Did 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 nice about short sellers. So it’s hardly surprising that after I made sympathetic noises about Jim Chanos this 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.