Wednesday, October 1, 2014

In defense of the Pershing Square analysts

I can't quite believe I am doing this - because I loathe Bill Ackman with a passion. Mr Ackman in the presence of one of my clients told the world that Bronte would blow up. I had the temerity to disagree with him on two stocks (Herbalife, Valeant). However my positions were much smaller than his in both stocks - so it was rich for him to suggest that I was risky.

Whatever: I think today's charging of one of his former analysts and his room mate for insider trading in Herbalife is a bad case of SEC over-reach.

US insider trading rules first require that someone breach a position of trust regarding the company that is being traded. In the Mark Cuban case - which the SEC ultimately lost on appeal - Mark Cuban was told by the CEO of that the company was going to need to do a secondary offer. Mark Cuban sold his stock and was charged with insider trading.

The whole case swung on whether Mark Cuban had agreed to be bound by the CEO into not trading the information he was given. The SEC could not prove that he had so agreed and so Mark Cuban had not breached any position of trust he had been put in by the company and hence was not guilty of insider trading. I blogged extensively about the Mark Cuban case here and again when the SEC lost the case here.

In the recent Herbalife an analyst at Pershing Square knew in advance that Pershing was going to do its "hit piece" on Herbalife. The analyst had a duty to Pershing Square but did not have any duty to Herbalife and was not an insider in Herbalife.

The analyst tipped his room mate who traded the stock. The room mate made about fifty grand.

Both were charged with insider trading - but neither was in a position of trust with respect to Herbalife and neither had inside company information.

As stated the analyst clearly had a duty to Pershing Square - and I think it is incumbent on Bill Ackman to sue his analyst if the analyst acted contrary to his obligations to Pershing. But it is not a case which should involve the SEC. It is not insider trading.

My guess is that the SEC put Bill Ackman through hell on this one.

For once - and I suspect it is only once - I am on his side.


Post script: I did not read the source material accurately. The analyst was not charged. It was the roommate as tipper and a friend as tippee. However either way I find it extremely hard to work out what duty was breached.

The only person here with a written duty was probably the analyst at Pershing.


Anonymous said...

You are a remarkable man John.
"I wud Luv it" if you get $HLF right.

Anonymous said...

Great post, as always.

Maybe Ackman encouraged the SEC to prosecute a former analyst who breached the trust of his company?

Ackman has a reason to want to deter future internal leaks, but a "former analyst" who had a "roommate" doesn't sound like someone who has assets enough to be worth suing.

On the other hand, generally people on wall street don't like former employees to be in a position to make a deal with prosecutors.

Joe McHugh said...

Firstly, the SEC didn't charge the analyst, only his roommate and the friend who traded the stock.

Secondly, insider trading isn't some fixed, immutable concept. There was a time when it wasn't even clear whether bonds or derivatives were covered.

In any case, your definition of insider is cramped if you think it only means someone duty bound to the issuing company. Just today the SEC charged 2 Wells Fargo employees with insider trading for trading ahead of the firm's research reports (

Finally, your related links claim that Martha Stewart didn't commit (couldn't have committed actually) insider trading. OK, she didn't got to prison for it, but she was charged with it, and settled the charges in a consent decree (

Anonymous said...

I think you've got US insider trading law wrong - you're still offside if the duty isn't owed to the issuer. See the Wikipedia entry for "insider trading", and the Foster Winans and O'Hagan cases. Having said that, Ackman should still be unhappy with his former analyst...

tiru said...

Odd that he said that.
Anyways, you're a super fun investor to follow - wish you would write more about your longs though; and if possible on your portfolio construction on the long side.

Anonymous said...

How is this insider trading if the analyst never tipped the roommate, and the latter just pieced it together based on his observations.
The analyst was not charged.

Brian said...

I'm less concerned with whether it is insider trading vs. whether it should be considered insider trading. IMO, Cuban should not be allowed to trade on non-public, privileged information. This is why some people think that stock market investing is a fixed game.

Anonymous said...

John, I really like your stuff, and I know you are well informed. However, regarding the insider trading rules, all it is said is that any "material, non-public information" is considered insider information. Material: potentially market moving. Non-Public: usually a small group, say less than 40 people (not sure, since now even Tweets are considered somewhat public, if I am not mistaken). You can't transmit "material, non-public info" if you have it or trade on it, even if it didn't come from the Co. or a person bound to the Co. in the common sense. Not sure how the courts read this in practice, it is purposely a vague definition, I believe. Judges have leeway in how they will interpret cases in the US, though.

However an interesting case which I have debated over the years is the case of an important, large investor, which starts building a position (before the 5% filing thresholds) and then makes an offer for the Co. Was the first 4.9% (or whatever level the investor stops at prior to disclosing the trades) insider trading? Part of me says yes, if the whole intention was to offer to buy the whole company anyway. What do you say?

Thanks for all the great work throughout the years. PBS.

Chaudhuri Investments said...

Hi John,

Would love to hear your take on the latest in the FNMA/FMCC saga.

Anonymous said...

Anonymous at 12:57 is correct; the information and duty don't have to be owed to the issuer.

McHugh is incorrect; the original federal insider trading cases, Carpenter and O'Hagan and such, did not involve breaches of duties owed to an issuer. In Carpenter the defendants traded on advance knowledge of a Wall St. Journal column.

The phrase "insider trading" is no longer meaningful. It used to describe a distinct species of securities fraud. That's no longer the case. The lines have blurred. We still here the phrase because it sounds catchy on TV.

The Pershing Sq. case is more like a cross-breed of frontrunning with insider trading.

The way to see this is to ask who the victim is, who was defrauded? In the early cases it was the issuers, who "owned" misappropriated information. But issuers are subject to restrictions on trading their own securities, so then we started saying the victims were the shareholders, who were paying the wrong price for the securities.

That was too abstract to be coherent, and in the late 1980s it metastasized into the idea that the general public is being defrauded because they're playing a "rigged game."

Except the law still requires a breach of a duty (here, to Pershing Sq.) so the whole thing doesn't make a bit of sense.


Nick said...

I agree with many above.
Material non-public is ALL that matters (certainly in the UK, not 100% sure about SEC).
How the SEC lost vs. Cuban is a mystery to me.
Einhorn on Punch is a better example.
He kept saying "don't make me an insider, don't make me an insider, lalala..." That doesn't matter.
What matters is if you are given the material info and it isn't public - e.g. A FRICKING RIGHTS ISSUE NO ONE KNOWS ABOUT!!!!

You are also absolutely wrong to hint about the "duty" to Pershing Square.
Clearly Pershing already had a fully built position short HLF before the hit piece - otherwise they would be doing themselves a disservice!!
So telling people a hit piece is coming isn't front running your own fund - there isn't anything to get in front of.
If anything it makes the hit piece more impactful.

Nevertheless, it is similar to trading ahead of an analyst upgrade or downgrade.
Which again is inside information.
Just because the analysis is coming from the buy side not the sell side it is still material and non-public - by definition.
It is material since it evidently moved the stock. And non-public since no one knew about it.
Looks very insidery to me.

Nick said...

I have just read your blog entries on the Mark Cuban case. I am still baffled how the SEC lost.
There is absolutely NOTHING as far as I can see that suggests you need to AGREE to be an insider - that is simply absurd.
If the CEO of Time Warner came up to me and said "Fox have raised their bid, we are putting a release out about it in an hour" - I can't just say "I don't agree to be an insider" and happily load up on TWC.

Utter nonsense!

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