"Short-sellers" (traders who sell borrowed securities in anticipation of an impending price drop) have long attracted controversy. They are, arguably, amongst the most-informed investors--these transactions demand a deep understanding of the market and ready access to information about the stock. But short-sellers are sometimes perceived by other traders as relying on information acquired through potentially inappropriate means. For instance, might short-sellers be capitalizing on knowledge about pending large insider sales? Carlson School Assistant Professor Mozaffar Khan scrutinized that potential connection in his recent work.

"We started out trying to get a sense of how these trades (short-selling and insider sales) are correlated," he explains. "Given that insiders are among the most informed sellers, we thought we'd see short selling after insider sales."

The data reveal a very different picture: Many short sales occurred before insider sales were reported to the Securities and Exchange Commission (SEC). "This "front-running" happens when insiders sold a large number of shares--but not when they sold a small number," he says. "This suggests short-sellers received advance information of upcoming large insider sales from parties involved in trade execution."

It also suggests the existence of the sort of activity that carries potential for hefty penalties. While the SEC continues to aggressively prosecute offenders, Khan notes there are no simple solutions to the underlying problem. "On one hand, highly frequent disclosures about short sales--for example, at several points within a day--could help level the playing field and deter some short-selling connected to inappropriately acquired information," he explains. "At the same time, releasing details with such high frequency could potentially destabilize the market and increase volatility, which is not a desired outcome."

"We don't have an answer yet," he adds. "However, our evidence sharpens the focus on the debate."

"Do Short-Sellers Front-Run Insider Sales?" Khan, M., Lu, H., The Accounting Review, (in press)