An eerie talent for profitable trading by workers at the Securities and Exchange Commission is probably the result of laws intended to root out conflicts at the regulatory agency, a new study says.
In a report titled “Stock Trades of SEC Employees,” which echoed past findings, two professors observed that commission employees regularly pick better times to sell shares than everyone else in the market. One logical explanation is a federal law requiring investigators to get rid of shares of companies they’re looking into or recuse themselves from the case.
“Given that the SEC is tasked by Congress with enforcing insider trading regulations against corporate officers and other market participants, our findings indicating abnormal risk adjusted profits on trades by SEC employees are noteworthy,” Shivaram Rajgopal, professor of accounting and auditing at Columbia Business School, and Roger White, assistant professor in the school of accountancy at Arizona State University, write.
Ryan White, a public affairs specialist at the SEC, declined to comment on the report but pointed to SEC rules restricting SEC staff from selling stocks in companies being investigated.
The topic got its first airing in an academic paper, also by Rajgopal, published in 2014that didn’t weigh the possible impact of the rule. Institutional Investor previously reported the current study’s findings.
Here are the numbers: A hedge portfolio imitating more than 7,000 trades by SEC employees from the end of 2009 to 2011 generated excess positive risk-adjusted returns of 4 percent a year for all securities, with earnings more than doubling to 8.5 percent per year when only U.S. common stocks were considered, according to the authors. That’s comparable to abnormal insider trading returns of about 6 percent per year, they note.
What the paper found was that SEC employees seem to be really good at selling stock at the right time, but not so much at buying. While share purchases look about the same as typical individual investors, their sales “appear to systemically avoid the revelation of bad news in the future,” the authors say.
After a report from the SEC’s inspector general in 2009 found two employees had neglected trading guidelines, the agency implemented rules that prevent employees from buying or selling stock of firms under investigation. Transactions must be pre-approved and their brokers must give the SEC transaction-level information.
“We are concerned that such a policy is tantamount to forcing employees to sell stock on non-public information given that virtually all investigations initiated by the SEC are private,” the study’s authors, Rajgopal and Roger White, write. Their question is why employees are even allowed to own individual stocks in the first place.
“If you look at the private sector there are many examples of cases where employees are not allowed to hold stock,” Rajgopal said in a telephone interview Tuesday. “In the press you’re not allowed to. If you’re in an auditing firm you’re not allowed to. If you’re an analyst following companies you’re not allowed to. So I just don’t understand why a securities regulator is allowed to.”
The study was based on trades from 3,500 SEC employees obtained from the SEC under the Freedom of Information Act. The authors note that they were not given access to trades identified by each employee, but rather a general list of transactions that didn’t show who did the trading or how many transactions each person made.
“Even if these trades were perfectly legal or if the estimated magnitude of trading profits per employee is considered to be small (about $650 in abnormal profits, at most, per employee per year), they open the SEC to allegations of compromised integrity,” they write.