When Does Insider Selling Increase Litigation Risk?

Abstract

In broad samples, insider selling does not increase the likelihood of a class-action lawsuit filing. In this paper, we examine the reasons behind this finding. We find that insider sales significantly increase lawsuit probability only when we jointly consider insider identity, insider sale timing, and the abnormal nature of the trade, during a period just before large price drops. Specifically, opportunistic sales by CEOs in the quarter prior to stock price crashes is associated with a significantly higher likelihood of a lawsuit. Sales by other insiders, including their opportunistic sales, do not materially impact the likelihood of a lawsuit. These findings are not constrained to firms in litigation intensive industries. CEOs appear to be aware of the impact of their selling activities on litigation risk and, on average, reduce their opportunistic sales prior to a crash. Though such decreases do not significantly reduce the likelihood of a subsequent lawsuit, they attenuate the negative market reaction to a lawsuit filing.

Keywords: Insider selling, Stock price crashes, Lawsuits

JEL Classification: G14, K22, K41, M41