The Effectiveness of Insider Trading Regulation in Italy. Evidence from Stock-Price Run-Ups Around Announcements of Corporate Control Transactions

Abstract

All developed countries and most emerging countries restrict insider trading in the belief that it may undermine investors' confidence and the integrity of financial markets.

Such regulation, however, has proved to be relatively ineffective almost everywhere, as shown by the records on convictions in the last few decades and by the pervasiveness of insider trading signalled by stock-price run-ups around announcements of private information.

Identifying illegal insider transactions may be difficult: the private information must be material, i.e. price-sensitive, and in some countries prosecutors have to prove the use of such information by corporate insiders. Moreover, the investigative powers of the enforcing Authority may be weak and the deterrence of criminal sanctions may be diminished by lengthy proceedings, especially when alternatives, such as administrative fines and civil actions, do not exist.

To date, the Italian legal system has experienced great difficulty in detecting and punishing illegal insider trading. Since they were first enacted in 1991, the insider trading rules have led to two convictions and to a very low ratio of prosecutions to allegations of illegal trading. Moreover, leakage of private information appears to be widespread, given that news about firm-specific events seems to be incorporated in stock prices long before it is disclosed in public announcements.

This paper examines the effectiveness of Italian insider trading legislation by focusing, among other things, on the stock-price run-up around announcements of corporate events. In particular, after a brief survey of earlier research on legal and illegal insider trading and on the most important weaknesses in the Italian legal framework, standard event-study methodology is used to analyse stock-price run-ups around 29 announcements of corporate control transactions in the period 1998–2000. Indicators of the “leakage” of non-public material information are then constructed, showing that securities prices follow similar patterns regardless of whether insider trading is likely to have occurred. This evidence raises questions as to the efficacy of Italian insider trading regulation and the paper concludes with some suggestions as to how it could be improved.