Insider Trading or Hard Work: Trading Before News Corp’s Bid for Dow Jones

Suspicion abounds when trading picks up in advance of an announcement, particularly if it turns out to be a significant one.  Sometimes the market-monitoring computers of the regulators signal possible anomalies, triggering an initial inquiry into “suspicious” trading to determine if there was illegal activity, such as, insider trading.  Sometimes a flurry of trading generates a lot of finger pointing and head nodding coupled with suggestions that “it must have been” illegal insider trading.  Sometimes it might be a sign of illegal activity.  Other times it might just be the sign of a healthy market. reported on “suspicious” trading activity in advance of the announcement by Rupert Murdoch’s News Corp. of an unsolicited $5 billion bid to buy Dow Jones & Co. for $60 per share. The announcement sent the stock of Dow Jones zooming up about 55% to $57.77, its biggest gain in months.  What was more interesting than the post-announcement trading, however, was the activity in the options markets prior to Mr. Murdoch’s blockbuster bid.  There, trading in options to buy shares of Dow Jones reached an 18-month high suggesting, according to the article, that “word of the . . .bid for the company may have leaked in advance” of the announcement.  The article continues quoting various sources who suggest that something untoward must have happened. 

Indeed, it might have.  As the Bloomberg article notes, just a few months ago the SEC brought an enforcement action and obtained an asset freeze following an investigation which begin with a similar trading pattern in TXU options.  That trading was in advance of a major announcement and the investigation turned up what the SEC says was insider trading. 

We have yet to see what happened prior to the announcement by News Corp.  But before everyone suggests that those option traders were doing something wrong, it is good to remember that the trading may well have resulted from good old fashioned work.  Every proposed deal like this one is worked on by dozens of people.  Those include executives at the company, outside lawyers, accountants, investment bankers, public relations specialists and a host of other people.  All of those people are brought “over-the-wall” and know about the proposed bid as it is put together in the days and weeks prior to its announcement.  It is not untypical for those people to participate in numerous meetings, phone calls, write documents and take other necessary steps.  Frequently they are working long hours.  Those around them including family, friends and others frequently see this increased activity.  Market professionals who watch companies and high profile executives such as Mr. Murdoch for clues to future activity often note the increase in activity – but do not know for certain what is being done.  

The bits and pieces of information gleaned from such observations are hardly material information – they do not tell the observer about the proposed bid.  Together with other public information, however, those bits and pieces can help traders make decisions about whether to buy and sell.  This activity, called “leakage” by economists, helps make the markets more efficient.  The more efficient the markets are the better the price – something that benefits everyone.  When the increased trading results from this type of activity, not only is it not “suspicious” or illegal, but rather it is beneficial to the markets and all traders. 

This theory is hardly new.  (see blog post 8/29/06)  In the late 1980s, then SEC Chief Economist Gregg Jarrell studied data on trading in advance of announcements based on information accumulated by the agency.  In his paper on this study now Professor Jerrell (University of Rochester) concluded that one cannot draw conclusions about insider trading from surges in trading activity prior to the announcement of a significant event.  While the trading might represent something suspicious, it may also be something beneficial to the markets. See Gregg A. Jarrell & Annette B. Poulsen, Stock Trading before the Announcement of Tender Offers: Insider Trading or Market Anticipation?, Journal of Law, Economics and Organization, vol. 5(2), at 225-48 (1989); Gregg A. Jarrell & John Pound, Hostile Takeovers and the Regulatory Dilemma: Twenty-Five Years of Debate, The Midland Corporate Finance Journal, 5 (2) (Summer 1987). Other economists have confirmed this work. 

All of this is to say that before we point the finger at those who trade just before an announcement by Mr. Murdoch we should take care to examine all of the facts.  Those traders may just have worked a little harder than the rest of us.  Those traders may also be doing us all a service by contributing to the efficiency of our capital markets.