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Nov. 12 — Rep. Carolyn Maloney (D-N.Y.) will introduce a bill banning trading by insiders during the “8-K trading gap”—the period between a corporate event and when the information is made public through an 8-K filing with the Securities and Exchange Commission.
The restriction would cover events not already affected by blackout periods, but not affect trades that occur automatically or are otherwise outside the insider’s control.
Maloney's office confirmed to Bloomberg BNA on Nov. 12 that the bill is forthcoming. The measure is a response to a recent Harvard-Columbia paper revealing that trading in the 8-K gap gives insiders “systematic abnormal returns of 42 basis points on average, per trade”. Co-author Robert Jackson Jr., co-director of Columbia Law School's Ira M. Millstein Center for Global Markets and Corporate Ownership, said the findings show “that SEC rules leave open a significant opportunity for insiders to trade on corporate information.”
University of Pennsylvania law professor Jill Fisch pointed out that a return on the scale of 42 points, on a risk adjusted basis, is insignificant in the long run, especially “compared to executive compensation and other loopholes. It’s hard to believe these trades are deliberate or calculated,” she told Bloomberg BNA.
Jackson admitted that the 42 point average return wasn’t much, “but it is 42 points effectively risk-free” and therefore performs better than many other investments.
The author also provided Bloomberg BNA with a list of 475 trades with more egregious potential returns, ranging from 3 percent to 22.5 percent, although some of these trades could be curbed by the Section 16(b) limitation on short-swing trading in the Securities Exchange Act of 1934. According to Jackson, the analysis didn't factor in the short-swing trade restriction because it is “regularly evaded by insiders” through stock-based pay programs, hedging transactions and other well-known avenues.
During the debate over implementation of the Sarbanes-Oxley Act in 2004, the window for filing an 8-K was slated to be changed from 15 days to two days as a response to the corporate scandals of WorldCom and Enron. But after receiving numerous comments from accounting and legal groups such as the American Institute of CPAs (AICPA) and the City Bar of New York, the window was set at four days. Those groups expressed concern that a two-day filing date would leave little time for proper disclosure of complex transactions.
To some securities experts, shortening the window was not an effective remedy to preventing insider trading. “Whether it’s two days or four days is irrelevant,” Larry Ellsworth, a securities litigator with Jenner & Block, told Bloomberg BNA. “If somebody is trading on non-public material information and breaking the law, it doesn’t matter.” While there might be some insider trades that take some time to process or pass on information, “most happen relatively quickly,” he said.
According to Ellsworth, trades in the 8-K filing window by insiders “should already be considered worthy of investigation by the SEC and [the Financial Industry Regulatory Authority],” even if there might not be anything illegal about their actions. In his view, the Maloney bill might prevent suspicious trading in the gap, but might prevent some legitimate trading as well.
Yale accounting professor Alina Lerman maintained that “corporate accountants and outside counsel need time to determine whether an event meets the threshold of material events for filing as well as proper review and sign-off. The larger and more complex an organization, the more difficult it can be to determine materiality in a timely fashion.”
Deadline pressure could lead to errors in 8-K filings, which in turn could spawn class and shareholder actions, as well as more amended-filing costs, Lerman said.
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