Insider Trading in Supervised Industries

Abstract

We investigate the effects of government oversight, such as the Federal Reserve, on trading based on material non-public information by examining the impact of regulatory supervision at the firm level. We categorize firms in financial services, pharmaceuticals, and utilities as supervised. Regulatory supervision potentially limits insider trading as it provides another basis of corporate governance to mitigate outflows of material non-public information. Yet, regulators themselves may serve as a source of information leakage, thereby facilitating insider-trading activity. In comparison to non-supervised firms, we find that supervised firms exhibit substantially greater trading based on inside information prior to earnings announcements in a pattern consistent with regulator information access. We also find that in the first few days after firms provide private information to regulators, these firms exhibit greater symptoms of insider trading activity. Similarly, when regulators possess private information unavailable to corporate insiders, we find greater symptoms of insider trading activity. Additional tests exploit disparities in state and federal regulatory supervisory bodies, finding more pronounced insider-trading symptoms in situations where regulators exhibit greater leniency or operate in states with greater political corruption. These insider-trading activities translate into over one billion dollars in annual transfers. We interpret these findings to suggest that regulatory oversight results in an unintended consequence, namely greater leakage of material non-public information.