December 1, 2006
Senator Grassley (R-Iowa), departing Chairperson of the Senate Finance Committee, has asked the NASD some straightforward questions on insider trading. At the core of his questions is the data, long understood by financial economists, that there is a high probability of abnormal stock trading in the securities of companies involved in deal negotiations, before any deal is announced. The latest data, gathered last August by the New York Times, is that 41% of the companies in big deals show abnormal returns in the pre-announcement period. Gains in stock price can be as high as 40 percent and often average over one- third of the overall run up in price of the target due to the deal. Insider trading around deals is, sad to say, commonplace. How much of the price run up is caused by illegal trading is hard to quantify because shadow trading by those who observe price jumps caused by insider trading is also a common trading practice. Grassley wonders why the NASD is not more successful in stopping such trading. Grassley asked for data on the NASD enforcement actions. His questions have also caught the attention of the GAO, which has agreed to review SEC enforcement practices. Grassley's questions will focus on what is, in reality, an acknowledged and understood weakness in insider trading enforcement. The answers may contain surprises. I, for one, believe that some of the problem is created by an overly broad definition of what is illegal. Enforcement would benefit from a more targeted group of trading crimes.
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