Pre-Announcement of Insiders' Trades

Abstract

Among the reactions to recent corporate scandals are calls for greater transparency of insiders' trades. The Securities and Exchange Commission's recent rule on fair disclosure is accompanied by a safe harbor from prosecution under insider trading laws for insiders who pre-commit to trades. A blue-ribbon commission convened to address recent financial scandals and subsequent decline in investor confidence recommended that insiders be required to preannounce sales of stock in their companies. The commission's call for insiders to preannounce their sales echoes proposals made over a decade ago in the legal press, law reviews, and the U.S. Congress that would require pre-announcement of all trades. We consider the effects of insiders pre-announcing their trades on their preferences for public disclosure that would pre-empt their private information when other motives for insiders to trade are present. Two principal forces emerge. With pre-announcement, insiders cannot expect to profit on their private information, but cannot ignore the incentive to do so when market makers are unable to disentangle insiders' motives. Pre-emptive public disclosure allows insiders to avoid the dysfunctional consequences of this incentive. However, such disclosure before insiders have an opportunity to trade exposes them to greater price risk than would otherwise be the case. Our analysis demonstrates these effects.