Do Criminal Sanctions Deter Insider Trading?

Abstract

Many developed markets have taken what appears to be a tough stance on illegal insider trading through the use of criminal sanctions. Although criminal sanctions represent a much greater penalty than civil sanctions, the higher burden of proof required makes their enforceability weaker. This trade-off between severity and enforceability makes the impact of criminal sanctions ambiguous. In this paper, we empirically examine this issue by studying the deterrence of insider trading following the introduction of criminal sanctions in a developed market. Significant changes in sanction regimes are rare, especially when criminal sanctions are introduced without other changes. In February 2008, New Zealand introduced criminal sanctions for insider trading. This change of law offers a unique setting in which to examine the deterrence effect of criminalization. Using measures for the cost of trading, degree of information asymmetry, and probability of informed trading, we find that the enactment of this law led to a worsening in these measures. These findings suggest that the weaker enforceability of criminalization outweighs the associated increased severity of the penalties.JEL Codes : C22, D82, G18

Price run-ups and insider trading laws under different regulatory environments

“…In particular, only 11.1% of the prison sentences given to individuals are due to trading in AIM firms, while 75.3% is due to trading in MM firms and the remaining 13.6% is due to trading in non-UK firms. 9 Our results are in line with prior studies reporting that it is the strict enforcement of laws that matters (Bhattacharya and Daouk, 2009;Frijns et al, 2013). We extend this discussion by showing that the focus of the regulatory enforcement within the same country also matters in countering information leakage.…”

“…Meanwhile, the enforcement actions are very important in keeping public confidence in the markets (Persons, 1997). Literature reports that the establishment of insider trading laws can be unsuccessful due to a country's poor enforcement (Bhattacharya and Daouk, 2002;Frijns et al, 2013;Gębka et al, 2017). This is relevant to our setting because even though the FSMA introduced stricter laws, it has received criticism for poor enforcement.…”

“…For example, Bhattacharya and Daouk (2002) suggest that the introduction of insider trading laws has no effect on the cost of capital; nevertheless, they find a significant reduction following the first enforcement. Frijns et al (2013) report that the introduction of criminal sanctions in New Zealand in 2008 was unsuccessful due to the country's poor enforcement. Finally, Bhattacharya and Daouk (2009) find that countries that enact laws but do not enforce them, experience higher costs of capital than those that do not enact insider trading laws at all.…”

Merger Announcement Effects and the Amendment of Insider Trading Laws in Brazil

“…On the contrary, Khan and Lamba (2001) and Seyhun (1992) argued that monetary penalties and criminal sanctions do not have deterrent effects on IT. In New Zealand, an enactment of stricter IT laws in 2002 improved the stock market efficiency (Frijns, Gilbert, & Tourani-Rad, 2008) while the imposition of criminal sanctions in 2008 had little impact on IT (Frijns, Gilbert, & Tourani-Rad, 2013). In the Netherlands, price run-ups prior to merger announcements decreased after the financial penalties for IT were increased in 2005 (Prevoo & Weel, 2010).…”

Impact of Regulatory Enforcement on Leakages Prior to Analyst Recommendations

“…Government enforcement against information leakages may discourage leaks and can attract more traders who are willing to trade in financial markets (see Leland, ). However, some studies acknowledge limited abilities of government agencies to enforce laws intended to prevent leakage (see Frijns, Gilbert and Tourani‐Rad, ).…”