CASELAW In the United States Court of Appeals
scattered.com
For the Seventh Circuit
No. 94-2015
SULLIVAN & LONG, INCORPORATED, et al.,
Plaintiffs-Appellants,
v.
SCATTERED CORPORATION,
Defendant-Appellee.
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
Nos. 93 C 4069, 93 C 5346,
93 C 5447, 93 C 5740--Harry D. Leinenweber, Judge.
ARGUED NOVEMBER 1, 1994--DECIDED FEBRUARY 8, 1995
Before POSNER, Chief Judge, and COFFEY and MANION,
Circuit Judges.
This is intended to be a discussion of the rules of arbitrage through the case mentioned above. This is only a summary and should be used for a quick review only. It is our express recommendation that all interested parties read the entire decision (as well as all other investment documentation) when determining weather or not to invest in any of our programs. We have highlighted a version of the case highlightposner.html and the version without emphasis added posner.html.
But like the district judge we have difficulty understanding what right of the plaintiffs the "manipulation" violated or how they were harmed.
The plan contained an estimate that the new shares would be worth only 3 or 4 cents. When the plan was announced, the old shares were trading for more than 30 cents. There were 122 million old shares outstanding.
It(Scattered) sold short, in fact, tens of millions of such shares a week, for a total, when trading ended on June 29, of 170 million shares, far more than the 122 million old LTV shares outstanding. The excess of shares sold short over total shares outstanding is the focus of the plaintiffs' complaint.
The plaintiffs in this case were buyers on the other side of Scattered's short sales.
The warrants, being worth approximately 100 times the old shares, were selling for between $3.125 and $4.125.
Scattered's counsel told us that the only reason the stock did not plunge immediately is that many brokers and investors do not read a plan of reorganization carefully--it is a long, complex, and jargon-ridden document and hence many of them did not at first, or perhaps even at last, realize that the old stock in LTV would indeed be worth only 3 or 4 cents after the reorganization was completed.
They see that the price of the stock is "low," and think that they are getting in on the ground floor rather than climbing aboard a sinking ship.
That is what short sellers do: they bet on a declining market, trusting that they have better information or better instincts than other traders, those who will buy from them. There is nothing unlawful about trading on an information advantage, provided that it is not based on inside information Scattered merely had a better understanding of the information about the reorganization than the investors with whom it traded.
It was a matter of a superior interpretation of public information, the information contained in the plan of reorganization.
The effect of trading on an information advantage is to dispel, by penalizing, ignorance and to bring market values into closer, quicker conformity with economic reality. The
profit that such trading brings at the expense of less knowledgeable traders provides the incentive for a private, for-profit firm, such as Scattered, to provide this economic service.
An efficient stock market is one in which stock prices reflect all potentially available information that is relevant to the economic value of the stocks.
But we would think twice before concluding that these laws prohibit "schemes" that
accelerate rather than retard the convergence between the price of a stock and its underlying economic value and therefore promote rather than impair the ultimate goals
of public regulation of the securities markets.
The name for what Scattered did is not market manipulation, but arbitrage. Arbitrageurs are traders who identify and eliminate disparities between price and value, or as in
this case between today's price and tomorrow's price where the difference cannot be attributed to any prospective change
The old stock was the stock until June 29, the new stock the stock thereafter. The two stocks were so far identical (putting aside the irrelevant difference in the roughly
100 to 1 rate at which old shares were convertible into new) we have not been able on our own to find, a law that requires arbitrageurs or other short sellers to borrow the stock that they are selling short.
Our analysis has shown that nothing alleged in the complaint is the kind of conduct that the securities laws are aimed at combatting.
to recapitulate the essential point of this opinion, since the conduct in which Scattered engaged appears to have served rather than disserved the fundamental objectives of the securities laws, |
