Where new insider trading theories are thought up. Photographer: Joshua Roberts/Bloomberg

Software Moguls Insider Traded on Market Fantasies

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Just in time for law school final exam season there is this weird insider trading settlement between the Securities and Exchange Commission and three founders of Lawson Software. Herbert Richard Lawson, the co-chairman of Lawson, knew that Infor and Golden Gate Capital had offered to buy the company for $11.25 per share. So he called his brother, William Lawson, and his buddy John Cerullo, who no longer worked for the company, and they traded on that information, making an illicit profit of around $2 million.

That sure sounds like insider trading: Richard Lawson knew about a merger offer, tipped his buddies, and they traded on the information. But the weird thing is that everyone knew about the merger offer. Lawson Software had announced it publicly in a press release before Richard Lawson leaked it. The merger news was no longer inside information.

But Cerullo and William Lawson weren't buying stock ahead of an un-announced merger. They were selling stock, ahead of an announced merger, because the market didn't believe the announcement. From the SEC's complaint:

The press release did not dampen the market’s enthusiasm for Lawson Software stock. On Monday, March 14, 2011, the first trading day following issuance of the press release, the stock price increased another six percent, closing at $12.24 per share -- now nearly $1 higher than Infor’s offer of $11.25; the stock price had now risen 23 percent in less than one week, since Reuters reported that the Company was considering a sale. The latest price increase was fueled, at least in part, by new reports predicting higher, competing offers for Lawson Software. One analyst wrote that the Company “could attract a higher bid from either Oracle or SAP . . .” Another analyst wrote that Oracle would likely make a higher offer for Lawson Software in a “multi-bid process” and that the Company would get at least $15 per share, perhaps as much as $18. By this time, both Oracle and SAP had informed Lawson Software that they were, in fact, not interested in acquiring the Company.

So Richard Lawson called his buddies, told them the market had gotten ahead of itself, and they sold stock, at prices north of $12 a share. Since the company eventually signed a deal at $11.25, Lawson's buddies did rather better than the public shareholders.

That's obviously a jerk move, but is it insider trading? What material nonpublic information did Richard Lawson have? Mainly, he seems to have known that unfounded analyst speculation was unfounded. It is not exactly best practices for a company's chairman (or his tippees) to trade while merger discussions are ongoing, but it's a bit of a novelty to call this insider trading. Plenty of corporate insiders sell plenty of stock without carefully checking analysts' reports to make sure that they're accurate; the insiders' obligation is to disclose all material facts, not to make sure that there are no mistakes in the analyst reports.

This is not a case of an insider knowing something material that the market doesn't know; it's a case of the market fantasizing about something that turned out not to be true. Insider trading law doesn't normally hold insiders liable for the market's -- or, at least, some analysts' -- fantasies.

But you can see why the SEC brought the case, and why Lawson et al. settled. I mean, this really is a jerk move, and I guess Lawson Software's disclosure was not as complete as it could have been. Mostly though this feels like the SEC's efficient-markets fundamentalism, and the notion of "fraud on the market," at work: The problem is not that analysts had fantasies; the problem is that those fantasies affected the market. The problem is that the price was wrong.

If you're an insider, on this theory, and you know that the price is wrong, you can't trade until it's corrected. Just announcing the truth isn't enough. You have to get the market to believe you.

  1. Incidentally, according to the complaint, "The calls marked the first time that Richard Lawson had phoned either man in 2011." This is March 12; that's kind of a long time to go without talking to your brother?

  2. It got the $11.25 proposal in February 2011; Reuters reported on it on March 8; Lawson publicly disclosed "that it received an unsolicited, non-binding proposal from Infor and Golden Gate Capital to acquire all of the company's outstanding common stock at a price of $11.25 per share in cash" on March 11; Richard Lawson tipped William Lawson and Cerullo on March 12; they traded on March 14; and Lawson Software ultimately signed a deal -- at $11.25 a share -- with Infor and Golden Gate in late April.

  3. Also, before the press release, there was speculation following the March 8 Reuters article:

    On March 8, 2011, while the Infor discussions were continuing, Reuters reported that Lawson Software had retained a financial adviser to explore a possible sale of the Company. The article identified Hewlett-Packard, IBM and SAP, among other companies, as potential acquirers of Lawson Software.

    The Reuters article led to an immediate increase in Lawson Software’s stock price, which jumped 13 percent on March 8 to close at $11.19 per share. The Reuters article also fueled widespread -- and incorrect -- media speculation as to potential acquirers of Lawson Software and a possible merger price. For example, on March 9, 2011, one analyst wrote that, “according to sources,” SAP, Hewlett-Packard and IBM, among other companies, “might be interested in buying Lawson.” In fact, by March 9, these companies had already informed Lawson Software that they were not interested in an acquisition. On that same date, another research analyst opined that investors should continue buying Lawson Software stock and suggested a merger price “in the $13-$15 (per share) range.” On March 10, another analyst opined that a “deal could get done in the $14-$16 range.” Amid these reports, Lawson Software’s stock inched upward; on Friday, March 11, shares closed at $11.55 per share – now higher than Infor’s offer of $11.25.

    By the way, strong move Infor, signing a merger agreement at a price 30 cents below the pre-announcement price.

  4. He did know that Lawson Software's financial adviser, and its board, thought that $11.25 was a "reasonable valuation," but presumably the market thought something similar, since the stock was trading below $10 on March 7, a week before Richard Lawson's buddies started trading. And he knew that Lawson Software had done a market check of the Infor bid and come up empty, reaching out to five potential bidders and getting no positive responses.

  5. Why didn't the analysts know that, by the way? Like everyone is going around saying "oh boy Oracle is going to bid for Lawson," but no one is calling Oracle to ask?

    One possibility is of course that Lawson's own bankers and lawyers were leaking stories of competing bids to try to drive up the price, though this theory works better for media reports than analyst ones. In any case, again, good work Infor, ignoring these efforts and standing firm on price.

  6. I mean come on seriously never do that.

  7. The counterexample is earnings: If you know that earnings will miss expectations, that seems like material nonpublic information, and is sort of analogous. The materiality comes from the disconnect between the actual facts and the analysts' rosier expectations. It's not perfectly analogous, though, because here they announced the proposal, and its price. It's like if a company discloses that earnings per share will be $2 and analysts say, "no we think they'll probably be $2.50."

  8. Like it omits things like "we've already been negotiating this proposal for months," "our board agreed this proposal is fair" and "we price-checked it and got no other interest." All of those are things that would undermine Lawson's negotiating position with Infor, or that would sound a little more definitive than securities lawyers would like, or both, but if you're going to trade on that press release ideally you'd like it to be a bit more informative.

  9. And in an easy-to-see, binary way: If the market knew that $11.25 was the best deal Lawson Software was gonna get, the stock would trade below $11.25. If it was trading above $11.25, then the market thought something wrong.

    This, by the way, is a weak theory. Like, Lawson didn't market-check with every conceivable buyer; what if someone came out of the blue and offered $15? And it was still negotiating the deal: It never got above $11.25, but it couldn't have known that at the beginning of negotiations.

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To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Toby Harshaw at tharshaw@bloomberg.net