Did Jim Chanos Break the Law?

The best way of getting lots of angry comments on a blog entry is to be rude about Apple. But the second-best way is to be nice about short sellers. So it's hardly surprising that after I made sympathetic noises about Jim Chanos Friday morning, commenters rapidly popped up to say that he had committed fraud and must indeed be prosecuted.

But that's really not obvious at all. Remember what he's being accused of: front-running the information that a negative research report was going to be put out on a certain company. I asked John Coffee of Columbia whether the SEC has ever prosecuted such a thing, and he replied:

They have where it was the analyst who front ran his own report in violation of firm rules. But today's case is different because the recipients owe no duty to the analyst UNLESS they agreed to maintain confidentiality.
This case may be affected by the pending Mark Cuban inside trading case where the SEC has alleged that Mr. Cuban had agreed to keep certain information confidential and then traded on it (but did not owe a fiduciary duty). In the actions discussed in today's news, there can be no claim of breach of fiduciary duty but there could be an allegation by the SEC of an agreement to keep the information confidential until an embargo date.

The fact is that the Cuban case is a bit of a stretch to begin with: it's basically based entirely on one man's recollection that Cuban promised to keep certain information confidential. But it's ludicrous on its face that Chanos would ever promise to keep a research analyst's information confidential -- it's his job to trade on information. It's equally ludicrous that a research analyst would ever ask Chanos to keep information confidential until an embargo date -- and what's more, there's no indication that the analyst in question did so.

In any case, I'm not at all convinced that it's even possible to start talking about when the contents of research reports become "public information". Research reports, by their very nature, are private documents, which are often released in advance to favored clients. My commenter "Patchie" writes this, which I think is entirely wrong:

Independent analysts are to be independent and the releases of their reports are to be in public forum not private pre-releases so that one gains advantage over another.

If the release of research reports was to be in a public forum, then there would be no way for the analysts to ever make money. Research reports aren't press releases: they're bought-and-paid-for private documentation. The recipients, once they have that information, can do with it as they wish. And if the information in the research report isn't "material public information", it's hard to see how information about the research report can be material non-public information. Which is one reason why it seems so silly that the SEC is going after Chanos here.

Comments

[Aviva:]

Just stupid people lookign for scapegoats, I think.

Feb 14 02:24 PM

[User 357093:]

There's a similar story with a similar reaction, about the HPY president, being covered on Bizzlo

bizzlo.com

Feb 14 02:44 PM

[kotika98:]

there was the long-running 15 year case against Soros in a french court, alleging "insider" trading. Some other entity approached Soros to see if he'd like to join them to bid for a publicly traded company. Soros declined, but then went and bought shares anyway. So, in a way, the "insider" who conveyed the non-public information to him was himself. Nevertheless Soros was eventually convicted, but i havent heard of the case since.

Feb 14 09:22 PM

[HiSpeed:]

The SEC would serve us much better buy going after the Madoffs of the world and simply enforcing the rules on the books (such as naked shorting) as opposed to going after lay-ups like Stewart, Cuban, Chanos, et al.

The nonsense that has been the Standard Operating Procedure of SEC bureaucrats doesn't instill confidence in the markets .

Feb 14 11:33 PM

[otbricki:]

Maybe he's not guilty under the current law, but damn there really needs to be tighter regulation and stiffer penalties on this stuff. It is ridiculous when you see a stock diving or spiking and a couple of hours the news comes out. Clearly there is some trading on materially significant news not available to all market participants going on here. It is one of the big transparency issues that make people mistrust the financial industry.

Feb 14 11:37 PM

[James Shaw:]

We should ban analyst public upgrade/downgrade. All the upgrade/downgrade should be a paid service.

Most of the cases, the free upgrade/downgrade will harm small investors in big way.

Feb 15 12:00 AM

[Steve Soden:]

Our markets need protection, shorting stocks with a small capitalation should not be allowed. This manipulation must stop!

Feb 15 03:18 AM

[Sigmund:]

I don't know the particulars of the Chanos allegations. Insider trading and front running reduce to what did you know, when did you know it and what did you do. If Chanos knew something before it entered the public domain and acted on it before it entered the public domain; then, he probably broke a law and/or regulation. Let us suppose that a research report is an analysis of information in the public domain. The conclusions of the reasearch report are not generally held in the public domain. You act on it, have you broken a law and/or regulation, I think not.

Feb 15 10:45 AM

[The Insider:]

Everyone is looking for the villan in this play- unfortunately everyone is guilty, everyone is innocent. Everyone played it too close to the edge.

Feb 15 08:03 PM

[Paul V. Azz...:]

You can look at it this way: suppose the analyst was working solely for Mr Chanos and Chanos went ahead and shorted? Nothing wrong. Suppose Chanos then went ahead and wrote an article saying he had shorted the company because of a, b, c..... Again, nothing wrong. So how can it be wrong if Chanos acted on what the analyst chose to tell him albeit he told him early on? From what I've read about this, there's nothing wrong. It would have been completely different if a public company discriminated in this way though and someone acted on this prior information.

Feb 16 10:55 PM

[Steve Soden:]

These people need to "Shut Up" and not trade on information they get
from anyone, they are too close to the game.
Don't listen to people with these kinds of ideas!

Mar 20 12:48 AM