Buybacks + Options + Hedge Funds + Inside Information = Crime?
by John Schroy filed under Equities, Corporate Managers, Bankers, Brokers
Stock buyback programs are a legalized form of market manipulation, sanctioned under SEC Rule 10b-18 and that serve to drive up the price of a company’s stock and to give false value to executive stock options — something that the SEC considers a “legitimate business reason” for rigging the market.
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Companies disclose the board approval and the intended scope of a buyback operation, but not information regarding the specific timing of trades or the brokers involved.
In 2003, an attempt to improve disclosure of buyback operations, including the names of brokers, failed. Stock brokers protested and the SEC caved in to market insiders.
No Safe Harbor From Insider Trading Sanctions
As Rule 10b-18 now stands:
The issuer announces that it has authorized the repurchase of a certain number of shares, without setting the price or timing, or committing to a certain volume of transactions. Details of the buyback program and the broker involved are secret from the public.
If the price of the company stock should rise after the announcement of a buyback, an investor has no way of knowing whether the price increase is the result of the market manipulation, or in anticipation of the manipulation, or a legitimate reflection of increased intrinsic value of the stock.
Contemporaneous information on the buyback operation is material and secret. This is “inside information”, privy to executives of the issuer and to brokers involved in the buyback program. Disclosure of inside information is a crime, subject to prison.
Once a buyback operation is completed or abandoned, buying pressure on the issuers’ stock ceases and the stock often falls in value. Until publicly announced, information as to the completion or abandonment of a buyback program is also inside information, subject to criminal sanctions on improper disclosure.
To Whom Is Inside Information on Buybacks Valuable?
Obviously, an executive who wants to time the sale of his or her stock options to meet the peak price during the buyback program, needs to know the timing and details of the transactions. This gives the executive an advantage over ordinary investors, but the SEC does not seem concerned with this. There seem to be no special procedures to keep buyback transaction information secret from executives who might hold options and benefit from the program.
The manager of an investment fund can benefit greatly from inside information as to the timing a buyback program. With these details , the fund manager can buy the stock cheaply, before buybacks begin. After holding the stock until the final flurry of purchases by the issuer, the fund manager can sell at a nice profit at the top of the market as the program ends.
