In 2015, an academic study, reported in the WSJ, showed that corporate insiders consistently beat the market in their companies' shares in the four days preceding 8-K filings, the period that the researchers called the "8-K trading gap." The study also showed that, when insiders engaged in open market purchases—relatively unusual transactions for insiders—during that trading gap, insiders "are correct about the directional impact of the 8-K filing more often than not—and that the probability that this finding is the product of random chance is virtually zero." The WSJ article reported that, after reviewing the study, Representative Carolyn Maloney, D.N.Y., a member of the House Financial Services Committee, characterized the results as "troubling" and said she was preparing legislation to address the issue. Five years later, in January 2020, by a vote of 384 to 7, the House has passed HR 4335, the "8-K Trading Gap Act of 2019." A substantially similar bill has been introduced in the Senate. Given the remarkably bipartisan vote in the House—and assuming that the legislation isn't suddenly tinged with politics—the bill appears likely to pass in the Senate as well...sometime.
The study, conducted by researchers at Columbia and Harvard, analyzed over 15,000 8-K filings as well as almost 43,000 reported insider transactions between 2004 and 2014 that occurred within the four business days between the 8-K event and the 8-K filing. The results showed that the insiders could have realized gains (absent the Section 16 prohibitions on short-swing trading) that were about 0.4 of a percentage point over a broad market index. Direct stock purchases (as opposed to option exercises) during the 8-K trading gap could have resulted in estimated gains that were about 1.6 percentage points over the index. In addition, the greater the time lapse between the event and the filing, the better the insiders' estimated returns, rising to an average excess profit over the index of 1.95 percentage points.
The study determined that open market purchases in the 8-K trading gap were the most profitable types of transactions; open-market purchases by insiders preceded stock price increases in approximately 57% of the transactions. Interestingly, the study showed that trades by insiders in the 8-K trading gap were profitable to a statistically significant extent when the 8-K reflected information about changes in corporate documents or capital structure, M&A transactions, key customer and supplier agreements, exchange listing violations and changes in accountants, but were unprofitable to a statistically significant extent only when the subject of the 8-K was related to a legal issue. (See this PubCo post.)
Some of the SEC Commissioners have previously expressed support for legislation to address the issue. In 2019, at an oversight hearing held by the House Financial Services Committee, Commissioner Robert Jackson (who will be stepping down on February 14) identified three areas where he believed the SEC and/or Congress needed to address regulatory gaps, among them the 8-K trading gap. Citing the academic study discussed above, he advocated legislation that would close the trading gap. (A similar problem occurs, he said, with insider sales after the announcement of stock buybacks. According to Jackson, many insider sales occur just after a buyback is announced, and company performance declines afterward.) In testimony in 2017 before the Senate Committee on Banking, Housing and Urban Affairs, SEC Chair Jay Clayton, in response to a question from Senator Van Hollen (the sponsor of the new bill in the Senate) about recent problems with insider trading, said that companies should have controls in place to preclude insider trading by executives and directors. Van Hollen specifically raised the issue of the 8-K "trading gap" shown in academic studies and said that he was working on legislation that would preclude trading by insiders once the company had decided that an event was material and required disclosure. Clayton appeared to approve of the concept and expressed willingness to work with Congress on the issue. (See this PubCo post and this PubCo post.)
The House bill would amend the Exchange Act to add section 10E, which would require the SEC, within one year (hmmm...), to adopt rules that would require reporting companies to have policies, controls and procedures reasonably designed to prohibit its executive officers and directors from purchasing, selling or otherwise transferring, directly or indirectly, any of the company's equity securities in specified circumstances. For events covered by the first six sections of Form 8-K, the prohibition would apply from the occurrence of the event to the filing or submission of the 8-K. The first six sections include events such as entry or termination of a material definitive agreement; bankruptcy; M&A transactions; financial results; creation or acceleration of direct or off-balance-sheet financial obligations; costs of exit activities; material impairments; notice of delisting; unregistered sales of equity; modifications of shareholder rights; changes in accountants; non-reliance on financials; changes in control; new and departing officers and directors, executive comp; changes to charters, bylaws or fiscal year; amendment or waiver of codes of ethics; shareholder voting results; shareholder nominations and asset-backed securities, among other events.
For events covered by sections 7 (Reg FD disclosure) and 8 (other events) of Form 8-K, the prohibition would apply between the date the company determines that it will disclose the event and the filing or furnishing of the 8-K.
The SEC would be permitted to exempt certain transactions, including transactions that occur automatically, are made under an advance election, or involve a purchase or sale of equity securities under Rule 10b5–1(c), except for a Rule 10b5–1(c)(1)(i)(A)(3) plan that, for any particular 8-K event, was adopted within the prohibition periods described above. The SEC is also required to exempt certain investment companies, as well as events described under sections 1 through 6 of Form 8–K that the company has announced in a press release or otherwise publicly disseminated in compliance with Reg FD.
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