Saturday, March 10, 2012

Is this insider trading?

A while back, my colleague John R. Lott Jr. and I wrote two papers around the same general topic, on the effect that one firm has on another firm through competitive actions and the implications for stock market prices.

For instance, we discussed what might happen if Firm A were to announce a decision to entry into Firm B's market. Without perfectly competitive markets, it should be expected that Firm A's decision would cause Firm B's market value to fall.

Knowing this, would it be profitable/feasible/legal for Firm A to trade in the securities of Firm B before making their announcement?

We looked into the legal aspects of this and concluded that it did not appear illegal, so long as the announcement were not fraudulent. Legality at least on insider trading grounds hinges on the managers of Firm A not having a fiduciary responsibility to Firm B. Of course, Firm A might restrict its employees from such trading (not sure why they would, but they could). But Firm A could instruct its pension fund, for instance, to short Firm B before the entry announcement.

We had trouble finding current examples of such behavior. Too bad, or the article would have gotten into an even better journal.

But now we have this Reuters article about Starbucks and Green Mountain Coffee. Quoting from the article:
A heavy burst of bearish option action in Green Mountain Coffee Roasters Inc in the hours before Starbucks announced plans to launch a single-cup coffee and espresso brewer has raised eyebrows among some option market participants.

"The level of aggressiveness that traders early on Thursday came for Green Mountain March downside puts was very suspicious," said Alan Thompson, options market maker at Timber Hill, a division of Interactive Brokers Group. "It raised our eyebrows."

"We expect that the regulators will take a deeper look at both Starbucks and Green Mountain ahead of (Thursday) night's announcement," Najarian said.

The U.S. Securities and Exchange Commission, which looks into unusual stock and options activity, declined to comment.


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