FREE ELECTRONIC LIBRARY - Online materials, documents

Pages:   || 2 | 3 | 4 | 5 |   ...   | 7 |

«April 2014 Abstract Companies planning a private placement typically gauge the interest of potential buyers before the offering is publicly ...»

-- [ Page 1 ] --

Hole in the Wall:

Informed Short Selling Ahead of Private Placements

Henk Berkman, Michael D. McKenzie and Patrick Verwijmeren

April 2014


Companies planning a private placement typically gauge the interest of potential buyers before

the offering is publicly announced. Regulators are concerned with this practice, called wallcrossing, as it might invite insider trading, especially when the potential investors are hedge

funds. We examine privately placed common stock and convertible offerings and find evidence of widespread pre-announcement short selling. We show that pre-announcement short sellers are able to predict announcement day returns. The effects are especially strong when hedge funds are involved and when the number of buyers is high.

JEL classification: G32 Keywords: Insider trading, Hedge funds, Private placements, Wall-crossing, Short selling * Henk Berkman (h.berkman@auckland.ac.nz) is from the University of Auckland, Michael McKenzie (michael.mckenzie@liverpool.ac.uk) is from the University of Liverpool and the University of Sydney and Patrick Verwijmeren (verwijmeren@ese.eur.nl) is from Erasmus University Rotterdam, University of Melbourne, and the University of Glasgow. Corresponding author is Patrick Verwijmeren (Burgemeester Oudlaan 50, Room H14-27, 3000DR Rotterdam, the Netherlands, T: +31104081392, F: +31104089165).

1. Introduction The market for private placements has surpassed the traditional seasoned equity market in terms of both dollar volume and number of transactions.1 When a firm is planning a private placement, it will typically gauge the interest of potential investors in a series of confidential conversations before the offering is publicly announced. This practice is commonly referred to as ‘wall-crossing’ and regulation Fair Disclosure (Reg FD) deems the investor receiving the private information to be a ‘temporary insider’.2 Thus, having crossed the wall, an investor is expressly prohibited under the Securities Act from trading on the private information revealed during these conversations. This legal restriction of the trading activity of wall-crossers is understandable given that the announcement of a private placement will often have a material price impact.3 While the academic literature has yet to consider the issue of wall-crossings, it has drawn the attention of the regulatory authorities. For example, in a testimony before the U.S. Senate Banking, Housing and Urban Affairs Committee, the then chairman of the Securities and Exchange Commission (SEC), Christopher Cox, stated that the SEC would create a new working group to enhance the efforts to combat insider trading by hedge funds and one of the enforcement priorities was short selling based on insider information in private placements (Mahoney et al., 2008). The SEC’s decision to target hedge funds is understandable as hedge De Jong, Dutordoir and Verwijmeren (2011) document that approximately 95 percent of convertible issues in the period 2003 – 2007 were privately placed. Huson, Malatesta and Parrino (2010), Chen, Dai and Schatzberg (2010) and Floros and Sapp (2012) provide evidence that the Private Investment in Public Equity (PIPE) market has surpassed the traditional seasoned equity market in terms of both dollar volume and number of transactions.

Wall-crossing is different from the typical form of book-building, which occurs after the public announcement of the intended security issue.

Variation in the observed announcement effects can be large. Wruck (1989), Hertzel and Smith (1993) and Hertzel, Lemmon, Linck and Rees (2002) examine the announcement effects of private placements and observe positive average announcement effects. De Jong, Dutordoir and Verwijmeren (2011) and Duca, Dutordoir, Veld and Verwijmeren (2012) find negative average announcement effects for privately placed convertible bonds.

funds are often the subject of insider trading allegations.4 The focus on private placements is also unsurprising given that wall-crossings create an obvious opportunity for insider trading.

In this paper, we investigate the trading behavior of short sellers around PIPE and Rule 144A private placements.5 The focus on short sellers is guided by statements of regulatory authorities, such as the SEC, which clearly highlight short selling as a potential problem.

Moreover, using proprietary data from Dataexplorers, we measure changes in short interest at a daily frequency and are therefore able to closely monitor the actions of these sophisticated investors, who are predominantly hedge funds. Our sample consists of private placements of common stock and convertible securities between January 2007 and August 2011, which is the period for which we have data from Dataexplorers.

Our results may be summarized as follows. First, we document significant preannouncement increases in average short interest, which is evidence of information leakage.

