More Academic Studies: Is There a "Dark Role" Played by Investment Banks in the Market for Corporate Control?

By Cydney Posner

Will another academic study spark another series of scandals or regulatory frenzy, depending on your POV, as occurred with the options backdating study?  In a WSJ article today, the authors report that regulators are currently reviewing pre-deal trades by investment banks to determine if a number of favorable stock purchases were merely fortuitous "or something else." The investigations were triggered by a new academic study that found accumulations of shares of merger targets by banks advising on the mergers occurred more frequently than would be expected by happy coincidence, concluding that some banks were likely trading on inside information about deals handled by their investment banking arms. The study found that, during the last quarter before a merger announcement, large investment banks serving as lead advisers to acquirers accumulated shares in target companies just over 19% of the time -- either by taking new stakes or significantly increasing existing stakes-- compared to the 10.5% rate of investment banks not serving in that role. The article suggests that, while banks are required to monitor trading to ensure compliance with "watch lists" of stocks in which trading is prohibited, there may be a potential weakness in the construction of watch lists. When bankers notify their compliance departments about a potential merger depends upon when merger talks become "material,"  which is a judgment call made by the bankers. Delays in putting clients on the watch list could leave a window of opportunity for news of the talks to leak without much scrutiny.  The article discusses several interesting examples.

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