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I'd like to welcome Daniel Taylor to knowledge at Wharton he's a professor of
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accounting here and he's written a very interesting paper on the connection between political connections and and
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insider trading during or just after the financial crisis and during the period where tarp was under consideration and
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tarp is the Troubled Asset Relief Program that's right and so I'm going to
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let you give us a short summary first and then we'll get into more specific questions about what your paper is about
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what it found okay so what we what we did in the paper is we look at the trading of corporate insiders so by
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corporate insiders we mean officers and directors of publicly traded corporations all of these individuals
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have to file what's known as form fours with the SEC in the public record that
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discloses their trades in their firms shares or their firm stock so there are allowed to trade in their firm shares
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they file that information with the SEC so what we did is we gathered all of the
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information that's out there on these on these form fours on their their trading
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and we looked at the trading before the financial crisis during the financial crisis and after the financial crisis so
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this is the trading of executives and directors in their own firm and we look specifically at financial institutions
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and so one of the big questions that comes out of the financial crisis that's
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interested you know and Wall Street and on Main Street is did anyone know you know did anyone see the crisis coming
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and so we initially started the project by looking at okay can we see whether insiders corporate insiders officers and
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directors traded in advance of the crisis so did banks that did poorly during the crisis to their executive
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sell shares before you know the crisis hit and then we looked at the trading during the crisis so around the bank
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bailouts the tarp monies that you alluded to and then sort of after the crisis what what what did it stabilized
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and we found that there was there didn't seem to really be any evidence of trading before the crisis
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there was no evidence that insiders traded in anticipation of the crisis but we did seem to find some evidence that
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insiders traded during the crisis in the period in which the tarp funds were dispersed and then we investigate that a
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little bit more and what we find is interestingly enough that it's only the insiders that had political connections
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and by political connections I mean connected to a bank regulatory agency or the current House or Senate at the time
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so we looked at bank boards who had a director or officer who had work experience current or past at a bank
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regulatory agency the senator the house and we found that the boards of those banks that had those political
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connections traded more heavily during the financial crisis their trades had higher predictive ability of outcomes
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during the financial crisis so they predict for example the market reaction and the amount of the bailout that the
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bank would receive so we basically find that during the crisis there is some trading and anticipation of a bank of
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bank bailouts and then after the crisis of course we sort of things go back to normal and we don't really find that the
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day that those trades or those individuals trades have any more information than otherwise so this would
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seem to be the definition of insider trading on the face of it so I wanted to just point out because I think it's very
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interesting that this study had a very large sample right looked at 7300 corporate officers is that right just
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fit across 497 publicly traded tarp eligible institution so this Greta says this was a very wide net work that you
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cast right I mean one way to think about this paper is to think about it as using
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big data and computer algorithms to sift through public information on the trades
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of officers and directors and to see which trades of the officers and directors are correlated with future
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outcomes and so we would say it trade is correlated with the future outcome if it has a high predictive
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ability it's more likely that that trade might have been based on on on information about that future outcome
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but I do want to i do want to clarify that you know in the popular press and legal scholars they use the term insider
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trading they're thinking of illegal insider trading when we use the term insider trading we're thinking of the
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trading by officers and directors so we say insider trading we mean trading by corporate insiders and there's two types
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the first type is the legal trading so this is they can you know the the board the CEO can trade in his shares you know
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just like anyone else can with proper disclosure with proper disclosure you know as long as they do not have any
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private information the illegal kind is when they have private information that they have not disclosed to shareholders
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so this would this sort of relates back to a set of rules called discloser abstain so if you're a CEO or a manager
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and you have private information it's your duty to either disclose to shareholders or abstain from trading and
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so in this setting it's a little bit more murky because when we're looking at
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political connections and connections to bank regulators you know it's not really
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clear how the manager would disclose any information that they would have gotten
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from their connections so for example because it's not definite information right so you know that's something looks
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someone is telling a bank insider it looks likely let this is going to happen so legally he can't he doesn't really
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have an obligation to disclose something that's not really certain is that right
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that's correct that's correct and so I think you know there's been a spate of
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recent insider trading cases that have gone on that the government is prosecuted and you know out of those
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insider trading cases the definition of illegal insider trading has become more murky slippery yes more slippery and so
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I you know I don't think it would be wrong to suggest that this paper has sort of a smoking gun okay what we're
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doing is we're reporting correlations when as you mentioned a large sample and
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casting sort of a suspicious I in the direction of insiders that have political connections I mean if you if you go back
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to all of the books and the popular press during the period you know the bailouts were effectively decided in you
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know backroom meetings with sort of insiders there's a great book you know too big to fail yes by Sorkin it's sort
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of details sort of all of these you know his interviews with people and so a natural question is is well you know if
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if the bailouts being decided in private and in consultation with you know bankers or you know Treasury officials