Second, we find that abnormal pre-announcement increases in short interest are negatively related to the stock price reaction to the public announcement of the private placement. We also observe this negative relation when we replace actual announcement returns by predicted announcement returns that are solely based on information available to wall-crossers before the offering. Both results suggest that the information received during the wall-crossing procedure is material and that some privately-informed investors take speculative positions prior to the The reputation of hedge funds as potential inside traders was reinforced with the very public arrest of the Galleon Group hedge fund founder, Raj Rajaratnam, in 2009. He has since been sentenced to 11 years in prison and fined over $150 million. Empirical evidence of insider trading by hedge funds in the syndicated loan market and around mergers and acquisitions may be found in Massoud, Nandy, Saunders and Song (2011) and Dai, Massoud, Nandy and Saunders (2011), respectively.

The main difference between PIPEs and traditional private placements is the duration of the resale restrictions on the participating investors. The restriction period was typically two years for traditional private placements, whereas for PIPEs, the shares can typically be publicly traded within 90 days. Traditional private placements have only been issued sporadically in the 21st century (Chen, Dai and Schatzberg, 2010). Rule 144A offerings are only issued to Qualified Institutional Buyers, which are typically large institutional buyers with more than $100 million of investable assets.

announcement in order to profit from this information. Third, we find that short selling before the announcement is more pronounced when there are more buyers involved in the private placement. As the number of buyers is likely to correlate closely with the number of investors who have crossed the wall, we interpret this result as supporting our hypothesis that the existence of more potential traders with private information increases the probability of informed trading in the pre-announcement period. Finally, using information on hedge fund involvement in privately-placed security offerings, we find that the observed patterns are non-existent when hedge funds are not involved and strongest when hedge funds are heavily involved.

This study relates to the broader insider trading literature. Prior studies have examined situations in which private information has leaked through “Chinese walls” designed to separate, for example, commercial and investment banking within the same bank.6 We make three contributions to this insider trading literature. First, we differ from the above studies by examining an explicit breach of trust between a firm and potential investors. Second, we provide new evidence in the context of private placements. Henry and Koski (2010) find no evidence of increased pre-announcement short selling in public seasoned equity offerings. However, public seasoned equity offerings are less likely to be targeted by insider traders, due to the lower involvement of hedge funds in that market and the higher scrutiny compared to private security offerings. We establish that pre-announcement short selling is widely present in private placements but not in public offerings. Third, we are able to observe the identity of the buyers in Ivashina and Sun (2011) and Massoud, Nandy, Saunders and Song (2011) find evidence of insider trading by institutions that obtain private information by lending in the syndicated loan markets; Acharya and Johnson (2007) find that informed banks exploit information in the credit default swap market; and Bodnaruk, Massa and Simonov (2009), Dai, Massoud, Nandy and Saunders (2011) and Beny and Seyhun (2012) find information leakage around merger and acquisition events. On the other hand, Griffin, Shu and Topaloglu (2012) find no evidence that investment bank clients use inside information to trade around merger and earnings announcements.

private placements and contribute to the literature by showing how placing securities with hedge funds affects the probability of insider trading.

Our study also contributes to the burgeoning literature on short selling. While it has been suggested that short sellers are informed traders who are particularly skillful at digesting public information (see Engelberg, Reed and Ringgenberg, 2012), we are able to focus on short sellers’ use of non-public information. Our findings are consistent with studies that observe increased short selling before negative earnings surprises (e.g., Christophe, Ferri and Angel, 2004;

Boehmer, Jones and Zhang, 2012) and before the appearance of negative firm-specific news in the media (Fox, Glosten and Tetlock, 2010).

Our results have clear regulatory implications and suggest that the limited resources of the regulators should be focused on examining placements with a high degree of hedge fund involvement and a large number of wall-crossers. Furthermore, our results suggest that regulators may wish to provide more extensive and timely disclosures of short interest.7 Disclosure of short interest would be of great interest to the parties directly involved in private placements, and would help market participants and enforcement authorities in filtering out suspicious private placements, thereby increasing the integrity of stock markets.

The remainder of this paper is organized as follows. Section 2 describes insider trading regulation in the context of wall-crossings, and Section 3 develops the hypotheses. In Section 4 we describe our data and in Sections 5 and 6 we present our results. We provide additional tests in Section 7 and conclude in Section 8.

Section 417 of the Dodd-Frank Act requires a study of “the feasibility, benefits and costs of requiring reporting publicly, in real time short sale positions of publicly listed securities.” The U.K., France and Spain have recently adopted rules requiring short sellers to disclose their positions (see Jones, Reed and Waller, 2012).

