Executives prove best insider dealers

Serious Money: There is a cottage industry in tracking activity of directors/managers who buy or sell company stock

Insider trading is usually thought of as illegal. In most cases this is perfectly true. The sort of trading that can land you in jail - depending on the jurisdiction where you commit the crime - is almost always of the insider type.

Lawmakers everywhere try to have precise definitions of what constitutes an illegal trade: the term "insider" gives us a clue about what is considered unlawful. In its broadest sense, it means anyone with access to price-sensitive information not widely available to the market. So if you know something that the market doesn't, and that something will move the share price once the market finds out, you can be jailed if you buy or sell shares while in exclusive possession of that knowledge.

Clearly, this is pretty broad, and you can see how lawyers could tie themselves up in knots trying to decide what constitutes price sensitivity, exclusivity etc. In principle, anyone who knows anything about a company could be considered to have price-sensitive information. What, after all, is the point of all that stockbroker research if it is not supposed to be about price-sensitive information?

Legislators say that stockbroker tips are perfectly legal, provided no one investor is given preferential access to them. This, however, misses the point. If there is any value to be had from stockbroker research (and a lot of people have poured cold water on that idea), it is when an investor is able to profit from it. By definition, if the market is given this research at the same time, nobody will ever be willing to pay for it - hence its value will be zero.

This explains, perhaps, why everybody moans about the quality of stockbroker research. Furthermore, it accounts for regulatory and compliance costs which are becoming such a major source of concern for many within the business.

Perhaps the value is to be had in stockbroker opinions. They come from within, rather than from insider knowledge of facts not accessible to anybody else. A grey area exists, however, between knowledge and opinion.

The ultimate insider is to be found, obviously, inside companies. If anyone has knowledge of how a business is performing, it is an employee of a company, particularly its managers and directors.

It could be argued that anyone dealing in the shares of the company in which they work must be a form of insider - they must know something. So the rules governing the trading of shares by employees are very tight indeed. However, company insiders can, from time to time, buy and sell their company's stock. This form of insider trading, provided it is kept within the rules, is legal.

Some market participants think there can be no such thing as a neutral insider. It is believed, therefore, that there is information to be had from observing the share dealings of company insiders.

Different countries operate different disclosure requirements but most countries demand that when a director or senior manager engages in buying or selling, that activity is immediately (or quickly) disclosed to the market place.

The practice is not widespread, but there is a cottage industry in tracking such insider dealing and drawing investment inferences from the activity of directors who buy or sell their stock.

Whether share trading activities of corporate insiders is any more revealing than activities of ordinary investors has long been a hot topic of debate. A recent US academic paper by James Hsieh, Lilian Ng and Qinghai Wang reveals a curious asymmetry: insiders should be followed - and stockbroker recommendations ignored - when you see them buying their own stock. But corporate insiders who sell their own shares do not fare any better than the sell recommendations of stockbroker analysts.

So when you see, say, Bank of Ireland executives buying shares in their own bank, you should do likewise. But when they cash in, there is little point in following them.

Almost always, the best and most easily accessible information on insider dealing is to be found in the US. In fact, this kind of information can be had for free. The finance section of Yahoo.com, for example, has a tab called "insider dealing", which provides a lot of information on US companies.

The information is to be had in other markets, but you often have to dig a little harder - or pay someone to do the digging. For example, anyone lucky to have full access to Bloomberg technology will often be able to see insider information neatly graphed at the click of a button.

According to Bloomberg, there have been six significant insider trades in AIB over the past six months (a period of generally buoyant conditions for AIB shares) and they have all been net purchases. There has been one notable insider transaction in C&C, which took place over €1 below the current share price. Eircom has seen insider buying at about €1.65 and quite a lot in the range €1.80 - €1.90.

According to the professors, all of this should be taken quite bullishly for the stocks concerned.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.