Insider Trading and Effectiveness of Chinese Walls in Securities Firms

Abstract

This study investigates the profitability of insider trading around the times when investment bankers appoint their representatives to the board of directors. If Chinese Walls at security firms are somewhat porous, then the presence of investment bankers on the boards is expected to increase the information efficiency of the clients' stocks and reduce the profitability of insider trading. Consistent with expectations, arrival of investment bankers on the boards of directors eliminates the profitability of insider trading, and reduces both the bid-ask spreads and volatility. These effects are temporary and they are reversed when the representatives depart. The finding that Chinese Walls are porous has a number of important economic, legal, and regulatory implications.

Keywords: Market Microstructure, Insider Trading, Investment Banking, Brokerage, Government Policy and Regulation, Banks and Other Depository Institutions

JEL Classification: G24, G28, G21