Capital-market effects of tipper-tippee insider trading law: Evidence from the Newman ruling

Abstract

This study examines the capital-market effects of tipper-tippee insider trading laws. To do so, I exploit the unexpected decision issued by the Court of Appeals for the Second Circuit in U.S. v. Newman 773 F.3d 438, which reduced legal jeopardy for Second Circuit-based market participants prior to being overturned. Consistent with Newman constraining insider trading enforcement, I find strong evidence of plausible insider trading in the Second Circuit following the ruling. I also document a substantial reduction in general trading activity in Second Circuit stocks, as well as an increase in daily quoted spreads and the price impact of trading. These findings are consistent with unchecked insider trading increasing transaction costs and crowding-out investors. In total, my results show that tipper-tippee insider trading restrictions play an important role in bolstering market integrity, and that market participants can to some degree counteract insider trading when public regulation is constrained.