Here's an interesting article about "rigged markets".
More specifically, Merrill Lynch doing some front-running on a few of it's funds it's selling to its customers:
February 23, 2000
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Heard on the Street
Merrill Hands Investors Gift
As Stake Lists Spark Copycats
By SUSAN PULLIAM
Staff Reporter of THE WALL STREET JOURNAL
It's as close to a sure thing as you can get these days on Wall Street.
A major Wall Street firm discloses the names of a group of red-hot stocks it plans to buy in bulk -- several weeks before the purchases are made. As soon as big orders begin coming in for the stocks, you snap them up, and bingo! The stocks run up, and you've made a pretty penny.
That's the copycat game going on now between Merrill Lynch and some big institutional investors.
It all started in September when Merrill rolled out a new product called HOLDRs trusts. The trusts are mini-index-like products that trade on the American Stock Exchange and allow investors to own shares in a fixed portfolio of 20 stocks in sizzling areas such as the Internet, biotechnology, drugs and telecommunications. HOLDRs trusts are a lot like unit investment trusts, which have become big business these days for the Street. But Merrill has pitched its trusts, which will be liquidated in 40 years, as a less expensive version, carrying 2% underwriting fees that are about 30% cheaper than equivalent charges for rival products.
Behind the scenes, there's another story. In each of the four trusts Merrill so far has sold, totaling $2.4 billion, there has been a big price climb in the stocks that will go into the trusts the day before they begin trading. Why? Because Merrill must buy all the shares for a HOLDRs trust the day before it is formed.
And here's the catch: The shares are then sold to the trust at their closing prices, sometimes as much as 5% to 10% higher than where they started the day. Who benefits from the runup? So far, it's been Merrill and a host of hedge funds that have begun buying up shares of the stocks they know will go into the trusts.
Says a hedge-fund manager who has been buying shares of the stocks earmarked for Merrill's trusts: "There's an opportunity because it creates artificial demand in the stocks as the trusts are being formed." Translation? It pays to buy the stocks going into the trusts the day they are formed and sell them when the buying binge is over.
Merrill, for its part, defends the action in the stocks the day before the trusts have been assembled."There has been sizable investor demand for HOLDRs and that can have an upward influence on stock prices. In sizing these offerings we are confident that we balance the need for critical mass and aftermarket liquidity with the need to manage market impact,"(Huh?) says Steve Bodurtha, head of customized investments, at Merrill. Mr. Bodurtha added, "Through the public offering process we make the same information available to everyone. A level playing field is designed to protect investors."
It's difficult to quantify the exact boost that institutional buying is giving the trust stocks. But it doesn't take a rocket scientist to figure out what shares to buy. In its duty as a good corporate citizen, Merrill discloses the names of the stocks, including their weighting in the trust itself, in prospectuses for the trusts filed with the U.S. Securities and Exchange Commission several weeks before the trusts are to begin trading.
Consider what happened to shares of stocks included in the telecommunications trust the day before it began trading. SBC Communications rose 9.2%; AT&T jumped 7.9%; MCI WorldCom surged 10.3%, and Level 3 Communications climbed 12.49%. Overall, the telecommunications stocks in the trust's portfolio rose 5.4% on Jan. 31.
A similar, though less severe, pattern emerged the same day pharmaceuticals stocks were slated to be included in the Merrill drug-stock trust. Merck was up nearly 3%; Pfizer rose 2.8%; Johnson & Johnson rose 1.9% and Bristol-Myers Squibb leapt 3.1%. Overall, the group of 20 stocks was up about 2%.
To be sure, the broader market had a good day that day. But the stocks in Merrill's trusts fared better. The Standard & Poor's 500-stock index was up 2.5% that day and the Dow Jones Industrial Average was up 1.9%. The Nasdaq Composite Index was up 1.4%. Overall, the 40 stocks included in the Merrill trusts were up an average of 3.7% on the same day.
