DAVID GREENE, HOST:
Government regulators at the Securities and Exchange Commission have recently made a big push to fight insider trading. This is the practice where people profit from illegal tips about internal news at a company. NPR's Shankar Vedantam joins us regularly to share interesting new social science research and he tells us he's heard about an unusual way to spot insider trading. Shankar, thanks for coming back to the program.
SHANKAR VEDANTAM, BYLINE: Happy to be here, David.
GREENE: OK. So what is this new technique? I understand it involves some travel to Finland.
VEDANTAM: That's right. So it's an analysis of trades made by a half a million investors in Finland over a 15-year period. Now, why Finland? Apparently, Finland offers researchers unusual amounts of access to information about who's making trades on the stock market.
I spoke with Paul Koch. He's a professor of finance at the University of Kansas. And along with Henk Berkman at Auckland University and Joakim Westerholm at the University of Sydney, they have a new study coming out in the Journal of Finance.
What they did was really simple. They divided these investors in Finland into groups: older adults, younger adults and even looked at accounts that belongs to children - obviously these recounts being managed by their guardians.
VEDANTAM: Then they looked in which a set of accounts had the best stock market returns. And guess what they found? The accounts belonging to the youngest investors, the babies, blew everyone else out of the water.
PAUL KOCH: We were very surprised when we first found this evidence. Again, we were not looking for the result we found. The group from age zero to 10 seemed to outperform all the others.
GREENE: OK, hang on a second. We have kids who are age zero to 10 who are having the best returns. I assume it's not that they're just making really good investment choices compared to adults.
VEDANTAM: You know, one possibility is that all these kids are from Lake Woebegone, where we know the children above average.
GREENE: That's right, exactly.
VEDANTAM: But failing that explanation, it's the guardians of these kids who are obviously making these calls. And so, the researchers looked at what happened right before big company announcements, like mergers and takeovers announcements. And typically, there're huge stock swings, you know, right after a takeover announcement. What they found is that adult investors were right about 50 percent of the time right before a big takeover announcement, which is what you'd expect just by chance.
VEDANTAM: The kids' accounts were right 72 percent of the time. And that translated into a profit of 15 percent. And that's not 15 percent per year. It's 15 percent per day.
GREENE: A lot of money.
VEDANTAM: A lot of money. And the researchers then didn't stop there. They drilled down, they looked at the accounts that the guardians were running in their own adult accounts. And what they found is that when the guardians were operating their own adult accounts, the returns were not nearly as good as when they were running their children's accounts.
Koch told me this was a really big, bright red flag.
KOCH: Guardians are willing to trade on behalf of their children to earn these extraordinary returns. But they're reticent to trade through their account. One reason would be a fear of getting caught breaking an insider trading law.
GREENE: One reason, indeed. I mean I'm trying to follow the detective work here. But if you have kids who are making a lot more money, more successful trades, who are aged like two or three, you're starting to get suspicious that these guys are using their kids to make these insider trades.
VEDANTAM: Right, exactly. Now, Koch is a fisherman so he gave me a fishing analogy.
VEDANTAM: He says that the Securities and Exchange Commission essentially has access to the kind of information that he was able to get on investors in Finland.
GREENE: We have as much information here as you do in Finland about these...
VEDANTAM: The SEC has access to that kind of information in the United States. Now, the challenge with going after insider trading is you often don't know where to look. And Koch says this technique can tell regulators where they can catch some fish.
KOCH: I found that the people who I know who are the best fishermen go where the fish are. And the regulators have their own fishing expedition. We would suggest that the age of the accountholder might point to a better place to catch some fish.
VEDANTAM: Now, one thing I should point out, David, is that people may think typically the SEC goes after the really big fish - they don't go after the minnows. And people may think that the guardians operating these baby accounts in Finland, you know, they're probably small investors. One of the interesting things that Koch finds is that it's the wealthiest investors in Finland, who are the most likely to be channeling these trades through the accounts of children.
GREENE: Interesting and I can just imagine these arguments in court, where investors are saying, Hey, Your Honor, no, no, no, no, no. My kids are just really smart - they're prodigies - that's why this happened.
VEDANTAM: It's only a question of time, David.
GREENE: I'm sure it is. Anyway, thanks so much, Shankar.
VEDANTAM: Thanks, David.
GREENE: Shankar Vedantam, he regularly joins us to talk about interesting social science research. You can follow him on Twitter @hiddenbrain. While you're at it, follow this program @nprinskeep, @nprgreene and @morningedition.
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