Study Reveals Insiders Use ETFs To Conceal Trading Ahead Of M&A Announcements

A new study published on the Social Science Research Network (SSRN) reveals that exchange-traded funds (ETFs) are a “new form” of insider trading for those in the ‘know’ about upcoming merger and acquisition deals. The reason is that the ETF conceals their trading and is harder to track because the fund owns a basket of other stocks. Insiders, who trade on non-public information, are pivoting from single stock bets ahead of announcements because securities agencies can easily flag trading activity. 

The paper is titled “Using ETFs to Conceal Insider Trading” and explains:

Our evidence suggests that some traders in possession of material non-public information about upcoming M&A announcements trade in ETFs that contain the target stock, rather than trading the underlying company shares, thereby concealing their insider trading. 

Researchers described several reasons insiders gravitate toward ETFs:  

• First, the stock that is the subject of the information may be a constituent of the ETF, so that one can get a direct exposure to the company’s share price via the ETF, but in a vehicle that is more subtle than trading the company shares directly, helping reduce scrutiny from law enforcement.

• Second, ETFs are cost-effective and often more liquid than the underlying company shares, potentially reducing the price impact of insider trades. Both theoretical and empirical evidence shows that insiders trade in highly liquid assets so that they can hide their information and maximize their trading profits.

• Third, shadow trading in ETFs prior to price-sensitive news allows insiders to benefit from increases in the price of both the source firm and related firms.

Using 13 years of data (2009-21) of all US-listed companies and ETFs, researchers found “significant levels” of transactions known as shadow trading or insider trading. Their results were derived from analyzing sizeable volume increases in the five days before M&A announcements in 3% to 6% of industry ETFs. 

“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 randomized control samples of other ETFs and other trading days. We eliminate M&A events that are preceded by rumors to ensure that the analysis is not picking up general information leakage,” Elza Eglite, Dans Staermans, Vinay Patel, and Talis Putnins wrote in the study. The paper is from academics at the Stockholm School of Economics in Riga and the University of Technology, Sydney. 

The amount of insider trading they identified was about $2.75 billion during the researcher’s same period or about $212 million per year. 

“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,” they said. 

This study shows that some insiders conceal their trades in ETFs instead of single stocks.