Thoughts on the Berliner charges

Berliner's rumor was rather cleverly crafted. It contained enough specificity of imaginative detail to make it appear that someone 'in the know' was talking.

Here is the i-m he was sending out:

ADS getting pounded - hearing the board is now meeting on a revised proposal from Blackstone to acquire the company at $70/share, down from $81.50. Blackstone is negotiating a lower price due to weakness in World Financial Network - part of ADS’ Credit Services Unit, as evidence by awful master trust data this month from the WFN Holdings off-balance sheet credit vehicle.

The whole incident does tend to reflect poorly on "efficient markets" theory, at least in any very strong form.

On the other hand ... if the EMH is understood on a day-to-day basis (rather than minute to minute) the incident may be educed in the theory's support. ADC did 'get pounded' by the rumopr that it was getting pounded -- yes. But the pounding only lasted for minutes, and at the end of the day the price was back about where it had started. Even before the company had had a chance to issue a denial that the meeting had ever occurred.

Furthermore, the first MSM news coverage that the rumor ever got was coverage of its falsehood under the heading "Anatomy of a Bum Rumor".

Congrats to the folks over at the WSJ blog for getting this story both quickly and accurately.

Third, let me ask a very naive sounding question. Why does exchange self-regulation seem so toothless? Is it really toothless, or is that a false impression? What happened to Mr. Berliner or his employers in terms of their ability to trade on the NYSE hereafter? The SEC's complaint makes no reference to any action by the NYSE itself on that point.

Why not? Hmmmm. The obvious answer is that it is easier to do nothing than to do something, just as in an industrial context it is easier to pollute than to install smokestack scrubbers.

But that obvious answer isn't, by itself a very good one. The problem with pollution is that it's an "external costs," -- the manufacturers with the smokestacks are naturally tempted to pass those costs on to the public at large. But the costs imposed by such disinformation campaigns as Berliner's AREN'T EXTERNAL. They are costs imposed upon some members of the exchange itself by other members thereof.

This should, logically, be the ideal case for self-regulation. Why didn't it happen? I have a theory (I always do) but I'll hold it for now. We'll be back to covering proxy contests in this space tomorrow. Its the height of that season.

Berliner charged with securities fraud

The SEC has charged Paul Berliner, formerly of the Schottenfeld Group LLC, with securities fraud and market manipulation.

It claims (he neither admits nor denies -- though he has settled) that he intentionally spread falsehoods about Alliance Data Systems (ADS) while selling ADS short.

Some background. Last May, ADS -- a company that does something for retailers that involves processing their credit card transactions -- agreed to be acquired by The Blackstone Group, at a price of $81.75 a share. During the period between such an announcement and the actual consummation of the sale, the price of the target company often fluctuates, sometimes rising avove the bid price on speculation that the would-be buyer will have to improve its offer. Sometimes, on the other hand, the target company's price will stay at a discount below the bid price because there will be some skepticism in the market about whether the deal will go through -- whether, especially, the stockholders and the necessary regulatory bodies will sign on to it.

In fact, the ADS/Blackstone merger never happened. The reasons? that's in litigation. Blackstone says it was a regulatory problem -- the Comptroller of the Currency raised objections, because ADS owns a bank. [Actually, it owns two banks, but only one of them is under the regulatory authority of the Comptroller.]

At any rate, the merger was still pending in November, when the stock price for ADS went for its thrill ride, at the Red Flags Theme Park.

Enough background. The gist of the complaint is that during a five minute period in the early afternoon of November 29, Mr. Berliner sent instant messages to 31 other traders/securities professionals that Blackstone was twisting ADS' arms into accepting a lower stock price as part of the merger -- that it would acquire the company at only $70 a share.

When Berliner began disseminating this misinformation, ADS price was selling at $77 a share, so some (justified) skepticism that the $81.75 deal would ever go through was already priced into the stock. But, according to the SEC, what Mr. Berliner was i-m-ing around was simply false: Blackstone had not proposed a lower acquisition price, nor was the ADS board "now meeting" on the subject.

As the rumor spread, the stock price cratered. The intra-day low was $63.65 -- or 17% less than the pre-rumor value.

This enabled Berliner to cover his substantial short position and pocket a quick profit.

In consequence, the SEC brought this lawsuit in the federal district court in Manhattan, and simulatneously settled it. Mr. Berliner agreed to "disgorge" (I love that word) $26,129 in profits and interest, to pay a maximum third-tier penalty of $130,000, and to consent to the entry of an SEC order barring him from association with any broker or dealer.

There is more that might be said about this case, of course. I hope to say a bit of it tomorrow.