Investments can be very profitable. When doing investments, managers of big companies can use information that isn’t accessible for others. That is why the purchase and sale of shares by insiders have so many additional conditions. They have to report their transactions with the FSMA supervisor. In spite of the strict rules and supervision, a lot of insiders have been active on the stock market in Belgium in the past few years. They bought expensively and sold these stocks with profit.
Jan Annaert, Professor of Finance at Antwerp Management School, and his colleague Nils De Wit, looked into the investment behavior of insiders. In De Tijd, they shed a light on the differences between the behavior of insiders and normal investors and talk about a possible solution.
"Purchase orders have a much bigger signal worth on the long term than sales orders. For buying there’s just one reason: the insider thinks the share is a bargain."
Purchase orders and sales orders
It is a matter of foreknowledge when members of the Board or other insiders have specific knowledge, that could influence the course of a share strongly and that has not been made public. Trading with foreknowledge is punishable by law. But next to insiders, informed investors can also make a good amount of money on the trade of shares by basing themselves on purchase orders. “Purchase orders have a much bigger signal worth on the long term than sales orders”, Jan Annaert says. There are a lot of reasons for insiders to sell shares. They could need money for a renovation or purchase of real property. “But to buy there’s just one reason: the insider thinks the share is a bargain.”
Investment behavior of Belgian insiders
A study in which Annaert and his colleague Nils De Wit analyzed the investment behavior of Belgian insiders, shows that insiders do 7,5 percentage points better on average than other investors in the first six months after a sales transaction. “That’s not a small number. On a yearly basis that means a higher profit of 15 percentage points”, De Wit says. It’s not hard to explain that difference. “Insiders are dealing with their company every day. They know better than anyone else how to guess the effect of news on their company. Or when a share has been reprimanded by the market.”
"Some insiders do use their foreknowledge and our research shows that the rules around decent management have not been able to push back that tendency."
A lot of insiders know quite well when they should buy shares and when to sell them again. The objection to this is that the risk of trading with foreknowledge is enlarged when insiders of a company buy and sell a lot of shares. Between the rule that course-sensitive information should be made public on the one hand, and the fact that insiders have more knowledge about their own company and sector on the other, there is a considerable grey space.
This raises the question if the rules work sufficiently correcting, if insiders can make more profit than other investors on the market. It seems we have to answer that question in a more negative rather than affirmative way. De Wit: “Some insiders do use their foreknowledge and our research shows that the rules around decent management have not been able to push back that tendency.”
De Wit and Annaert plead for more transparency, on top of strict rules. That leads to normal investors being able to to follow the transactions insiders better and could even copy them. That allows them to profit as well.
"The delay that's caused by FSMA, causes a part of the potential profit to have already been lost.”
The European rules form a limitation to this solution. They allow a term of three working days before the insider transactions have to be reported on the FSMA website. “That delay causes a part of the potential profit to have already been lost”, Annaert says. Furthermore, the data that the FSMA supervisor reveals are now inadequate. It’s impossible for a normal investor to find out what the long term planning of an insider was.
“Transparency is important and the publication of the transactions on our website adds to that”, an FSMA spokesperson says. “A lot of top executives from the business world are well informed and know the sector. But the publication on our website has not been interpreted as a capital index of insiders. That is not what the legislator expects from us, and it wouldn’t agree with the privacy aspects of the database. We should be very careful with that.”
During this research, researcher Nils De Wit was a student in our Master in Finance and at the request of the investment fund where he is currently working, he used this theme for his master thesis as well. In this research he was supervised by Jan Annaert, who teaches in that same program.