If the SEC is going to crack down on insider trading, it may want to focus its limited resources not on the few headline-grabbing mega deals but on the scores of run-of-the-mill financings that hit the markets every day.
As reported Wednesday, call options, or options to buy shares of Florida East Coast Industries, spiked in the days before Tuesday’s announcement that Fortress Investments had purchased the company for $3.5 billion.
Yet another example has emerged that follows the same pattern.
On Monday BAE Systems purchased Armor Holdings for $4.1 billion, or $88 a share. The stock rose around 5% on the news. But the real action appeared to take place in the weeks before the deal was announced, when there was a sharp spike in the trading of Armor call options.
Since Armor was the acquired company, holding call options prior to the deal could mean big bucks for the investor who was lucky or smart enough to predict the deal.
It appears that there was plenty of predicting going on: There were two major spikes in call option trading, one of April 19th and one on Wednesay, May 2 just days before the deal was announced when 21,567 Armor call options traded, a massive increase from its daily average of just 1,731.
What caused the move? Often stories predicting deals send the stock soaring and ramp up call-option trading in the acquired company. But press coverage of the deal appeared to take place over the weekend just before Tuesday’s announcement. Last week, Yahoo message board cited the increase in call-option activity, but the press didn’t seem to catch on until the deal was announced.
Does this mean insider trading took place? Not quite. Insider trading is notoriously difficult to prove and it takes more than the mere passing of “material, non public information” which is the short-hand definition of the crime.
The material must be passed by a true insider, and must be of a certain caliber, not to mention, people who trade on it need to know what they were doing is illegal.
But the trading that preceded of Florida East Coast Industries and Armor Holdings does suggest that certain market professionals have a leg up on average investors. And if SEC chairman Chris Cox is serious about stamping out insider trading and democratize the market, these examples show that he has a real problem on his hands because the problem doesn’t seem to be confined to large, mega deals, but smaller deals that occur every day.
His only solution: Follow the lead of former New York City Mayor Rudy Giuliani who along with police commissioner Bill Bratton dramatically reduced crime rates and hire more cops. Without more cops, the SEC appears to be stretched too thin to handle the size of the problem.