New Evidence on the Effects of the Insider Trading Sanctions Act of 1984

Abstract

This paper analyzes the effects of the Insider Trading Sanctions Act of 1984, the first federal level insider trading statute since 1934 which substantially increased the penalties of illegal insider trading. I find that, around the passage of the Act on July 25, 1984, there were positive abnormal returns for stocks heavily traded by insiders in the past. After the passage of the Act, insider trading frequency decreased significantly and insider trading volume also declined once firm characteristics are controlled for. I also explore insider trading behaviors in merger target firms before the merger announcements between 1979 and 1989 and find a significant decline in abnormal pre-announcement insider net purchases. After the enactment the odds ratio of a positive net insider purchase decreased from 0.08 to 0.04. The price run-up before merger announcements also attenuated after the ITSA enactment. The five-day pre-announcement abnormal return accounted for about 48% of the total price increase before the enactment, but only about 27% after the enactment. Overall, the evidence supports the hypothesis that the ITSA effectively reduced informed insider trading.

Keywords: Insider Trading Sanctions Act, informed insider trading

JEL Classification: G34, G38