Joint university study on insider trading wins prize

Dr David LontInsider share trading in the United States gleaned almost $US2 billion ($NZ2.7 billion) in profits from the buying and selling of stock in faltering debt-laden companies, according to a prize-winning joint study undertaken by the University of Otago's School of Business and the University of California.

The eight-year study, from 2000 to 2007, scrutinised stock sales and buys before and after companies announced breaches of banking covenants. It was led by Prof Paul Griffin, of UC's Davis campus, working with Otago University's business school's Dr David Lont and Kate McClune.

Dr Lont said while the study was solely looking at the US markets, a recent New Zealand Securities Commission action suggests debt covenant violations and subsequent waivers may now fall under the New Zealand share market (NZX) continuous disclosure rules.

However, if there is any doubt on this, the New Zealand Securities Commission should review the rules to ensure the adverse effects shown in the study are sufficiently covered.

"New Zealand could help avoid this [insider trading] situation by requiring companies to reveal debt covenant violations and waivers promptly to the market and impose a blackout period for insider trading around debt negotiations," Dr Lont said.

The study hinged on the sale of stock by insiders before breaches of banking covenants were publicly disclosed, which generally then saw the share price fall, partly as concerns of bankruptcy took hold.

This was followed by the subsequent purchase of shares by insiders after banks refinanced the company and the share price recovered alongside the company's turnaround.

Prof Griffin tracked insider stock transactions around the times when 1718 first-time disclosures of debt covenant violations were made by US publicly-listed companies, between 2000 and 2007; before the October 2008 crash.

"The waiver of a debt covenant is an important step taken by a lender to resolve a company's debt problems and help bring the company back to financial health," Prof Griffin said in a statement.

The study documented increased insider selling as stock prices dropped, just before disclosure of violations, and subsequent increased insider buying following the disclosures, as stock prices recovered in response to the company's turnaround.