Kinnucan: How to Tell an Investment Bank from an “Expert Network”
On an early morning last February I was talking with a hedge fund client when apropos of nothing much he let out, “Wow. Company "X" (ticker "XX" for this post) — was just in here, and they are totally pumped. They said RFP (Request For Proposal) activity was off the charts, and they think their telco business is going to explode later this year and next.”
At the time of our conversation (around 10am EST), "XX" was trading at about $50, essentially unchanged on the day — but not for long. Within an hour the stock was up $2, and ended the day near $54, up 8% on the day, increasing the value of the company by hundreds of millions of dollars, and the net worth of the management team participating in the dog and pony show (CEO, CFO, Investor Relations guy) by tens of millions.
These types of “marketing trips” by senior executives, sponsored by the big investment banks (certainly not small research firms like Broadband Research ), are very common, and are often great trading opportunities. The dog and pony show usually starts out in Boston, and long before it reaches New York, on its way down to Philadelphia, the word is out that the management team is talking extremely bullish, and it’s time to get on board the gravy train.
A thoughtful observer might wonder whether these management tours end up disclosing non-public information, leaving aside the issue of materiality.
However, when a stock increases 8% for no discernible reason, other than top management making the rounds with large investors, the question of materiality does seem at least somewhat germane.
Said observer might also wonder whether company management is receiving a “payment-in-kind,” in the form of enhancing their net worth by millions of dollars, for disclosing this non-public information. (Presumably if the information they are providing to large investors were already public, the stock would not leap by 8% that day.)
Furthermore, the sponsoring bank is being effectively paid being paid handsomely for facilitating this exchange (starting to sound familiar?). You can be sure that as soon as the company management leaves the fund offices, a salesman at the sponsoring bank will be on the line with the fund trading desk, inquiring about how much stock he can expect to be purchased as a result of the visit.
For the uninitiated, this is essentially no different than how an expert network functions, i.e. facilitating access to individual company information by investors, for a fee.
So, the answer to the question posed in the title now appears obvious: The Feds will not go after an investment bank (bad career move, etc…), but they are more than happy to make a small research firm extinct (think snail darter).
Mr. Kinnucan will be discussing this post and the expanding insider trader investigation when he appears live on CNBC's Strategy Session today at 12:20 pm/et.
John Kinnucan is a principal at Broadband Research in Portland, Ore.
