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Inside Job: SEC Employees 'Systematically Dodge the Revelation of Bad News' for Their Stocks

8:01 AM, Feb 28, 2014 • By DANIEL HALPER
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Securities and Exchange Commission (SEC) employees aren't necessarily better at investing in stocks than everyone else, but they are much better at getting out of bad investments before the "bad news" hits. That's according to a new paper by Shivaram Rajgopal and Roger M. White, called, "Stock Picking Skills of SEC Employees."

"The decomposition of returns earned by SEC employees suggests that the abnormal returns are earned in the sell portfolio. In particular, the 12 month ahead (252 trading days) abnormal returns, using the four factor Fama-French model as the model of expected returns, of U.S. common stocks that SEC employees buy (sell) is 0.56% (-7.97%). Hence, SEC employees’ stock purchases look no different from those of uninformed individual investors ... but their sales appear to systematically dodge the revelation of bad news in the future. This fact pattern is consistent with the greater informational advantage related to potential enforcement activities that employees of a regulator are likely to enjoy over other market participants," the authors of the study write.

Bloomberg's Matt Levine is suspicious but cautious. "Statistical anomalies are, perhaps, the lowest form of evidence, but they are evidence, and this is some evidence that the Securities and Exchange Commission's employees are making use of their inside information to trade stocks," reads a Bloomberg article on the study.

And Levine wonders why SEC employees are even trading individual stocks:

"I guess a bigger question, though, is why are so many SEC employees trading stocks in the first place? The authors' sample, which runs from August 2009 through December 2011, consists of 29,081 transactions, of which 4,806 are trades in individual stocks (with a dollar value of $41 million) and 1,221 are in exchange traded funds ($15.7 million). Most of the rest of the trades appear to be in mutual funds, though the dollar amounts there are not clear. That's for a bit under 4,000 employees, so while it's not exactly frenzied day-trading, it's a meaningful amount of single-stock trading.

"Individual stock ownership obviously creates the possibility of corruption, or the appearance of corruption, at least one of which seems to be represented by this paper. The SEC has policies requiring trade pre-approval and barring trades in stocks under investigation, but those policies are sometimes evaded, and presumably the SEC gets usable information even on companies that don't quite rise to the level of a formal investigation."

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