Average investors face long odds of beating the markets consistently over the long term. In What Investors Really Want, Professor Meir Statman says that one of the reasons retail investors face these long odds is insider trading. According to one study quoted in the book, corporate insiders beat the markets by six percentage points each year on average. The same study also found that U.S. Senators beat the market by a Buffett-esque twelve percentage points annually. To be sure, most of the trading by insiders and Government officials is perfectly legal. But it isn’t always so.
Just last week, the Ontario Securities Commission alleged that a corporate lawyer passed along non-public information concerning pending corporate transactions to investment advisors who would in turn trade in the securities themselves and/or recommend the securities to family members, friends and clients. And investigators in the U.S. are in the midst of a major insider-trading investigation that is said to involve consultants, investment bankers, hedge funds, mutual funds and analysts. The current US probe comes just as the Galleon insider trading case, in which insiders at technology companies are alleged to have passed along material, non-public information to a hedge fund, is working its way through the courts.
Prof. Statman urges active investors to understand the good and bad news about insider trading:
But a false belief that the government is effective at preventing insider trading is costly to outsiders. The good news about the work of regulators in the United States is that they are largely effective at preventing insider trading. The bad news is that they leave the impression that they are more effective than they truly are, promoting unrealistic optimism among outside investors who are persuaded that the playing field is level when, in truth, it is tilted toward insiders.