2. Wall-Crossings and Insider Trading Regulation Reg FD requires that companies disclose material information to all investors at the same time. Exemptions to this rule do exist, however, as communications without public disclosure can be made to those who owe the issuer a duty of trust or confidence, such as an attorney or an accountant. These exclusions also apply to communications made to any person for legitimate business purposes, subject to the proviso that they expressly agree to maintain the information in confidence. This class of exclusions is relevant when a firm is considering raising capital through a private placement, as it allows issuers and underwriters to confidentially gauge interest in an offering prior to any public disclosure.

In general, private placements are initially marketed on an anonymous basis by an underwriter to a limited number of institutional investors. This is sometimes called a presounding, sounding-out or pre-marketing campaign. If an investor is interested, they sign a confidentiality agreement and are informed of the identity of the issuer and the specifics of the offering. It is at this point that the investor legally crosses the wall and becomes a temporary insider. As such, they are restricted from trading in the issuer’s securities until a public announcement of the offering has been made or else face the risk of prosecution for insider trading.

In 2004, potential irregularities in wall-crossing attracted the attention of the U.S regulator. The SEC sent out requests for documents to securities brokers and other firms that sell securities to hedge funds in private transactions. The agency was concerned that these firms may have leaked news of forthcoming deals to favored clients, allowing them to profit by trading the stock ahead of the announcement (Pulliam, 2004). Subsequently, the SEC made the decision to focus on the trading activity of hedge funds and one of the enforcement priorities was short selling based on insider information in private placements (Mahoney et al., 2008).8 Since 2005, the SEC has filed complaints against a variety of hedge fund managers. The SEC accused them of engaging in illegal insider trading by short selling issuer securities on the basis of material, non-public information prior to the announcement of a private offering, notwithstanding their agreement to keep information about the offering confidential and to refrain from trading prior to the public announcement. Appendix A provides a brief description of these cases. Most of the defendants consented to final judgments, without admitting or denying the accusations, leading to civil fines and repayment of unlawful profits. The amounts can be high and exceeded $15 million in the case of SEC versus Langley Partners. In the cases where the judges did make rulings, a not guilty verdict was returned in some cases because the judge ruled that the announcement effect was too small for information to be deemed “material” (see Hartlin, 2009).

Pages:   || 2 | 3 | 4 | 5 |   ...   | 7 |

Similar works:

«AGBIS Annual Conference Keynote Speech by Dr Anthony Seldon Monday 11th March 2013 It is a great pleasure and honour to be with you today. I would like to thank AGBIS very much for the kind invitation to speak to you. It is exactly four years since you asked me to speak on optimal governance, and in particular the relationship between the head and the chair of governors, which is my same topic today. As in 2009, I have polled over a hundred heads, asking them the very same questions that I did...»

«LIVERPOOL WOMEN’S NHS FOUNDATION TRUST ANNUAL REPORT & ACCOUNTS 2015 /16 LIVERPOOL WOMEN’S NHS FOUNDATION TRUST ANNUAL REPORT & ACCOUNTS 2015 /16 Presented to Parliament pursuant to Schedule 7, paragraph 25(4) (a) of the National Health Service Act 2006 ©2016 Liverpool Women’s NHS Foundation Trust Table of Contents 1. Foreword from the Chair & Chief Executive 2. Performance Report 2i. Overview of performance 2ii Performance analysis 3. Accountability Report 3i(a) Directors’ report...»

«Firm: Cube Capital Cube Capital Headcount: Hidden Asset Manager Founded in Hidden Assets Under Management: Hidden Hidden Hidden Hidden Simon Philip Wallace Meter Eye, back door listed in early 2011. He has Considerable experience is built up in the public company arena as Managing Director of Cube Capital. He served as a Director of Veritas Investments Limited. He is a member of the NZ Institute of Directors. Bloomberg August 19, 2015 Report Report inappropriate or irrelevant content InSite...»

«Instructions for use submitted to Applied Microbiology and Biotechnology Screening for improved activity of a transglutaminase from Streptomyces mobaraensis created by a novel rational mutagenesis and random mutagenesis Keiichi Yokoyama1, Hiroe Utsumi2, Takefumi Nakamura1, Daisuke Ogaya2, Nobuhisa Shimba1, Eiichiro Suzuki1, and Seiichi Taguchi2 1. Institute of Life Sciences, Ajinomoto Co., Inc., 1-1, Suzuki-cho, Kawasaki-shi, 210-8681, Japan.2. Division of Biotechnology and Macromolecular...»

