For more than thirty years, one of the most prevalent strategies for insider trading has gone undetected and unaddressed. Our research uncovers the techniques by which executives and directors sell overvalued stock worth more than $100 billion per year, shifting losses to ordinary retail investors, without ever running the risk of prosecution or civil litigation.  The technique by which insider do this is to conceal and miscode their suspicious trades by calling them “Other” disposition.  Even though these trades are reported, the “Other” designation is confusing to the investing public, regulators and policy makers.  This allows insiders to evade both detection and prosecution.

Section 16(a) of the Securities Exchange Act of 1934 contains reporting requirements for persons considered “insiders” of public companies. If these insiders acquire or dispose of the company’s shares, they are required to provide timely (two business days) public notice of that transaction. Trade reporting law serves a number of important policies: (i) it discourages insiders from trading on the basis of inside information; (ii) it may discourage other misbehavior apart from insider trading, e.g., market manipulation; (iii) reporting may encourage officers and directors to buy and hold large amounts of their company’s stock—shareholders benefit from manager ownership as it aligns their interests and leads to more efficient pursuit of corporate objectives; and (iv) disclosure sends signals about company quality—when insiders sell their shares, it may hint at pessimism among those with the most knowledge, and v) allow outsiders and regulators to monitor insider compliance.

When insiders report their transactions, they are required to characterize the nature of the transaction using one of thirty-three transaction codes (twenty of which are currently in use). Most trades fit into tidy boxes such as purchase (P) and sale (S). Insiders who disclose a “P” at a low price followed by an “S” at a high price will face scrutiny, because they appear to have purchased and then sold at a profit. Traders who want to avoid scrutiny may prefer to dispose of their shares under code “J.” That designation is reserved for transactions that fit into none of the predetermined templates. Its meaning is “other” in the sense of “none of the above.”

The J-code is properly applied to a grab-bag of peculiar transactions:  Shares acquired or disposed in a stock split or reverse split; Cancelation of shares; spinoffs; some mergers, and some corporate transactions requiring a corporate name change; Securities paid as consideration to redeem a poison pill; The insider had previously acquired exchange-traded call options on the company’s stock, but the options are now gone, because they expired unused;  Shares previously granted to a Grantor Retained Annuity Trust that are returned in substitution for other assets; The execution of an equity swap agreement; Shares received because of the rescission of a transaction. While diverse, these transactions share common features. They are challenging to understand while also posing little opportunity for insiders to profit. So, it is understandable that investigators might decide that a J-coded transaction isn’t worth serious scrutiny.

Yet the lack of scrutiny for J-coded transactions encourages insiders to apply that code to their most suspicious trades.   They may prefer the J Code because the subjective and vague nature of the “other” categorization lends itself both to opacity and plausible deniability. Accordingly, insiders may structure their transactions to arguably warrant J-coding or outright miscode transactions.

In an empirical study, we have examined the information content of J-coded transactions and we found them to be very informative. In other words, the evidence is consistent with insiders using their privileged access to corporate information in order to buy low and sell high – and then concealing the transaction under the cover of an obscure transaction code.

We find that insiders earn more than 8% abnormal profits (net of the market) from their J-coded transaction over the following year.  Top executives’ J-coded trades top everyone else at about 14% abnormal profitability. Profitability also increases with volume of trade reported.  When insiders dispose of more than $100,000 worth of shares, abnormal profitability reaches over 12%.  Another important feature is that most informative trades are reported late.  When insiders report promptly, there is no information content.  Trades with 3-20 days late reporting enjoy 6.7% abnormal profitability.  Trades with more than 20 days late reporting enjoy more than 10% abnormal profitability. Large volume of trades in large firms can increase abnormal profitability to around 30%.

These results are best understood in comparison to the “ordinary” sales on which investigators typically focus. Prior research has found that insider sales typically outperform the market by 4.4%, which is almost half of the outperformance associated with “other” transactions. Even though J-coded transactions are somewhat less frequent than open market sales, they are frequent enough to constitute the plurality of the dollar volume of dispositions. In our 32-year dataset, we observe $3.4 trillion in J-coded sales compared to $3.3 trillion in open-market sales. Consequently, the superior relative performance of J-coded transactions plus larger volume of trades result in relatively larger abnormal dollar profits. Insiders seem to position their largest and most informed trades where they suppose investigators won’t look.

And the insiders are correct in their supposition.  An examination of the public record for evidence that the Department of Justice (the “DOJ”) or SEC has prosecuted insiders for illegal trades undertaken with the J Code turned up no such evidence.  Likewise for civil plaintiffs. J seems to work.

Some uses of J-codes are cagey but probably legal; if an insider sufficiently modifies their transaction, they can sometimes earn a J-code. Other times, the use of the J-code appears to be fraudulent. We can determine this because J-coded transactions require the filer to explain their transaction in prose. Yet some filers neglect to include any explanation and other explanations provided are utterly implausible or illogical. We find that suspicious textual explanations often predict suspiciously profitable trades, and we supplement this finding with anecdotes from specific companies.

In spite of its importance, all studies so far have ignored the information hidden in J-coded transactions.  To get a complete picture, we suggest that studies in the future must include J-codes. From a policy perspective, vigilance is needed.  To discourage informed insider trading, regulators must monitor J-coded trades. Where J-codes are invoked fraudulently, the prosecutors must be vigilant in prosecuting misfiling. Where J-codes are invoked strategically but with some legal basis, the SEC should consider redefining filing parameters to force intelligible disclosures.