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or government officials how does that information sort of leak out so this I think that it's also interesting to note
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that this was not the result you were expecting when you started out on this path could you just talk about that
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briefly right this surprised you yes but is all surprised yes absolutely and frankly we're still kind of stunned at
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the at the results and so when we started the project several years ago you know as I mentioned it was sort of
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like a big data study you know we sat down the co-authors and I and you know talked about you know okay does this you
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know this would be interesting does it make sense because there's all of this
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concern about did they anticipate the crisis so we began the paper thinking okay we would shed some evidence on
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whether they anticipated the crisis or not and so five years ago that would have been sort of a very timely you know
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finding they did anticipate the crisis or they didn't anticipate the crisis but
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it took us a little longer than we expected to gather the data and to do the analysis but the analysis was you
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know a couple months of you know you know coding and get gathering data and and so when we started doing the
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analysis and we realized okay we're probably after the crisis let's add some
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more data let's add the post-crisis the bailout period data let's add you know
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the data from you know 2010-2011 into it and run the analysis we kind of we found
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somewhat surprisingly that there was this you know blip for lack of a better term in the correlation between insider
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trades and future performance during the what we call the bailout period and that's the
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from when tarp began dispersed in october through june and so when we saw the blip the next question is okay where
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is the blip coming from why is the blip there and so then we found that the blip
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only occurred in banks that actually received tarpon money okay so then we could you know think about like a you
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know an investigative journalist dig deeper okay so now the blip is only in those banks that receives tarp money ok
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so then dig deeper look at the connections of the individuals or of the bank okay well now the blip is not only
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and banks that receives tarp money it is also only within that set also those that received tarp money and had ties to
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former or current bank regulatory bank regulatory agencies like the Fed the Treasury the office of the comptroller
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of the currency the FDIC and so that's when we said you know like wait you'll
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wait a second you know is this actually you know what were is is this actually where the blip is and so you know we're
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my co-authors and I are actually pretty suspicious and skeptical people by nature so in terms of data analysis we
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threw everything we could add it to make it go away and so I I wouldn't be here
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if it went away and so this isn't a case where you know we're trying to you know
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can some suspicion on something that may or may not go away I mean this is a very
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very robust result i also want to mention that the data on political connections it was not like we collected
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this data or that we generated this data everything in the paper is generated from public available information so
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it's perfectly conceivable that somebody could go out there and you know investigate it themselves the data on
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political connections right where to get data on political connections well in the bios of directors and officers in
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the annual reports they list what their current and former work experience was so everything that's that's in the paper
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sort of out there in the public domain so you aren't using any insider information no we were not using it off
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what are some of the practical implications of these findings so I think I mean it's really interesting you
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pointed out that the alleged criminality of all this is is questionable because the information they had wasn't
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necessarily actionable in the way that they had to disclose it but if someone was whispering in their ear and it was
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good information you know it seems a little bit it seems sleazy right I have to put it mildly right so what what
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practical implications could come from this I mean for example I mean this speaks to the damage that can be done
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with the revolving door of government officials you know having come from industry and then going right back into
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industry perhaps without a you know a proper amount of gap in time but I'll leave it to you what what are some of
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the practical I mean I think that there are probably I would say two main practical practical implications the
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first is we need to give some more thought to what exactly constitutes illegal insider trading I think right
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now in light of recent court cases there's a big gray area out there and I think a lot of people would be surprised
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at how gray the area actually is so you need a smoking gun to be able to prove an insider trading case and it's very
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hard to get that smoking gun you have to get the tipster the tipster has to confess you know there has to be a
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series of dots that you can that you can collect a tipster who may have benefited
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some way from this to begin with it's it's it's difficult to do that using a
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large sample with correlations but this suggests areas where you know people may
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want to shine a light so think about is this this insider trading is a dark room
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we're shining a light you know it's not entirely illuminated but you know we've
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got a good area where you know people should look the second one is like you mentioned the revolving door there are a
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series of studies in the academic literature on political connections and specifically political connections of
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financials solutions so for example there's a recent study in the journal of financial
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economics and they found that this was before Tim Geithner was was made Treasury secretary that when he was
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announced to be the Treasury secretary the banks that had connections to him either on the board seats or what not
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experienced old massive increases in shareholder value so what this is saying is is that the market is aware that
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there is this connection between bank regulators and the banks at which they are regulating so for example many
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people are surprised when I when I say go to the go to the Federal Reserve's
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website you know you can even look during the crisis Lehman Brothers CEO was you know one of the board of
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directors of the Federal Reserve you know Jamie Dimon was on that was on that board at all first calls himself correct
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was heading that backroom deal right that you alluded to earlier so you've got this marriage is too strong of a
