The Wharton researchers, in a detailed parsing of four years of insider trading at 15 of Wall Street's largest brokerages, find that market makers executing insider trades at these firms appear to act on information gleaned from those trades.They also find that the pattern becomes far less pronounced following the passage of Reg .FD.
The evidence can be seen in the more aggressive prices they set for the company's stock following an insider trade. Put another way, compared to their peers, market makers affiliated with the brokers used by insiders post more aggressive ask quotes during periods when insiders trade. The study was undertaken using information from trades made between March 1999 and November 2003.
"Academics and, to some degree, those who trade in the market, might assume that market makers are there simply to take the other sides of trades and provide liquidity, whereas it looks as though they may have, and may act on, information," says Géczy. "What we found is that there is a leakage somewhere along the lines in the information transmission channel between the investor -- in this case, company insiders -- and ultimate trades, and the way information is transmitted into the market in the form of buy or sell orders."
It's worth a read - the study has a lot of implications both for the models we use to describe market-making behavior, and for regulators of financial markets. Plus, it's thorough and well written.
Read the article describing the study in Knowledge at Wharton here, and you can get the actual study on SSRN here.