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Nov. 27, 2017

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Lazaridis School of Business and Economics

  • William McNally, Associate Professor
  • Andriy Shkilko, Associate Professor and Canada Research Chair in Financial Markets
  • Brian Smith, Professor and BMO Financial Group Professorship of Entrepreneurial Finance 

Our joint paper "Do Brokers of Insiders Tip Other Clients?" was recently published in Management Science, a Financial Times top 50 rated journal and one of the top six finance journals in the world. Our preliminary paper won the Toronto CFA Society and Hillsdale Canadian Investment Research Award.

The topic of this paper is at the intersection of the individual research interests of Professors Shkilko, McNally and Smith, and represents a one-time collaboration. Professor Shkilko is one of Canada’s foremost researchers in the area of market structure, which is the study of how well financial markets work. He has researched issues like short selling, financial market liquidity fees, and high frequency trading. Professor Smith has published on how the Canadian equity markets process large trades (the ‘upstairs’ market) and professors McNally and Smith have published work on the impact of stock repurchases and insider trading.

This research looks at trading activity of other traders around the time of insider trades. In particular, we look at the trading of other traders who share the same stockbroker as the insider. We were curious whether brokers tip their other clients about insider trading. To test this, we look at the amount of trading a brokerage handles in the same direction as an insider trade around the time of that trade. Specifically we calculate each broker’s percentage share of buying (selling) on a given day (and within the day) and compare that market share to a base-line period. We find that brokers of insiders have a bigger market share after an insider trade compared to their typical share of trading. This is the pattern that you would expect to see if the brokers of insiders tip their other clients about the insider trade.

The most surprising finding of this paper is that we found a small increase in trading before the insider trade, which is consistent with some brokers front-running their insider client.

We are concerned about these results, because it suggests that there might be an unfair playing field. Some traders have better information than others. Many investors try to mimic insiders, but the public has to wait up to five days for the insider to publicly disclose their trade (on the SEDI system). Some clients of the insiders’ brokers appear to get the information prior to its public release. This lack of fairness may lead to a reduction in liquidity, which is bad for the entire market. We hope that Canadian securities regulators take steps to remove this advantage and level the playing field.

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