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word but you have these very strong connections between the regulators and the people that they are regulating now
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that's good and bad on the one hand you want somebody knowledgeable about the
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industry and how banks worked to regulate banks but where it you know where it becomes questionable is are
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their conflicts of interest and sort of our paper suggests that yes there are conflicts of interest and these
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conflicts of interest are potentially pervasive and I don't think that's
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really been given enough sort of you no consideration out there is that you know
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there's a good side to having a banker regulate the banks and there's also uh
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you know there's also a bad side did you attempt to quantify any of this like how
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much some folks may have benefited well so the benefits are tricky because what we're looking at is what we call
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opportunity profits so when an individual trades if their share price goes up let's say six percent over the
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next same month then that means that they've earned a six percent return on their on their money if they sell but we
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don't we can't match buys and sells so we can't actually compute a measure of
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realized profit all we can say is well you bought this month stock price went up six percent right that's six percent
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more than you would have made right if you had waited a month usually better when it goes up yes no that's right and
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so in this case we look at the trades in advance of the tarp infusion so we know
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the date of the tarp infusions we know the date of the trade and so we look at the trades and surprisingly we find a
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significant amount of trades both both in volume and dollars clustered 30 days before the bank actually receives a tarp
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infusion now I have done some some work on insider trading policies in my prior research what was surprising to us is
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that most companies have something known as trading blackout windows in a trading
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blackout window is imposed by the company in the code of ethics on the officers and directors and it says you
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shall not trade n days typically 20 30 40 days in advance of a material event so for example for an earnings
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announcement that firms make on a quarterly basis insiders are prevented from trading you know several days in
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advance of that earnings announcement in this case if there was a blackout window
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applied to the tarp infusion those trades should not have existed so what this suggests is is that either the
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event the tarp infusion was unanticipated so a blackout window could not apply or that they sort of skirted
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the their firms no blackout windows just one final thing I just wanted to focus on the no smoking gun comment that you
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made at the outset so this is seems like pretty clear evidence that there was insider trading to me as I create it
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very strong evidence and yet this isn't pointing to any individuals or necessarily I mean you were sort of
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doing this globally and the information that you have while interesting isn't
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the kind of information that someone takes the court it's the kind of information that
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together would use to say here are the most interesting places to look if I were going to try to find a wrongdoer
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right so I guess I would think about this as sort of as an academic paper on the costs and benefits to political
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connections so most of the academic literature has focused on the benefits that the shareholders in the firm
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receives from having political connections on the board right so it may very well be that you know you like as a
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shareholder in the firm you want your bank to be politically connected because you're more likely to get bailed out you
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know you're more likely to get special favors and so most of the academic literature suggests this is a good thing
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for shareholders you know not necessarily for the government for the public but for a narrow set of
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shareholders what we're coming along and saying in the you know sort of the a
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Couture the academic debate is there is also a cost what is the cost well the cost is if you have these political
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connections and during the crisis they may engage in some flack riveter term shady trading that shady trading comes
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at a cost to shareholders so who loses out from the you know the insider trading if the executives traded at with
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private information its other shareholders who potentially are on the other side of that trade and they lose
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out so this is really about sort of in if you think about academics is okay political connections have a have a
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benefit to the firm and we're documenting one cost which is sort of extracting rents will be say is rent
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extraction and also the potential cost or the risk of being exposed and what that could do right to the bank's stock
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right no so i don't i don't want there to be you know to one shouldn't ascribe
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any sort of policy agenda or anything like that to the paper or two to the findings we're just basically saying
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look there's this cost of of political connections and you know and by the way
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this is this is not a trivial cost this seems to be a big deal especially in light of all of the debate about tarp
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how the bailout monies were doled out the decisions about how of those things were
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were given out and so hopefully something like this doesn't you know doesn't happen again but it does suggest
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that you know these conflicts of interests do have real costs for for the bank shareholders even if the bank gets
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bailed out you know the the managers or the officers and directors may have traded you know in private information
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advance of that actual any idea of how many people were involved in that potential violation well its potential
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violation it's difficult because it's hard to say whether anything was actually sort of whether you know I
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can't go or it since everything's based on correlations I can't go around and
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say uuuuu this from that from this firm all I can say is the set of firms and the set of individuals where the
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correlation is particularly high now those trades may have been conducted entirely legally you know within sort of
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the per views of the existing and set of trading rules and by chance there was a
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very high correlation but the fact that we find that you know these correlation so pervasive as you mentioned and
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specifically focused within those that are politically connected suggest that there is you know it's not just one or
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two or three individuals they would not be able to drive a result on 73,000 insiders or 7300 excuse me 7300 insiders
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but you know it's so it's sufficiently pervasive that you know it's able to
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generate a large sample result thanks for coming in today oh my did it my pleasure
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you