Dealing on inside information is illegal in the UK and yet many share prices still move mysteriously sharply upward ahead of a formal announcement that company XYZ is in talks with a bidder who wishes to take them over.  Cue an investigation by the FSA which hardly ever results in charges being laid.  Is the FSA just incompetent or is something else going on.

The answer is a bit of both.  It is very difficult to prove insider dealing and the few people who have been prosecuted thus far are usually not professional market participants but rather the relative of a director who buys ahead of a takeover and then splits the winnings with the director and thereby leaves a very visible paper trail which results in a successful prosecution.  However trying to win a case in the following scenario is far trickier – when asked why he bought call options for his Personal Account in Consolidated Goldfields ahead of them being taken over in 1987, the market professional pointed to the back cover of the Stock Exchange’s 1986 yearbook (which had a full page advert for Cons Gold) and said that was where he got his inspiration to buy Cons Gold from. No chance of proving guilt beyond reasonable doubt.  Hence the market professional makes out like a bandit and so the regulators concentrate on catching the small fry.

There is also a more subtle effect at work.  Namely not dealing whilst in the possession of inside information.  No law is broken because no deal has taken place.  By simply not selling a share which is shortly to be taken over, supply is removed from the market and the lack of sellers leads to a rise in the share price.  This outperformance is then jumped on by momentum players who push the share higher still and the resulting parabolic rally in the share price eventually forces the Takeover Panel to insist the target company makes an official announcement that they are “in talks which may or may not lead to a bid for the company”.  Now finally there is a level playing field and the losers are those who didn’t know and sold ahead of the formal announcement.  C’est la vie - no market is ever going to be perfect.