traded dollar volume per employee per year. Outside of these exchange traded securities, most SEC employees conduct the bulk of their investing in brokered mutual funds.
Turning to returns, SEC employees beat the market by about 5% overall and by 8% in U.S. stocks (on average, per annum). These abnormal returns come not from buying winners, but rather by avoiding losers (i.e., SEC employees tend to be good at selling securities prior to price declines). In dollar value terms, this trading leads to the average SEC employee earning a relatively modest $600 in abnormal profits per year (about 5% of what corporate insiders earn via insider trading [3]).
These results are indicative of SEC employees being either: (i) skilled investors, (ii) lucky investors, or (iii) privately informed. We cannot confirm that our results are driven by trades on non-public information. While we do observe some unusual trading patterns around certain SEC activity (e.g., trading prior to enforcement actions and after whistleblower tips), several other innocent and viable explanations exist for our results. For example, SEC employees are likely very familiar with securities markets, accounting, and financial analysis, and they may just be good stock pickers.
Our primary aim is to provide evidence that the current SEC employee trading policy is questionable, even if our abnormal return results are attributable to innocent explanations that are hard to test or rule out. Even an appearance of financial impropriety potentially undermines the credibility of the SEC with its stakeholders. At a minimum, we hope our evidence encourages the SEC to (i) reassess the consistency of trading rules when firms are under investigation; (ii) review procedures related to selecting case staff assigned to handle investigations; (iii) assess the methods followed by the ethics group that approves trades; and (iv) drill down on specific individuals’ trades to assess whether abnormal returns are isolated to particular divisions or locations. Alternatively, the issues highlighted in the linked paper would be solved by a simple, bright-line rule prohibiting SEC employees from trading in individual stocks. These policies exist in some law firms and accounting firms, and we believe that while potentially draconian, such a policy is the simplest way to abrogate the concerns of the even the most cynical observer.
The complete article is available here.
Endnotes
1S. Barlyn, “Compliance Watch: Trading By SEC Staff Raises Question,” Dow Jones Newswires, New York, 14-Jul-2009.(go back)
2SEC, “Adoption of Supplemental Standards of Ethical Conduct for Members and Employees of the Securities and Exchange Commission and Revisions to the Commission’s Ethics Rules,” Office of Government Ethics and Securities and Exchange, Washington, DC, Final Rule 34–62501, Jul. 2010.(go back)
3P. Cziraki and J. Gider, “Perks or Peanuts? The Dollar Profits to Insider Trading,” University of Toronto and University of Bonn, Working Paper, Dec. 2016.(go back)
