In addition to her Sunday column, Gretchen Morgenson has another article in today's NYT – page 1, above the fold. It's about a NYT-conducted study of trading in advance of mergers. And it displays many of the worst aspects of business reporting today in our major newspapers.
Morgenson says
an analysis of the nation’s biggest mergers over the last 12 months indicates that the securities of 41 percent of the companies receiving buyout bids exhibited abnormal and suspicious trading in the days and weeks before those deals became public. The boom in corporate mergers is creating concern that illicit trading ahead of deal announcements is becoming a systemic problem.
She adds that "many investors are troubled by what they now see as rampant insider trading, saying it fosters the perception that insiders can profit in the markets at the expense of outsiders."
Of course, the "concern" is hers – there's no other evidence in the article of a "systemic problem." So watch out for a bunch of screeds about this "problem," with vague calls for regulatory action, in upcoming GM columns.
The most important problem with the story is that it's impossible to separate GM the columnist from GM the news writer, despite a clear public concern that newspapers clearly separate these functions. As I noted a few weeks ago about another GM "news" story:
So, is this commentary, like the executive pay rants Morgenson does every Sunday, or is it news? Or is the Times' point that we're not supposed to get that straight?
This story is replete with issues that GM has already discussed in her opinion pieces. For example, she has written about the need to bring back Glass-Steagall type regulation to break up the financial services industry. Today she says,
it is undeniable that brokerage firms, with their varied businesses all under one roof, remain particularly well-positioned to capitalize on inside information. Not only do these firms advise buyers and sellers in mergers, giving them immense access, they also have proprietary trading desks that invest the firm’s money in stocks and other securities, money management units that invest for clients and trading desks that profit mightily by executing trades for hedge funds.
Last April 30, I discussed a Morgenscreed in which
Morgenson talks about "breaking up financial giants" and asks darkly whether "anybody else noticed how many scandals based on conflicts of interest at big financial firms have surfaced since Glass-Steagall's demise.
So is today's story news, or is it fodder and "support" for her opinion columns. As with prior Morgenson news/opinion stories, it's very hard to tell.
Even worse, so much of Morgenson's analysis, as usual, is faulty and misleading. In particular, Morgenson deliberately obscures the important difference between trading on non-public information and trading on illegal inside information.
The point of the story is to criticize the SEC for not going after more insider trading on merger activity. Morgenson rehashes the firing of Gary Aguirre, and quotes a money manager as saying "Either the S.E.C. should get very, very serious and prosecute a lot of people or forget about it.” But the question is, which of this trading is illegal, and which is simply trading on news?
Although Measuredmarkets, which the NYT hired to conduct its study, apparently attempts to distinguish the two, this is extraordinarily difficult because so much legitimate trading can be based on non-public information. Should we rely on Measuredmarkets or the SEC and the exchanges? As Morgenson reports: "The S.E.C. . . . .said that it had looked at Measuredmarkets’ system and concluded that surveillance techniques of self-regulatory organizations like the New York Stock Exchange were more sophisticated."
Morgenson hints that the SEC prosecutions of insider trading are the tip of a bigger iceberg. Hence the horrible problem that sparked the story. She says, '[t]he probability of detection appears small, based on the number of cases brought in the United States, and the penalty for insider trading is often a negotiated settlement that may not involve much more than giving up the gains."
But there is no reason to suspect that the probability of detection is in fact low. The events that might have triggered insider trading eventually become known. It's pretty easy to spot abnormal trading that might be related to material non-public information. In other words, illegal insider trading may be over-detected -- the difficulty is sorting out the legitimate and the illegitimate activity. Illegal insider trading is therefore a fool's game – sort of like bank robbery. There is no reason to think there's a major undetected crime problem here.
All of this relates to Morgenson's inability and/or unwillingness to understand the relevant legal rules. She says, "Mergers and acquisitions present particularly rich opportunities for profiting on insider information, a violation of the securities laws written to keep all investors on a level playing field."
This legal analysis is flat wrong. The Supreme Court has explicitly said that the insider trading laws are not intended to keep investors on a "level playing field." Moreover, any such intent would destroy property rights in information which are the basis of efficient securities markets. Rather, the insider trading laws police misappropriation of information.
Morgenson's mistake is inherent in her typical effort to leverage her story by referring to the highly public prosecution of Martha Stewart. Although she notes that Stewart wasn't convicted of insider trading, she slyly says Stewart was found guilty of "related charges." Well, that depends on what you mean by "related." As I discuss here, she was found guilty of charges that had nothing to do with insider trading.
And then there's Morgenson's misguided economics. She says
When stocks gyrate because nonpublic information about deals has leaked out, many people are harmed. The most affected are those who sell shares in the company before it is taken over at a significant premium. An investor who sold Georgia-Pacific shares on Nov. 9, just before the unusual trading, missed a 46 percent gain. Those who sold the Andrx Corporation, just before unusual trading began last February missed, a 36 percent gain.
No. The investors in this scenario lost because of non-disclosure, not because of insider trading. Indeed, investors in the market likely gained in the sense of trading at more accurate prices because of the presence in the market of informed traders. And that's the whole problem with broadly regulating trading trading on nonpublic information.
Finally, Morgenson says:
Others also lose. The company that makes the acquisition, for example, may wind up paying more. Investment advisers typically include a company’s target share price and total market capitalization in the analysis of what an acquirer should be willing to pay. If a stock rises in the days or weeks during negotiations, the purchase price could be driven higher. A rising price could even scuttle a merger if the deal becomes too costly to the prospective buyer.
At last she gets something right. But this, too, doesn't help her argument. The point here is that the losers from insider trading are the companies that own information, not investors who don't have a "level playing field."
In sum, this page 1 story on one of America's leading papers is a particularly egregious example of shoddy and slanted reporting by, perhaps, America's leading practitioner of shoddy and slanted reporting. No doubt Morgenson's influence will lead to misguided regulatory and legislative activity, which will impose additional costs on American business. Shame on Morgenson, and even more importantly, shame on her editors for failing to see the dangers of mixing news and commentary, for propogating these phony scandals to sell newspapers.
Right on as always; she really is a national embarrassment. Do you ever take the time to write letters to the Times summing up your blog posts on Morgenson? It'd be nice to sometimes see a saner view in the paper itself.
Posted by: Matt | August 28, 2006 at 10:25 AM