In a surprise announcement today, billionaire Warren Buffett‘sBerkshire Hathawayannounced it had agreed to purchase food giant H.J. Heinz Co. for $23.2 billion, with shareholders set to receive $72.50 a share – a nearly 20% premium to Heinz’s closing price yesterday. While those shareholders are no doubt counting their good fortune today, it appears that advance news of the announcement may have leaked yesterday afternoon judging by options market trading activity. Indeed, historical options data shows that trading in the June $65 calls yesterday was nearly non-existent, with only 14 contracts purchased Tuesday and not a single contract changing hands on Monday. This trend continued into Wednesday, until 1:31:32 P.M., that is. In a one hour span from just after 1:30 P.M. to 2:30 P.M., over 2,500 contracts were purchased for a total outlay of nearly $92,000. In less than 18 hours, those same contracts would be worth nearly $2 million more after news of the deal broke.
Options, which give the holder the right – but not obligation – to buy or sell a security at a specific price on or before a specific date, are favored by sophisticated investors as a cheaper way to bet on the direction of an asset with potentially exponential returns. As a result, options are often the tool of choice for those who attempt to profit off access to non-public information. In this example, the Heinz options purchased yesterday appreciated nearly 2,000% after Buffett’s purchase was announced.
credit: Zero Hedge
However, just as suspicious trading in a company’s stock can signal suspicious trading, drastic swings in options volume just before a significant event may act as a red flag for regulators. In this case, as shown in a graphic posted by Zero Hedge above and historical options data acquired by the author, the open interest in the June $65 calls showed that less than 300 contracts had changed hands since December 2012, and as recently as mid-January had seen multiple days of zero volume in the contract. The purchase of 2,593 contracts within the span of a single hour on the last trading day before the acquisition’s announcement is sure to raise questions with the Securities and Exchange Commission (“SEC” or “Commission”).
On its face, the turn of events certainly appear suspicious, and it is likely the SEC may at least investigate the details behind the purchases. Indeed, insider-trading prosecutions have become a top priority for the SEC, which is recently coming off a banner year in 2012 having brought the highest ever number of insider-trading-related enforcement actions. This featured not only an increase in the sophistication of the SEC’s investigative tactics, but also the use of methods such as wiretaps that were previously used for primarily drug-related and racketeering offenses. Wiretaps were front and center in the prosecution of the Galleon Group’s Raj Rajaratnam, who was found guilty and received an 11-year prison sentence.
But don’t expect the SEC to come out swinging in the financial presses. While in the past the SEC might first talk directly to the suspected trader, the Commission now prefers to operate under the radar, first collecting trading data from various sources and investigating potential connections between those involved in the headlines.
Another Brush With Insider-Trading Laws For Berkshire
If the incident does raise eyebrows with regulators, it would be the second time in nearly two years that an insider-trading issue was linked to Buffett’s Berkshire. In March 2011, Buffett’s right-hand man, David Sokol, resigned abruptly amid accusations he had mislead Berkshire about his personal stake in a chemical manufacturer he had recommended to Buffett as a takeover target. An internal Berkshire review later accused Sokol of violating company standards, but stopped short of concluding Sokol violated federal insider-trading laws. The SEC investigated the matter, but declined to file charges against Sokol.
UPDATED AT 4:53 P.M. EST: Bloomberg is reporting that the SEC has opened a preliminary investigation into the unusual trading activity. The review is said to be in the early stages.
More options trading data for Heinz is available here (daily) and here (5-minute).