THE WALL STREET
Investors Often Leak Their Plans to a Favored Few
Tips Help Build Alliances for Campaigns at Target Companies
Susan Pulliam, Juliet Chung,
David Benoit and Rob
March 26, 2014 10:37
Rino International Corp. sank
28% in the two days after investment firm Muddy Waters LLC put out a
report attacking the Chinese company's accounting.
Three investment firms were ready for the news.
For a new breed of
"activist" investors, tipping other investors is part of the
playbook. Susan Pulliam joins MoneyBeat with details. Photo:
The firms had been tipped beforehand by Muddy Waters about the
scathing November 2010 report, according to a person close to the
matter, who said one of them made a bet against Rino stock that
produced a $1 million-plus profit.
"We sold advance copies of our report," said Muddy Waters's founder,
Carson Block, adding that since then he has tried to limit advance
knowledge of his firm's research.
For a new breed of "activist" investors, tipping other investors is
part of the playbook. Activists, who push for broad changes at
companies or try to move prices with their arguments, sometimes
provide word of their campaigns to a favored few fellow investors days
or weeks before they announce a big trade, which typically jolts the
stock higher or lower.
In doing so, they build alliances for their planned campaigns at the
target companies. Those tipped—now able to position their portfolios
for price moves that often follow activist investors'
disclosures—benefit in a way that ordinary stockholders who are still
in the dark don't.
"Premarketing, that's what they are doing. This is all part of the
campaign. They are building a constituency," said James Woolery,
chairman-elect of corporate law firm Cadwalader, Wickersham & Taft LLP,
who represents companies against activists. "Some are using, in
effect, the pop in the stock price to help pay these people" for being
on their side in a coming battle against the target company.
Stocks often move in the days just before activist investors tell the
world what they are up to, a Wall Street Journal investigation shows.
In the 10 trading days before bullish activists revealed in regulatory
filings that they had bought particular stocks, the stocks rose an
average of 3.2% more than the overall market, according to a Journal
analysis of 975 announcements by leading activist investors since
Similarly, an analysis of 43 announcements by bearish activists since
2007 found that in the preceding 10 trading days, shares of targeted
companies fell by an average of 3.8% more than the market as a whole.
It is impossible to know how much of the price change is due to
activists' own trading or other factors.
Many lawyers believe that there are few insider-trading risks in one
investor tipping another about his plans or actions because this
typically doesn't involve a breach of a duty to keep the information
confidential. A spokesman for the Securities and Exchange Commission
said he couldn't recall the agency having brought a case in the area.
But potential legal issues lurk. The SEC requires disclosure in
certain instances where investors act together on a particular stock.
And the agency recently has been expanding boundaries in its pursuit
of securities-fraud cases, some lawyers say.
At first glance, it might seem bizarre for an investment firm to tip
others to its intentions. Many large investors do the
opposite—striving to hide their moves, through techniques such as
breaking up large stock purchases into many tiny ones.
But activists approach stocks differently from investors who simply
take a stock position and wait for the market to justify it.
Activists—some of whom might have been called corporate raiders in the
past—don't just wait but try to move the stock by disclosing their
investment and often making a vigorous public argument about the
target company, pro or con.
The role they play can be positive. Bullish activists often pressure
management for changes some shareholders welcome, such as repurchasing
shares, raising dividends, spinning off noncore business units or
selling the company. Bearish activists can expose questionable
accounting or other issues. On the downside, companies' adoption of
short-term strategies to avoid being targets can have "very serious
adverse effects" on companies, attorney Martin Lipton of Wachtell,
Lipton, Rosen & Katz LLP has written.
Activist investors' clout is growing. They managed $93.1 billion last
year, up 42% from 2012, according to a tally by research firm HFR that
looked at 67 activist hedge funds.
Some activist investors say that speaking with other investors about
their ideas helps them test and refine their investment theses. "I'm
happy to give people my thoughts on things I own and I'm happy to
learn about how other people think," said Greg Taxin, who heads the
activist strategy of hedge-fund firm Clinton Group Inc. "Putting
earplugs in and blinders on isn't the smart approach." He said Clinton
pursues only "conversations that are permissible under the rules."
