The Threat of Insider Giving

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Scholars advocate greater regulation of manipulative stock donations.

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Not all gifts are good. When shareholders manipulate the timing of their charitable stock donations, they can personally benefit at the expense of others. But is this problem widespread and harmful enough to merit regulation?

The answer is “yes,” according to a recent article by Süreyya Burcu Avci of Sabanci University and her coauthors. Describing manipulative stock gifts as “insider giving,” Avci and her coauthors report new empirical evidence that insider giving is widespread and imposes social costs. To curb this problem, the authors propose regulatory reforms in securities and tax policy.

According to Avci and her coauthors, a lax regulatory environment has increased the prevalence of manipulative gifts that contravene several policy goals. Although many state and federal laws regulate manipulative gifts, insider giving faces far less regulation than insider trading. For example, there are more lenient reporting deadlines for insider gifts than for insider sales.

In addition, although state laws restricting disclosures to select shareholders apply to insider giving, the boundaries of state disclosure laws remain unclear. Avci and her coauthors also highlight the uncertain extent to which federal statutes and rules aimed at insider trading may restrict insider giving.

With little regulation, manipulative stock gifts can create profit for donors because stock donations are not subject to capital gains tax. This often makes individuals better off directly donating stocks rather than selling them and then donating the proceeds. In addition, individuals make tax deductions based on the stock’s trading price on the day of the donation, which can overestimate fair market value. Donors may also choose to give rather than sell securities when selling could be illegal or attract unfavorable attention.

In these ways, gifting stocks can actually generate profits. For example, suppose a stockholder knows that a stock’s value is about to fall dramatically. Selling the stock before the drop could lead to criminal charges for insider trading and negative publicity. Donating the stock while its price remains high, however, would result in a large charitable tax deduction that could make the individual better off than waiting to sell.

At first glance, manipulative gifts may seem harmless since they benefit charities. Avci and her coauthors, however, dispute this intuition. Although such gifts make charities better off, allowing insider giving can undermine other policy goals. First, because shareholders receive tax benefits for stock donations, they can manipulate timing to receive large tax deductions for trivial gifts, thus undermining revenue collection. Second, insider giving allows insiders to misuse connections to profit personally, making the market more dangerous for non-insiders.

Besides donating stock at strategic times, individuals can also advance their personal interests by using connections to alter the timing of disclosures in relation to gifts. This occurs when a gift date has been set, such as with a pledged commitment, and the donor informs executives about the preferable timing of announcements.

Furthermore, individuals might alter a recorded gift date to maximize tax benefits. After a stock price has dropped, a donor may decide retroactively that the gift actually occurred on an earlier date, when the stock was worth much more. To do so, the donor simply enters the wrong date for the gift on the form filed with the U.S. Securities and Exchange Commission (SEC).

Through these strategies, donors can net more money with a manipulative gift than an honest sale, according to Avci and her coauthors.

To assess the prevalence of insider giving, Avci and her coauthors rely on a comprehensive database of all gifts of common stock by large shareholders in publicly listed U.S. firms between 1986 and 2000. Large shareholders tend to abuse gifts far more often than sales, with ample evidence that gifted stocks reflect suspiciously apt timing. The maximum stock price closely follows the timing of the gift, with stock prices rising 3 percent abnormally in the year before the gift date and falling 8 percent abnormally following the gift date.

What explains these well-timed gifts? Luck seems like a far-fetched answer, according to Avci and her coauthors. Similarly, the authors reject the theory that large shareholders better predict the future, since other literature shows that large shareholders’ trades tend to merely reflect information available to the public. Instead, only large shareholders who contribute large gifts make abnormally well-timed decisions.

Manipulation provides the most compelling explanation, conclude Avci and her coauthors. Their analysis suggests that large, gift-giving shareholders are much better connected to firm executives than non-gift-giving shareholders.

Avci and her coauthors point out that stock prices tend not to decrease much between the gift and reporting date, indicating that backdating is not the primary manipulative strategy. Instead, gift-giving shareholders appear to have access to executives, allowing them to use manipulative strategies based on better information.

Challenging the SEC’s claim that gifts are less likely to be abused than sales, Avci and her coauthors recommend several policy reforms. First, they advocate reforming securities law to equate gifts and sales. Second, they propose equating cash and stock in the tax code to eliminate the tax incentive to donate stock. Finally, they suggest requiring charities to immediately liquidate stock gifts, ensuring that an individual who deducts a certain amount has actually enriched a charity by that amount. Avci and her coauthors, however, acknowledge that charities would likely need some leeway to sell shares in an orderly fashion.

Ultimately, emphasizing the prevalence and social costs of insider giving, Avci and her coauthors say the problem “cries out for a solution.”