Date Submitted: 02 Apr 2017
WHAT’S THE INVESTMENT ISSUE?
In this brief, we provide an investor’s-eye view of a piece of research that shines a floodlight on an inherently opaque subject—private meetings between senior management and investors. Both camps are presumed to know better than to share or receive anything that could be considered material non public information (MNPI). Nonetheless, the authors of this study point to some dubious trends associated with these sit-downs. The question of whether a falling tree makes noise in a forest devoid of hearing-enabled life forms has long held its own as a rudimentary philosophical riddle. But as a practical matter for debate, it’s not much of one, i.e., we’re pretty sure that in all likelihood, a tree crashing to the ground does make a sound. Now ponder this: If a private meeting between senior management and a fund manager takes place—and no one else is there to hear what’s said—are there consequences in the stock market? In other words, what is the point of these cozy sit-downs? Do the parties stand to benefit? Such meetings, of course, are routine and perfectly legal, provided the executives at the publicly traded company steer clear of disclosing any MNPI. The authors set out to ascertain, among other information, to what extent corporate insiders—who control the timing and content of meetings—trade on those meetings. “Overall, our results suggest that companies disclose material non-public information during these meetings and some participants trade on the information,” the authors state.
HOW DO THE AUTHORS TACKLE THIS ISSUE?
The question of whether the meetings lead to some competitively advantageous information being leaked, maybe inadvertently, under the camouflage of crafty syntax, or even brazenly, might have remained one of mankind’s eternal mysteries had it not been for the Shenzhen Stock Exchange (SZSE). In 2009, the SZSE became the first exchange to require listed companies to report dates of private meetings with investors. Since August 2012, the SZSE has also required summary notes of what was said during those meetings, creating a dataset of some 17,000 meeting reports that the quartet of authors mined to startling effect. The authors found highly suspicious trading patterns among company insiders timing transactions ahead of and in the wake of private meetings. Although only 20% of private meetings can be connected with disclosed insider-trading activities, it is worth underscoring that the trades, some USD12 billion over a 28-month sample period (August 2012–December 2014), represent nearly two-thirds of the value of all insider trading among SZSE-listed companies during that time. Interestingly, nearly three-fourths of listed companies held at least one private meeting per year; the average was around five meetings per year. Most meetings were hosted in the companies’ headquarters.
WHAT ARE THE FINDINGS?
The research shows a clear trend of abnormally positive stock returns starting approximately 22 days prior to the private meeting dates. In fact, the average stock price run-up translates into RMB73.1 million (or about USD11 million) per average firm in the sample. Call it the “meeting anticipation effect” whereby investors/insiders trade on the not-irrational belief that in-house meetings generally reveal positive information. Some insiders appear to be selling into what they anticipate to be herd buying, using the increased volatility to mask their offloads.
WHAT ARE THE IMPLICATIONS FOR INVESTORS AND INVESTMENT PROFESSIONALS?
Many large institutional investors will undoubtedly scoff at the implication that they are gaming the system—or being gamed—by participating in face-to face conversations with the leaders of the companies in which they are investing large sums. These fund managers will also point to proprietary research processes that emphasize sophisticated models and, using the authors’ term, a “mosaic” of skillfully assembled information. Companies that hold meetings, likewise, could just as easily frame these interactions as transparent corporate citizenry, as evidenced by the high “information quality” scores enjoyed by the majority of the companies that report private meetings. The pieces are thus firmly in place for the facilitation of reinforced feedback loops: Companies that hold meetings have more analysts covering them, and these analysts represent large funds whose trades are closely watched. Insiders, who have seen this movie before, are not blind to the ripple effects of a few well-placed dollops of promising insinuations or even flat-out MNPI utterances. That there is an opportunity, thanks to the SZSE and the authors, for a sophisticated fund manager to write an algorithm scouring the mere record that meetings took place in an effort to catch some window of upside could be seen as one logical outcropping of the findings here, although we can think of another. Regulators in a developed market such as the United States might also find it useful to require some record of private meetings. Fund managers in the United States spend USD1.4 billion a year for face time with executives. The investment pays off well for those fund managers who are invited to these meetings and who make profitable trades around the meeting dates. According to the authors, the information gained from private in-house meetings provides these fund managers, and their investors, with an additional competitive edge. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
Summarized by Rich Blake. Rich is a veteran financial journalist who has written for numerous media outlets, including Reuters, ABC News and Institutional Investor. The views expressed herein reflect those of the authors and do not represent the official views of CFA Institute or the authors’ employers.