There also is a kind of buddy system among activist investors, some
say. Many high-profile investors who know each other don't want either
to get blindsided by another's investing—or to blindside others.
Lawyers often advise clients it is generally permissible to share
information about their trades before announcing them. "In the U.S.,
information that an investor would have about its intentions is not
material nonpublic information that can't be used," said David
Rosewater, a lawyer who represents a number of activist investors.
Still, there are gray areas that haven't been tested. Investors whose
stake in a company reaches 5%—a level SEC rules require them to
disclose—must inform the SEC if they are working as a part of an
investor group or have an understanding or agreement with other
investors about a stock. If one or more investors collectively own 5%
of a stock and are operating as a group, they too are required to
disclose that to the SEC, along with their holdings. Such disclosure
rules don't apply to bearish bets.
In recent months, the SEC has increased its focus on activist
investors' moves, including whether there is proper disclosure, a
person close to the situation said. Last summer it began looking into
whether some hedge funds were working together to try to profit ahead
of public disclosure of an investment stake.
The probe relates to the tug of war over nutrition company
Herbalife Ltd., which
William Ackman of Pershing
Square Capital Management LP has bet against and publicly criticized.
Last July 31, Herbalife's stock rose sharply after reports that Soros
Fund Management LLC had taken the opposite bet with a large stake in
A couple of days later, according to a person familiar with the
situation, Mr. Ackman's lawyers wrote to the SEC alleging that a Soros
portfolio manager, Paul Sohn, had told people at other hedge funds
that the Soros firm would soon disclose a 4.9% Herbalife interest, and
had urged them to make the same bullish bet. On Aug. 14, the Soros
firm disclosed the 4.9% stake.
In a previously unreported development, the SEC has since sent about
25 subpoenas to hedge funds asking for information about their trading
in Herbalife, according to people familiar with the investigation. The
SEC spokesman declined to comment. So did a spokesman for Soros Fund
Management, which manages the assets of billionaire
George Soros, his family and
their foundations. Mr. Sohn didn't return calls for comment.
Some leaks occur even when activist investors say they have kept their
William Ackman Reuters
On Nov. 8,
Riverbed Technology Inc. shares
leapt 16% after hedge-fund firm Elliott Management Corp. publicly
disclosed that it held a stake in the company. Before Elliott's
disclosure, information leaked to traders who acted on it by taking a
bullish position on the stock, according to a person who was apprised
of Elliott's intentions by a firm with close ties to Elliott.
In the 10 trading days before Elliott's disclosure, Riverbed shares
rose 7%. Elliott continued buying Riverbed shares during the 10 days,
a regulatory filing showed.
Elliott sometimes buys a stake, usually 5% to 10%, in a company and
then pushes for a sale of the whole company. Before such moves,
Elliott at times speaks with officials of private-equity firms about
their thoughts on the target company, people close to Elliott said.
Sometimes, Elliott has been on the receiving end of a tip.
Jana Partners LLC, another activist hedge fund, told Jesse Cohn,
Elliott's head of U.S. activist investing, that Jana had taken a stake
Juniper Networks Inc. before
news outlets reported this stake on Jan. 23, according to people
familiar with the matter.
Though Jana's investors had already been informed of the stake, and
Juniper stock was rising, the stock gained 1.2% more in after-hours
trading following the news reports. Elliott, which was already a
Juniper stockholder, didn't increase its Juniper position after the
tip from Jana, according to a regulatory filing.
Jana disclosed a 2.7% holding in Juniper in a regulatory filing on
Feb. 14. A Jana representative said there is nothing wrong with fellow
shareholders talking, adding that the fund firm already had told its
investors in advance of what he described as the "alleged
conversation" with Elliott's Mr. Cohn.
Critical research reports that Muddy Waters publishes on stocks often
knock them for a loop.
The targeted stocks, however, typically don't wait for the reports to
begin their slide. Twelve companies Muddy Waters has targeted since it
began publishing reports in 2010 tumbled an average of 13.1% below the
overall stock market in the 10 trading days before its reports came
out or the firm's Mr. Block publicly said he had bet against the
Among such target companies was Rino International, which sank nearly
18% in the 10 trading days before a Nov. 10, 2010, Muddy Waters report
Before that report on Rino—a Chinese maker of equipment for the steel
industry—three investment firms, including hedge fund Oasis Management
LLC, paid $20,000 to $25,000 apiece for an advance look at the report,
a person familiar with the matter said. Oasis then placed a bet
against Rino's shares, the person said.
