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Circumstantial, but true?

Finance professor’s study points to evidence of insider trading

by Ed Cohen

December 15, 2010


Government investigations into insider trading took a dramatic turn last fall when the offices of three hedge funds were raided. But a member of the Mendoza’s finance faculty has been on the trail of potential illegal insider trading – involving investment banks – for years.

In 2007, when Andriy Bodnaruk, assistant professor of finance, was with Maastricht University in the Netherlands, he and two European co-researchers analyzed trading patterns of investment banks involved in secret merger negotiations. They focused on banks belonging to large financial conglomerates such as Goldman Sachs, Merrill Lynch and Morgan Stanley.

Companies often hire investment banks to advise them on acquisitions. In that role, they’re privy to information about potential takeover targets, bid amounts and the timing of offers. When one company buys another, it almost always offers more than the target company’s current stock price. This presents an opportunity to anyone with advance knowledge of a takeover bid to purchase the stock now and sell it at a profit after the bid is announced.

According to the researchers, that appears to be happening within these conglomerates.

Bodnaruk and associates looked at stock-trading records surrounding hundreds of U.S. merger deals done between 1984 and 2003. They found that mutual funds, money managers and other investment divisions of financial conglomerates held stakes in many of the companies that their investment-banking divisions were helping clients acquire. These conglomerates then often cashed out their stakes after the merger was announced.

Bodnaruk acknowledges that the evidence is circumstantial. They have no proof of any particular investment bank using or passing along insider information to profit illegally. Nor did the data they studied indicate whether a conglomerate bought a stake in advance of a merger or already held shares.

However, the researchers say their analysis showed that these trades happen much more often than would be expected by chance.

The researchers’ findings prompted an independent investigation and report by the Wall Street Journal published January 14, 2008. The newspaper’s article included many examples of suspicious-looking trades but also denials of any wrongdoing by executives at the financial institutions.

The finance professor says government regulators can go beyond the statistical analyses carried out by academics such as himself and demand information directly from the companies. Better disclosure by investment banks could mitigate the problem, he says.

Bodnaruk and his co-investigators published their findings in December 2009 in an article in the Review of Financial Studies, “Investment Banks as Insiders and the Market for Corporate Control.”