Wednesday, June 04, 2008

Lehman Brothers: Destructive power greater than half the starfleet

What to make of the fact that Lehman was apparently buying their own stock in the open market yesterday? Who knows. I think its supposed to send a signal that management remains confident, but no one is buying it. What seems more likely is that Lehman is close to a deal to sell shares to a private buyer (Korea?) and was trying to defend the price.

But here is a serious question that I honestly don't know the answer. Lehman reports earnings the week of June 16. Obviously the people directing purchase of Lehman shares have significant knowledge of what that earnings report looks like. We aren't talking about a run-of-the-mill earnings announcement here, where the question is whether EPS beats the street consensus by 2 cents or not. If Lehman has a significant writedown to announce, senior management already knows it. If they don't, management knows this too.

So given all that, why wouldn't this activity constitute insider trading?

Let's say, for the sake of argument, that Lehman actually has much better results coming that people think. Hey, anythings possible right? Maybe they indeed took losses on some CMBS hedges, as has been widely reported, but lucked into some gains on some other hedges. I'm not saying it happened, this is just for discussion.

So if indeed that's what happened, Lehman management is buying Lehman stock knowing it will rise in the near term. Management wouldn't be allowed to buy shares just before earnings for their personal accounts. But somehow the company can buy shares?

It smells fishy either way doesn't it? They are either just trying to prop up the price a little before a large equity sale. Or they are buying shares with insider knowledge.

Anyway, I know we have readers from the SEC and the Fed. And we have lots of other people more familiar with insider trading rules than I. Someone please explain how they are allowed to do this.

9 comments:

The Epicurean Dealmaker said...

Let one thousand lawyers opine, but in my understanding insider trading only applies to individuals who might profit differentially from inside information. The spirit of the idea is that they are using information asymmetry to profit at the expense of outsiders.

The company, on the other hand, does what it does for the benefit of all shareholders. The only harm or potential harm is to people who are not shareholders (who miss a buying opportunity?) or people who sell shares to the company (and somehow miss further appreciation, e.g.). But these people by definition are no longer/not shareholders, and the company has no obligation to them. Furthermore, LEH is sending a strong signal to all current and potential shareholders with its buying, which constitutes allowed investor communication.

Whether you believe whatever signal they are sending or not is another matter.

Josh Kalish said...

Strange b/c whenever we do basket trades against other banks they can never trade their own name. For example if we swap and S&P500 basket against Citi, we will have to get the Citi shares ourselves. They are always restricted by compliance.

It does seem strange. Don't they have to do an official buyback to buy shares?

acoors said...

If they have an existing 10b5-1 plan they can buy stock at any time. Presumably they set up a buyback matrix shortly after releasing earnings and then automatically buyback shares when prices fall. This is the way corporations buyback shares regardless of insider information.

jult52 said...

Just to clarify what acoors wrote, the 10b5-1 plan sets trading limits to be executed close to automatically by the firm's trader (which I assume would be an external brokerage) between the close of the most recent quarterly books (5/31) and the earnings call (which I believe is sched for the week of 6/16).

One other comment is that these pre-set 10b5-1 instructions would be set right after quarter-end so Lehman could have set aggressive repurchase targets in the recent past.

David Merkel said...

I'm pretty certain that Lehman almost always has a buyback authorized... I don't think it is a smart way to run an investment bank, but maximizing ROE is a religion to many.

Not perfectly certain on the insider trading, but if the buyback is authorized by the board, and done within the parameters that the board has set, then I think that The Epicurean Dealmaker has it right... the buyback affects all shareholders equally.

Accrued Interest said...

I'm hearing that it was normal buying to offset options grants. Much more boring than I had hoped!

Anonymous said...

It's an agreed principle that a company cannot be its own insider. A company always acts on insider information. Anything else wouldn't make a lot of sense...

wilburbls said...

Automatic 10b-5 plan must be the answer because otherwise it's clearly insider trading, even if it's done by the company and not an insider. The whole idea of 10b-5 plans is to strip the entity/person using it from discretion to time purchases/sales. A shareholder who sold its shares back to the company when the company has material non-public information has been defrauded just as if it sold to an insider who is buying on inside info. the beneficiary may be all other shareholders, but that's irrelevant, as it is the unfairness to the seller that is the issue because the buyer has inside info. of course, it's lunacy anyway to think that insiders who buy or sell during permitted windows don't have inside info, it's just that it's become the custom to permit such transactions so long as it's tied to a recent earnings release (and thus not much presumably has transpired from the most recent earnings announcement). i highly dobut leh is breaking the rules here. now whether the buys are sensible is another thing, but it's all a confidence game at this point.

Chus said...

This is what I think: Lehman Brothers Bankruptcy