Stocktake: ETFs are being used to conceal insider trading

British billionaire and Tottenham Hotspur owner Joe Lewis is in the news after being accused by US prosecutors of “brazen” insider trading.

While Lewis is innocent until proven guilty, in general terms the problem with “brazen” insider trading is that it’s easily spotted, which is why insiders may be increasingly resorting to a more discreet vehicle – exchange-traded funds (ETFs).

A recent study, Using ETFs to Conceal Insider Trading, notes some company insiders are engaging in shadow trading – that is, trading in ETFs containing their target stock, as opposed to buying the underlying company shares.

The authors found “significant” levels of shadow trading in up to 6 per cent of same-industry ETFs before M&A (merger and acquisitions) announcements.

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They estimate that there has been at least $2.75 billion in such insider trading between 2009 and 2021, particularly in the healthcare and technology sectors.

The strategy makes sense. It’s increasingly easy these days to find ETFs covering niche sectors. Far from being diversified, such ETFs may be dominated by a handful of stocks.

Of course, insiders would make bigger profits by directly buying their target stock, but that carries an obvious prosecution risk. Regulators must wake up to the threat. ETFs “are not purely passive investment vehicles”, the authors caution; they “also play a role in insider trading strategies”.