Do Hedge Funds Exploit Material Nonpublic Information?

Serving on unsecured creditors’ committee (UCC) of a bankrupt firm, hedge funds gain access to material nonpublic information. Although hedge funds are prohibited from trading bankrupt firm’s securities with information access, less is known about whether such information access facilitates hedge funds’ trading in securities of nonbankrupt firms. We show that hedge funds have higher portfolio turnover and make large trades in the few quarters after joining UCC. Hedge funds do not trade differently after accessing public information of bankrupt firms, and other institutional investors do not experience abnormal portfolio turnover after joining UCC. Hedge funds’ large trades concentrate in stocks of nonbankrupt firms that have close economic linkages with the bankrupt firm. Those trades are profitable. The evidence suggests that hedge funds exploit material nonpublic information to trade across asset markets.