Insider trading catches regulators’ attention and garners headlines, but another type of insider activity is also widespread—and far less likely to be detected or prosecuted.
That’s the conclusion of new research that looks into the practice of insider giving: timing the donation of a stock to a charity around inside information about the stock. That way, you take a tax deduction before bad news sends the share price tumbling or after good news sends the price higher—and the gift delivers a bigger deduction than you would have gotten otherwise.
Insider giving is “worryingly widespread” among large shareholders, or those who hold 10% or more of a company’s shares, according to the study by
professor of business law at the University of Michigan’s Ross Business School, and
professor of finance at the school.
In many cases, insiders benefited from large share-price moves. In the year before large shareholders made their gifts, the stocks they donated rose about 6% on average. The year after donations, those stocks dropped about 4% on average, according to the professors and their co-authors,
Sureyya Burcu Avci,
lecturer and visiting researcher at Istanbul’s Sabanci University Business School, and
professor of law at the University of California, Los Angeles, Law School.
These “suspiciously well-timed” donations “suggest more than chance,” says Mr. Seyhun. “The fact that large shareholders can determine or choose—with pinpoint accuracy—the average maximum price over a two-year period when they give gifts is surprising,” he says.
Timing raises suspicion
The researchers examined information from a database now known as the Refinitiv Insider Filing Data Feed on 9,858 gifts of common stock by large shareholders in 1,655 publicly listed U.S. companies from 1986 to 2020. Those gifts represented about 2.1 billion shares valued at $50 billion.
The database includes all gifts that are reported to the Securities and Exchange Commission. The researchers excluded samples that weren’t in the Center for Research in Security Prices data service, which tracks stock prices; they also dropped samples that were made by officers and directors of companies. (The researchers analyzed those types of gifts in another study, they say—and also found large amounts of insider giving.)
The timing of insider donations is likely primarily due to the sharing of material nonpublic information by corporate executives, the researchers say. Another big factor is backdating—a misreporting of the true date of the gift—to further increase the tax deduction, they say.
There are several incentives for shareholders to want to donate shares before bad news. In addition to the tax deduction a shareholder receives for a charitable gift, donations of securities are exempt from capital-gains tax.
Individuals who value altruism or obtain reputational benefits from the gift may find that the tax breaks sweeten the deal enough to make a gift, the researchers say. “Insider giving is a potent substitute for insider trading,” they say.
Chances of detection unlikely
It is commonly believed that there’s no law against insider giving, but that’s an overstatement—many state and federal laws constrain manipulative giving. But the laws are less clear and developed than those that restrain insider trading, and the tax code that awards deductions for gifts “appears to be entirely naive to the possibility of manipulative giving,” researchers say.
As a result, the chances of detection and prosecution are much lower for strategic gifts than for sales, they say.
Several bodies of law, including federal insider-trading law, constrain a person’s ability to trade after learning corporate secrets. The laws surrounding giving are ambiguous, however, and enforcement of insider giving “requires plaintiffs or the government to reach for less familiar tools or seize upon less common facts,” researchers say.
In addition, insider gifts, if made near the beginning of a company’s fiscal year, can be reported more than 400 days after they are donated, as opposed to two days for insider trades, they say.
“It seems that no one is paying attention that far out,” says Ms. Schipani.
Some may be inclined to defend insider giving—“after all, it is charity”—but it is not inherently harmless, says Ms. Schipani.
Deductions are available for charitable giving to encourage generous philanthropy, but here society has gotten a bad deal, the researchers say, sometimes granting a large tax deduction for a trivial gift.
The researchers call on regulators to ensure that stock gifts are subject to the same reporting requirements as sales and to extend all prohibitions on insider trading to insider gifts.
“There is reasonable argument” that 10b-5—one of the most important rules promulgated by the Securities and Exchange Commission to target securities fraud—and Regulation Fair Disclosure, an SEC regulation addressing the selective disclosure of information by publicly traded companies and other issuers, already prohibit insider giving.
But “the law should be clear,” the researchers say.
Amending the tax code so that donors who give stocks are required to pay capital-gains tax or so that the valuation for purposes of the tax deduction must be averaged over a period of time would dissuade the illicit timing of gifts, the researchers add.
“The SEC aggressively investigates insider trading in all of its forms under our existing rules,” an SEC spokesperson says. “We also continue to pursue enhancements to our oversight of insider trading and are considering refinement of our rules relating to 10b5-1 plans.” These plans are used by corporate insiders to avoid insider-trading claims when buying or selling their own company’s stock.
Ms. Maxey is a writer in Union City, N.J. She can be reached at firstname.lastname@example.org.
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