Insider Trading

The trading (i.e., buying or selling) of securities by a person on the basis of material non-public (or ‘inside’) information. Although a problem for companies’ generally, the difficulty with insider trading is particularly acute in mergers and acquisitions. Studies have shown that few items of information are as consistently leaked, particularly in certain economies, as the existence of merger discussions, so that worldwide, almost half of all M&A transactions involving public companies slip-out pre-closing or announcement. Such leaks are problematic for a variety of reasons:

First, they drive up the price the acquirer must pay for the target, typically also increasing the control-premium (i.e., the amount over the market price) that the acquirer must pay by a further third;

Second, if the merger is ‘full form,’ i.e., the acquirer is paying with its own stock, its share price will usually be depressed by a leak. As a result, such leaks can either ‘kill’ a deal, or at least render it much more expensive for the acquirer;

Third, target companies also, at least until they are committed to a transaction, have good reason to keep negotiations quiet, as a disclosure may disrupt customer relationship and cause internal morale problems as well as undermining the incumbent target management’s own position if the deal does not go through, damaging the value of the acquired business;

Fourth, résumés and curriculum vitae can “fly from the target like confetti” if it is known to be in play, potentially seriously devaluing it.

Addressing this category of leaks requires that the usual non-disclosure agreements (‘NDAs’) used to protect confidential business information be extended to all advisors of the target and acquirer and specifically encompass the fact of the contemplated transaction. It is not enough to assume that professional advisor organizations will have such confidentiality policies in place or carefully enforced; studies have shown they often don’t or that they are laxly enforced.

It should also be noted that objective studies have shown that the prevalence of insider trading and effectiveness of the enforcement of laws against it varies markedly across the world. The rules are regarded as most strictly enforced in the United States, where well-known business people are often jailed for transgressions. By contrast, even some countries with facially reputable corporate cultures have in real terms enforcement that is inconsistent. In general, if a transaction is price sensitive, it is wise to be conscious of such practical differences in business culture and find ways to deal proactively with it.

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