Insider traders have used exchange traded funds (ETFs) to conceal $2.75 billion of trades, according to a recent paper from academics at the Stockholm School of Economics in Riga and the University of Technology, Sydney.
The paper – Using ETFs to Conceal Insider Trading – showed traders with insider knowledge of upcoming mergers and acquisitions were buying ETFs that include a target company’s shares before the public is aware of the deal.
The academics said they found “significant levels” of such transactions known as shadow trading over their 13-year sample period of all US companies and ETFs.
They were based on observing statistically notable increases in volumes in the five days prior to M&A announcements in 3% to 6% of same-industry ETFs on average.
“These ETFs, which are the most likely to be traded by insiders if shadow trading does occur, have significantly higher levels of abnormal trading than various randomised control samples of other ETFs and other trading days,” Elza Eglite, Dans Staermans, Vinay Patel and Talis Putnins wrote in the study.
The paper noted that such activity amounted to a volume of $212 million per year from 2009 through 2021.
“Our estimates of the amount of shadow trading in ETFs provide a lower bound given that we only examine shadow trading prior to M&As and not prior to other price-sensitive news announcements,” the authors wrote.
The authors argued ETFs are an “attractive instrument” for insider trading for several reasons.
For example, using an ETF containing their chosen stock can be a more “subtle” route than trading shares directly, reducing the chance of being uncovered by law enforcement.
In addition, they noted that ETFs are cost-effective baskets and often more liquid than their underlying, allowing insiders to maximise their profits while benefiting from the impact positive price-sensitive news might have on related companies.
The results showed the trend was most prevalent in the health care, technology, and industrials sectors.
The authors said that shadow trading occurs in 2% to 12% of ETFs within these three sectors.
Although single-stock insider trading has become easier to spot, the report said that trading related securities is more difficult. This is because market participants have become more at avoiding regulators’ scrutiny.
As a result, they added, “Our paper suggests law enforcement agencies should also investigate trading in other related securities such as ETFs.”
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