Risk vs. Greed: Making A Large Purchase of Heinz Securities Just Before the Deal Announcement

One day after H.J. Heinz Company announced it was being acquired by Berkshire Hathaway and 3G Capital Partners, the SEC filed an insider trading action seeking a freeze order over about $1.8 million in trading profits. SEC v. Certain Unknown Traders in the Securities of H.J. Heinz Co., (S.D.N.Y. Filed Feb. 15, 2013). As in earlier cases of this type, the Commission moved quickly based almost exclusively on what it calls “suspicious trading” that is so out-sized and dramatic that it virtually demands regulatory scrutiny. The court granted the SEC’s request for a freeze order.

The complaint here differs little from a series of earlier “suspicious trading” cases. On February 14, 2013 Heinz announced that it would be acquired by Berkshire and 3G Capital for $72.50 per share. That price represented a premium of about 20% over the closing price for the previous day. Predictably, the volume of trading spiked dramatically following the announcement to about 64 million shares for an increase of about 1,700% when the announcement was made. The share price rose to approximate that of the deal.

The day before the deal announcement, unknown traders purchased 2,533 out of the money June $65 call options for Heinz. Since each option gave the purchaser the right to buy 100 shares, the options potentially represents a significant block of stock. The purchase was made through an account at what the complaint identifies as the Zurich, Switzerland office of “GS.” The press notes that this is Goldman Sachs.

The complaint alleges insider trading based on “information and belief’ built largely on trading that is “suspicious” because of:

The purchase: The timing and size of the option purchase made one day before the deal announcement;

The account history: In the weeks and months immediately proceeding the purchase, the account did not make any purchase of Heinz options or shares;

The stock price history: The options had an exercise price of $65 which means that to profit the price of Heinz securities had to exceed that amount despite the fact that over the last four months the securities had consistently traded at about $60 per shares;

The amount invested: About $90,000 was spent in one day to purchase out of the money, hight risk options;

The option market: On February 12 only 14 of the same options were purchased while on February 11 none were bought; and

The profits: In one day the value of the account increased by about 2,000% over the amount of the initial investment.

The complaint alleges violations of Exchange Act Section 10(b).

This is not the first “suspicious trading” case brought by the Commission, although since it was filed one day after the announcement it may be the quickest. In a series of cases the Commission has given notice to the market place that out-sized securities purchases made just prior to a deal announcement will draw scrutiny if not an enforcement action even if the identity of the traders may not be known. See, e.g., SEC v. Well Advantage Limited (S.D.N.Y. Filed July 27, 2012)(filed four days after announcement based on large stock purchase two days before deal announcement); SEC v. Yang, Case No. 12-cv-02473 (N.D. Ill. Filed April 4, 2012)(filed eight days after deal announcement against seven defendants who purchased largely options); SEC v. All Know Holdings Ltd., Case No. 11 cv 8605 (N.D. Ill. Filed Dec. 5, 2011)(action filed days after deal announcement based largely on trades placed by four defendants); SEC v. Compania International Financier S.A., Civil Action No. 11 CV 4904 (S.D.N.Y. Filed July 15, 2011)(filed four days after announcement based on large purchases of equity securities).

In view of the Commission’s ability to monitor the markets for large, well timed purchases of options or securities made shortly prior to a deal announcement, it is clear that making such purchases is so high risk it may be viewed as reckless — or as boarding on a wish to get caught. At the same time the potential profits are enormous, meaning that the greed factor his is huge.