Do Prosecutions Stop Insider Trading?

We generally assume that the prosecution of crime acts as a deterrence to others who may think about committing the crime. One of the key factors in fraud is opportunity. If the wrongdoer thinks they can not get away with the violation, they are less likely to commit the violation.

At least that is the theory. Social scientists have been looking at this strategy for a long time, with sometimes mixed results. My guess is that the deterrent effect will vary from crime to crime and deterrence strategy to deterrence strategy.

What about insider trading?

The UK’s Financial Services Authority has published a metric on insider trading. They look at the level of abnormal pre-announcement price movements (APPMs) in the share price of a company.

“The level of APPMs for the takeover data set has remained stable over the past few years including for 2009. The level of APPMs for the FTSE 350 data set remained at a low level in 2009.”

The data does not show any improvements. The data set is on the small side so it is hard to judge significance. The FSA program is also new. The program begin during a period of great turmoil in the financial markets.

On the other hand, the FSA’s new enforcement activity of criminal prosecutions and large fines did not affect the amount of abnormal pre-announcement price movements. If this robust enforcement activity is supposed to have a deterrent effect, it does not obviously appear in the data.

Perhaps robust enforcement activity catches more bad guys but does not reduce the bad activity.