«The Black Swan: the impact of the highly improbable. Nassim Nicholas Taleb Two contrasting summaries: Summary 1. This is an interesting read which is very Abstract in nature. The book has made me think in a very abstract way in looking at past events that happened and trying to work out if we could have known that this was to happen. There are all sorts of theories which are very personal and which are effectively opinions. The theme can be summated as being the ‘ known unknowns.’ I have...»

«Form 603 Corporations Act 2001 Notice of Initial Substantial Holder Section 671B APO To: Company Name/Scheme The Secretary APN Outdoor Group Limited Level 4 33 Saunders Street Pyrmont NSW 2009 Ph: (02) 8569 3000 ACN 122 574 583 1. Details of substantial shareholder National Australia Bank Limited and its associated entities listed in Annexure A Name (ACN 004 044 937) ACN (if applicable) The holder became a substantial holder on 18/11/2014 2. Details of voting power The total number of votes...»

«IN THE HIGH COURT OF MALAYA AT KUALA LUMPUR COMPANIES (WINDING-UP) PETITION NO. 28NCC-379-05/2015 In the matter of Open Fibre Sdn Bhd (Company No. 783109-M) And In the matter of Section 218(f) and (i) of the Companies Act, 1965 BETWEEN. PETITIONER RANJEET SINGH SIDHU AND 1. OPEN FIBRE SDN. BHD.2. ZULIZMAN BIN ZAINAL ABIDIN 3. KU HASNIZA HANI BINTI KU HASHIM 4. ROSLINA BINTI IBRAHIM 5. SHAILEN A/L POPATLAL. RESPONDENTS JUDGMENT (Court Enclosure No. 34) A. Introduction 1. This case raises a...»

«` MINUTES OF THE BOARD OF TRUSTEES THE VILLAGE OF CHESTNUT RIDGE AUGUST 20, 2015 The Board of Trustees of the Village of Chestnut Ridge convened in regular session on August 20, 2015 at the Village Hall, located at 277 Old Nyack Turnpike, Chestnut Ridge, NY 10977. PRESENT: ROSARIO PRESTI, JR. MAYOR JOAN BROCK DEPUTY MAYOR GRANT VALENTINE TRUSTEE ABSENT: HOWARD COHEN TRUSTEE PRESENT: WALTER R. SEVASTIAN VILLAGE ATTORNEY FLORENCE A. MANDEL RECORDING SECRETARY   1 1. Pledge of Allegiance. 2....»

«DELTA STATE UNIVERSITY Cleveland, Mississippi 38733 Founded April 9, 1924 Opened September 25, 1925 Undergraduate Catalog 2015-2016 This catalog presents information which most accurately describes the course offerings, policies, procedures, regulations and requirements of the University. However, it does not establish contractual relationships. The University reserves the right to alter or change any statement contained herein without prior notice. Volume 91 June 2015 Number 2 PUBLISHED...»

«IFRS Foundation 30 Cannon Street London EC4M 6XH 28 January 2015 Dear Sirs Measuring Quoted Investments in Subsidiaries, Joint Ventures and Associates at Fair Value (Exposure Draft ED/2014/4) 1. This letter sets out the comments of the UK Financial Reporting Council (FRC) on the above Exposure Draft.2. We note that the aim of the Exposure Draft is to clarify the application of fair value in certain circumstances and that comments are not requested on aspects of those standards that it does not...»

«FURUTECH RD – 2 DISC DEMAGNETIZER The Furutech RD-2 can be used to demagnetize any optical DISCS, such as CD, DVD, MD, and even Audio/Video CABLE wires and POWER cords. The RD-2 will rejuvenate their original tone quality and data image quality as vivid and lively.The RD-2 has the following Patents: • Japan Patent:No. 2942760 • U.S. Patent:PN/6058078 • Taiwan Patent:No. 110354 Theorem & Structure * It is absolutely impossible to obtain intact signals from a DISC if the DISC is...»

«Fruits & Veggies–More Matters® Curriculum July 2008 Introduction Lesson 1 Lesson 2 Lesson 3 Lesson 3a Lesson 4 Consumption Survey Teacher Supplement Introduction This is a revision of the 5 a Day Curriculum to the Fruits & Veggies-More Matters® Curriculum. There are four lessons with five objectives for each lesson. Separate lessons (3 or 3a) are written for a grocery store tour or a video produce tour. The Arizona Academic Standards that are addressed in each lesson are identified at the...»

<<  HOME   |    CONTACTS
2017 www.thesis.dislib.info - Online materials, documents

Materials of this site are available for review, all rights belong to their respective owners.
If you do not agree with the fact that your material is placed on this site, please, email us, we will within 1-2 business days delete him.