Impact of Regulatory Enforcement on Leakages Prior to Analyst Recommendations

Date01 August 2014
Published date01 August 2014
The Financial Review 49 (2014) 565–592
Impact of Regulatory Enforcement
on Leakages Prior to Analyst
Jeff Madura
Florida Atlantic University
Arjan Premti
University of Wisconsin, Whitewater
The financial press suggests that information is commonly leaked prior to analyst recom-
mendations. We examine the impact that three regulatoryactions (Regulation Fair Disclosure,
Global Analysts Research Settlement, and the legal case against Galleon Group) have on in-
formation leakage prior to analyst recommendations. We find that all three regulatory actions
have significantly reduced the leakage of information prior to analyst recommendations, even
after controlling for several characteristics that explain the variation in information leakage.
Our results are robust when applying an alternative method of measuring information leakage,
and when forming various samples of analyst recommendations based on different criteria.
Keywords: analyst recommendations, informed trading, insider trading, information leakage
JEL Classifications: G14, G24, G34
Corresponding author: Department of Finance, College of Business, Florida Atlantic University, Boca
Raton, FL 33431; Phone: (561) 866-1892; Fax: (561) 297-2956; E-mail:
Wethank B onnieVan Ness (FR Editor), an anonymous reviewer of FR, and Kevin Brady for their helpful
C2014 The Eastern Finance Association 565
566 J. Madura and A. Premti/The Financial Review 49 (2014) 565–592
1. Introduction
Analysts are commonly perceived to have advantages in valuing stocks, which
may be attributed to their unique skills, or to their unique access to information.
In fact, there is strong evidence that some analyst stock recommendations elicit an
immediate movement in the corresponding stock’s price (Womack, 1996). Conse-
quently, informed traders desire to obtain the private information of analysts before
their recommendations are publicized. To the extent that some analysts, or their
respective research departments, or their respective brokeragesubsidiaries rely on in-
vestors for their business, they may have adverseincentives to leak information prior
to the public announcement of stock recommendations (see Juergens and Lindsey,
2009; Christophe, Ferri and Hsieh, 2010; Niehaus and Zhang, 2010).
Although laws are established to preventthe use of inside information, numerous
reports from financial media continue to suggest that an analyst’s privateinformation
is commonly leaked to investors prior to analyst recommendations.1In a recent
case reported by the Wall Street Journal, the Securities and Exchange Commission
(SEC) charged a large investment banking firm for its weekly “huddles” between
its analysts and traders, and claimed that the investment bank had not established a
structure to prevent leakages of material information from analysts to traders before
the information was publicized.2
A recent New York Times article summarizes the claim of an ex-analyst that
information is commonly leaked within an investment bank prior to analyst recom-
mendations. The article suggests that leaks about stocks being analyzed flow from
the analyst research department to the proprietary trading desk, which take positions
in the stocks prior to the public disclosure of the analyst stock recommendations. In
addition, the article suggests that sales people of the investment bank tipped specific
hedge fund clients before the analyst recommendations are publicized.3Thesamear-
ticle states that according to some Wall Street professionals, “insider trading can and
does occur at many firms...ithasbeen institutionalized ...[andthat]theflowofin-
formation between a firm’s analysts, its traders, and its clients—a lucrativeheads-up
on stock upgrades and downgrades for instance—can bolster trading profits, broker
commissions, and Wall Street paydays.”
Another recent New York Times article reinforces the point: “They are sup-
posed to be among Wall Street’s most closely guarded secrets: changes in research
analysts’ views, up or down, of a company’s prospects. But some of the nation’s
biggest brokerage firms appear to be giving a handful of top hedge funds an early
1For example, see

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