Increased Disclosure Needed for Open-Market Repurchases

Insider Trading via the Corporation, by Jesse M. Fried of the Harvard Law School, examines the regulations applicable to U.S. firms trading in their own shares and puts forward a proposal for reform that I hope will be recommended to the SEC by the SEC Investor Advisory Committee (SECIAC), along with other recommendations I made in this June post, If I Were on the SEC’s Investor Advisory Committee: Recommendations to Help Retail Investors.

Open-market repurchases (“OMRs”) total hundreds of billions of dollars per year; in 2007, they reached $1 trillion. Firms are also increasingly selling shares in the open market through so-called “at-the-market” issuances (“ATMs”).

Yet, its trade-disclosure requirements are minimal. Firms must report aggregate trading activity during the next quarter, allowing them to secretly buy and sell for several months and never disclose the exact details of its trades. The lack of detailed disclosure, makes it difficult to detect illegal trading on material inside information. The lack of timely disclosure makes it difficult for investors to determine when the firm is trading on valuable but sub-material information.

The U.K. and Hong Kong require firms trading in their own shares to disclose the details of their trades by the morning of the next business day.  Since the Sarbanes-Oxley Act of 2002, U.S. insiders must report details of their trades in firm shares within two business days. Fried argues applying that same two business day standard to trading by firms in their own shares would be a step in the right direction.

When insiders are subject to strict trade-disclosure requirements and firms are not, they have a strong incentive engage in indirect insider trading to pump up the value of their own equity, which averages over 20% at publicly-traded firms. Fried finds considerable evidence that insiders use control of the firm to engage in indirect insider trading to their advantage—to the tune of several billion dollars per year.

The paper concludes by putting forward a simple and intuitive proposal: that regulators subject firms to the same 2-day disclosure rule applied to their insiders. Such a rule would substantially reduce insiders’ ability to engage in indirect insider trading and the resulting costs to public investors.  And it would be less burdensome than the trade-disclosure requirements already imposed on many firms abroad. (Insider Trading via the Corporation, Jessie M. Fried, HLS Forum, 8/24/2012; full paper of same title posted at SSRN on 8/2/2012)

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