Where do insiders trade?

In the article Bright Light, Dark Room: Where do Corporate Insiders Trade? Alexander Hübbert and Lars Nordén investigate the trading venue choices of corporate insiders, whether they opt to trade on public exchanges or in dark, less transparent markets. They examine how these choices depend on whether insiders are informed or possibly violating trading restrictions.

Their findings show that informed insiders tend to trade on public exchanges to quickly benefit from their information, while those engaged in illegal trading are more likely to use dark markets to conceal their actions. Additionally, they observed that trading on dark markets correlates with lower abnormal returns, suggesting that insiders face a trade-off between transparency and execution risks.

Alexander Hübbert started the PhD program at Stockhlm Business School in August 2021 and is now working on his second paper. His research is about insider trading.

Researching insider trading is important because it provides critical insights into how the trading behavior of insiders, especially in opaque or "dark" venues, impacts overall market transparency and fairness.

Alexander Hübbert, PhD student in Finance. Photo: Maria Stoetzer

Corporate insiders often possess valuable information about their company, and their trades can signal confidence in or concerns about the company’s future performance to other market participants. When insiders trade in these less transparent venues, it can obscure valuable price signals and slow the process by which information is reflected in stock prices, potentially disadvantaging other investors. By understanding these dynamics, researchers can help inform regulatory policies to create a more equitable and efficient market environment. This research thus supports efforts to ensure that all market participants operate on a level playing field, which is essential for maintaining public trust and participation in financial markets.

Professor Lars Nordén. Photo: Maria Stoetzer

Factors influencing the choice of trading venue

A balance between immediacy and opaqueness primarily influences corporate insiders' choice between trading on exchanges and dark markets. Insiders with high-quality information often prefer exchanges, as these offer faster trade execution, allowing them to capitalize on information swiftly. In contrast, those looking to conceal potentially illegal activity tend to favor dark markets, as the lack of transparency reduces the likelihood of detection, albeit with slower execution times. The reseach show that insiders favor dark markets when they violate trading restrictions, such as trading during restricted periods, like blackout periods, or when they report their trades beyond the allowed deadline. In contrast, they favor exchanges when they trade opportunistically or with large sizes.

The article concludes that venue choice significantly affects insiders' abnormal returns and reflects their trading motives. Informed insiders prefer exchanges for immediacy, achieving higher returns, while insiders engaging in illegal activities opt for dark markets to conceal their trades, leading to lower returns. These findings show that venue selection is endogenous to information possession and legal risk, with broader implications for price discovery and regulatory oversight. Despite concerns over dark market use, informed trades primarily occur on exchanges, supporting efficient market functioning.

How might policy changes improve market integrity?

The use of dark markets raises regulatory concerns about reduced transparency, the potential for concealing illegal insider trading, and the impact on price discovery. Insiders trading on dark markets are less likely to disclose critical information promptly, increasing regulators' difficulty in monitoring and detecting illicit activities. Moreover, dark market trades can slow the incorporation of information into stock prices, potentially harming market efficiency.

Policy changes could address these concerns by implementing stricter transparency rules, such as enhanced pre- and post-trade reporting requirements and capping the volume of trades allowed on dark markets. Regulatory frameworks like MiFID II, which limits dark pool usage, exemplify how policymakers can encourage trading on more transparent venues, thereby improving oversight, reducing information asymmetry risks, and enhancing overall market integrity.