Hedge funds, like any investor, are required to announce when they have acquired a large stake in a public company. Some hedge fund activists, however, may be quietly sharing their targets with peers before they tell the world — or so concludes new research into investors’ internet search activity.
Finance professors from three U.S. universities this week published a paper focusing on the ten-day window before activist targets are publicly disclosed. The study was based on public records from the U.S. Securities and Exchange Commission showing the IP addresses that accessed the SEC’s online database of financial records and regulatory filings, called EDGAR, between February 2003 and June 2017.
Using these IP addresses, authors Ryan Flugum, Choonsik Lee, and Matthew Souther were able to identify institutional investors, such as hedge funds, that accessed EDGAR data for activist targets — days before the activist campaigns became public.
Some of these internet searches may have been coincidental. But, according to the researchers, the download activity documented in the EDGAR log files suggests a pattern.
“We find that certain institutional investors are especially adept at predicting the targets of a specific activist, downloading information pertaining to multiple campaign targets from that activist during the 10-day window prior to public disclosure,” Flugum, Lee, and Souther wrote. “This pattern of informed EDGAR access suggests that these investors have information pertaining to the activist’s targets.”
Such non-public information can be “immensely valuable” to investors, the researchers argue, because stock prices tend to go up when activist campaigns are announced. And trading activity suggests that investors are acting on this information: According to the paper, the presence of a seemingly informed investor on a company’s EDGAR log file is “associated with significantly increased trading volume in the underlying stock,” with average turnover increasing by about 0.5 percent of outstanding shares.
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As for the activists, the authors argue that earning the goodwill of their peers can benefit them down the line: “By leaking this information, and allowing the informed shareholders to build positions in the targeted stock ahead of the disclosure-related price jump, activists have added a friendly base of voting support to their campaign, increasing their likelihood of winning any fight with managers.”
Based on the study, “leaking” information ahead of activist campaigns is a “pretty widespread occurrence,” according to Souther, an assistant professor at the University of South Carolina’s Darla School Of Business. Speaking to II by phone, he noted that EDGAR is only one source that investors use to look up a company’s financial records.
“If we can detect this happening with EDGAR, it’s probably happening on a much bigger scale,” he said.
In the original version of the paper, the authors pointed to two specific examples involving two large hedge fund firms: Millennium Management and Susquehanna International Group. Back in December 2006, Millennium filed a 13D — the regulatory form used to disclose large stakes — announcing a 5.8 percent ownership in a company then called Advancis Pharmaceutical Corp. The stock rose by 10.5 percent over the next three days, according to the paper.
One week before that 13D form was filed, an IP address connected to quant firm Susquehanna accessed the EDGAR database to download the pharmaceutical company’s financial statements. It was the first time the IP address had looked up Advancis on EDGAR in at least the previous few months.
“Perhaps this was merely a coincidence,” the authors wrote. “However, just three months earlier, on September 26th, 2006, the same Susquehanna IP address went to EDGAR and displayed a similar sudden interest in the financial statements of Auxilium Pharmaceuticals.” Millennium would disclose a 5.7 percent stake in the company the next day.
“We dispute the findings of these authors as the research does not accurately reflect what occurred,” a Millennium spokesperson said Friday.
The authors have since updated the paper, replacing the references to Millennium and Susquehanna with fake names, as well as anonymizing the dates and targeted firms.
Millennium does not position itself as an activist firm, and the two 13D filings contained no planned activist campaigns against either firm. Even if Millennium and Susquehanna exchanged information about the trades — which the EDGAR data does not definitively prove — there’s no rule saying they can’t.
According to Daniel Bresler, a counsel at law firm Seward and Kissel, activist hedge funds are required to disclose if they are working in a group — specifically, if they and other investors have agreed that they will vote in concert on a shareholder proposal.
“A one-way information flow does not rise to that level,” he said by phone. “There needs to be something that actually forms that agreement.”
In their study, Souther and his co-authors focused on hedge funds and other institutional investors that were not openly working together. They found that any time an activist appeared to have leaked campaign information to unaffiliated investors, that activist was more likely to enter into a proxy fight — and more likely to win.
“The data seems to point to friendly shareholders,” Bresler said. “The key fact will be whether there was an agreement to act in that friendly matter.”
The study’s authors “can’t conclusively say” such quid-pro-quo agreements existed in the cases they documented, according to Souther. “But it seems to be the pattern,” he added.
Souther suggested that the U.S. Securities and Exchange Commission may want to look further into information sharing ahead of 13D filings, noting that the regulator had already opened investigations into hedge funds that did not disclose agreements that they would vote together in proxy contests.
“At least based on the regulations they’ve laid out, I think they would classify this as an unfair trading practice,” he said.