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August 27, 2006

Insider Trading Rampant in Merger Wave

posted by MR WAVETHEORY at 8/27/2006 12:34:00 AM
When there is money to be made, traders can get greedy. The NY Times is reporting that 41% of mergers in the last 12 months may have been tainted by insider trading. The NY Times commissioned a study which scrutinized mergers with a value of $1 billion or more that were announced in the 12-month period that ended in early July. The factors that the study examined included:

1) Price
2) Number of shares traded
3) Number of individual trades

in each stock in the weeks leading up to the merger. The study concluded:

Of the 90 big mergers in the period, shares of 37 target companies exhibited abnormal trading in the days and weeks before the deals were disclosed.

Which companies were subject to insider trading?
The study concluded that several companies were subject to insider trading.

1) Amegy Bancorp, a Houston bank, saw trading in its stock quadruple the day that four bidders were putting together their buyout offers. The deal was worth $1.7 billion.
2) Carr America, a real estate investment trust, saw volume in its shares jump on Feb. 17, the day the real estate investment trust struck a confidentiality agreement with a potential bidder and Goldman Sachs began providing the bidder with an analysis of CarrAmerica’s books.The deal was worth $5.6 billion.
3) Dex Media, a yellow pages publisher, increased sharply last Sept. 14, the day that management, legal teams and financial advisers representing the company and Donnelley met. The deal was worth $9.5 billion
4) IDX Systems, a health care systems company, saw its share price and the number of shares traded jump on Sept. 7, when its chief executive and a G.E. executive talked and G.E. agreed to increase its bid by 5 percent.. The deal was $1.2 billion.
5) Texas Regional Bancshares. The deal was worth $2.2 billion.

In each of the five cases, the abnormal trading occurred during periods of significant behind-the-scenes progress in the mergers, as outlined by the companies themselves in regulatory filings long after the deals were struck.

How much can you make from insider trading?
In each of the last three months, over $100 billion of M&A deals have been announced. If 41% of these deals were subject to insider trading, then $41 billion of deal would have been victims of insider activity. Considering that the average takeover premium for a public company is between 20-30%, this implies insidering trading can generate profits of potentially $8-$12 billion per month!

How is insider trading possible?
Insider trading is possible for several reasons. According to the Times, "the takeover crowd includes corporations, management-led buyout teams as well as private equity firms, which represent wealthy private investors. Companies’ directors are reaching out to many potential bidders these days to ensure shareholders get the best price. In the process, they are expanding the number of people with knowledge of the deals."

Why is insider trading bad?
The reason insider trading is bad is simple. Traders who sell prior to the announcement of a deal lose out on the profits that would have accrued to them. Buyers of their shares who act on inside knowledge benefit. That is why insider trading is so controversial.

Has the punishment for insider trading fit the crime?
The Times seems not to think so citing several cases centering small individual investors where the defendants pad fines of $50,000 to $100,00 for their crimes. Penalties for insider trading is simply disgorgement of profits plus civil penalties. The Insider Trading Sanctions Act of 1984 does allow for penalties up to triple the profit.

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