When Muddy Waters's report came out, it alleged that Rino showed
"clear signs of cooked books." Soon after, Rino disclosed a letter
from its auditor acknowledging some of the accounting problems raised.
Oasis closed out its bearish bet with a profit of more than $1
million, the person familiar with the events said.
In a statement, Oasis said it "purchases and subscribes to research
reports, analysis, and opinions from investment banks and independent
research firms," and follows "rigorous compliance procedures at all
Two and a half years after Muddy Waters's report, the SEC alleged in a
civil complaint that Rino and two of its executives had inflated
revenue—allegations they settled without admitting or denying them. A
lawyer for Rino declined to comment. A lawyer for the executives said
they settled "to put the matter behind them." Rino's stock was
delisted. It recently traded over the counter at two cents a share.
In another case, Muddy Waters received an idea for a report from a
hedge fund and later asked questions that indicated a report could be
on the way, the person close to the situation said.
A senior person at Tiger Global Management LLC called Muddy Waters's
Mr. Block in 2011 to congratulate him on an investment success,
according to the person, and during the call said he wanted to "talk
at" Mr. Block about a Chinese company called Sino-Forest Corp.
The Tiger Global person advised Mr. Block not to respond, saying that
any response could make it impossible for Tiger Global to trade
Sino-Forest stock because of regulatory compliance issues, the person
Soros Fund's George
Soros Bloomberg News
Some time later, Mr. Block called Tiger Global asking detailed
questions about Sino-Forest, which showed he had researched it deeply,
the person said. Soon after, Muddy Waters issued a report on
Sino-Forest labeling it a "fraud." Sino-Forest denied the allegation
and filed a defamation suit against Muddy Waters and Mr. Block, which
Mr. Block said at the time was "without merit." The suit is pending.
In the 10 trading days before Muddy Waters made its negative report
public, Sino-Forest's share price sank 12.6%. When the report
appeared, the stock fell a further 21%, then 64% more the day after
Mr. Block, speaking generally and not about Tiger Global, said, "It's
a balancing act for us, because we want to do research as thoroughly
as possible without tipping someone off to what we are working on."
Tiger Global declined to comment.
John Courtade, a lawyer for Muddy Waters who is a former assistant
chief litigation counsel at the SEC, said, "There's nothing
questionable about investors doing their own due diligence, writing a
report, or choosing to speak about some aspect of their work with
Sino-Forest faces a regulatory hearing this fall on fraud allegations
by Canadian authorities alleging it inflated assets and revenue. Since
the Muddy Waters report, Sino-Forest has gone through a court-ordered
restructuring and now is a private entity. A lawyer for Sino-Forest
declined to comment on the allegations.
After the report, Mr. Block called Tiger Global to thank the manager
who provided the initial tip, the person familiar with the situation
said, adding that the Tiger Global manager cut him off and refused to
acknowledge the earlier conversation.
Susan Pulliam at
firstname.lastname@example.org, Juliet Chung at
email@example.com, David Benoit at
firstname.lastname@example.org and Rob Barry at
Methodology: Analyzing Stock Moves Before Activist Investor Events
2014 10:37 p.m. ET
To analyze price moves before investor announcements, The Wall Street
Journal obtained a list from FactSet showing about 1,100 SEC filings
by 50 top activist investors disclosing their positions between 2007
and early 2014.
Removing companies with multiple announcements within a 30-day period,
plus a handful of cases where stock prices weren't available for a
full 10 trading days before announcements, left 975 activist events.
Reporters calculated the price change from market close 11 trading
days before the announcement to market close one trading day before
the announcement. To adjust for the market, reporters subtracted the
S&P 500's change over the same period.
Because investors aren't required to disclose short positions,
reporters manually compiled a list of 43 high-profile announcements by
bearish investors since 2007, and performed the same calculation.
The results showed that targeted companies' stock price increased by
an average of 3.2% above the market in the days before bullish
announcements and decreased by an average of 3.8% below the market
before bearish announcements.