The whole thing has become such a game on Wall Street that hedge-fund investors are on the alert for the moment when a Merrill buying spree will begin. Says an individual at a well-known investment firm that has been playing along: "You watch the stocks and look for big prints. If you know someone is going to be buying $200 [million] or $300 million in a few names, it makes sense to buy them."
Now, the game involves betting on three more Merrill trusts that traders know will be put together in the coming days involving three new sets of stocks: business-to-business Internet stocks, or "B2B" stocks under the proposed symbol "BHH"; Internet infrastructure stocks under the proposed symbol "IHH" and computer hardware stocks under the symbol "IAH."
Last week, Wall Street was buzzing about the lists of stocks that were making the rounds on trading desks. For the infrastructure trusts, the stocks are: Exodus, Akami, Verasign, InfoSpace.com, Broadvision, Vignette, Inktomi, BEA Systems, RealNetworks, Portal Software, Vitria Technology, Internap, Digital Island, Network Solutions, Kana Communications, Alteon WebSystems, USinternetworking, E.piphany, NaviSite and Software.com.
The "B2B" trust is said by traders to include: Internet Capital Group, Ariba, Commerce One, FreeMarkets, VerticalNet, CareInsite, Chemdex, Agile Software, CheckFree, Retek, Sterling Commerce, Proxicom, Silknet Software, SciQuest.com, PurchasePro.com, QRS, Harbinger, Pegasus Systems, ImageX.com.
The computer-hardware trust is said to include: Cisco, International Business Machines, Hewlett-Packard, Sun Microsystems, EMC, Dell Computer, Compaq Computer, Sycamore Network, Juniper Networks, Cadmus Communications, Foundry Networks, Gateway, Network Appliance, Apple Computer, Cobalt Networks, Seagate Technology, Extreme Networks, Ciena, Unisys and Adaptec.
Can any investor now run out and play the copycat game? Theoretically, yes. In practical terms, however, small investors face big risks because they lack the buying clout and the ability to time precisely when the buying is taking place. Not only that: Finding the prospectuses, which Merrill lists by the symbol, isn't easy; many big investors are hearing about the planned buys by word of mouth.
Merrill takes a market risk in buying the stocks, of course. If the market craters on the day it is buying a basket of stocks for a trust, it could take a hit. So far, however, the firm has made a tidy profit.
Consider its two most recent trusts. Merrill is estimated to have earned as much as $17.9 million on the drug-stock trust and $19 million on the telecommunications trust, assuming the firm bought the shares at the midpoint in the runup.
To be sure, Merrill's trusts carry lower ongoing fees than competing products. HOLDRs trust investors pay ongoing fees of only eight cents a share, and that fee is waived if dividends aren't large enough to cover the fee.
Overall, however, the performance of the most recent trusts has been lackluster. The prices of the drug-stock and telecommunications-stock trusts have fallen sharply since they began trading Feb. 1. The drug-stock trust, which carries the symbol PPH, is down 9.3% from its high and the telecommunications trust, TTH, is down 8.9% from its high. Overall, the S&P is down 3% during the same period.
To some, it's all the latest lesson in how often the big investor still has an edge over the little guy. Often, products aimed at small investors that seem to hold the advantage of cost savings can create trading opportunities for big investors. "This looks like a low-cost solution, but it may be higher than the small investor realizes," says Samuel Hayes, professor emeritus of finance at the Harvard Business School.
For its part, Merrill makes no secret that the stocks included in the trust could have a runup in price before the trust begins trading. "Purchasing activity could create a temporary imbalance between the supply and demand of the underlying securities, thereby limiting the liquidity of the underlying securities due to a temporary increased demand for underlying securities. Consequently, prices for the underlying securities may decline after these purchases as the volume of purchases subsides," the prospectus for the pharmaceuticals trust says.
Too often, however, small investors may miss the message behind such information, Prof. Hayes says. "What you do is load everything into the disclaimers," he says. "If anyone comes back, you say, 'It was all in there.' "
Why not give investors in the trust the benefit of the runup? Indeed, institutional investors who buy specialized baskets of stocks frequently benefit from any runup in the stocks because they pay the price at which the shares actually are bought by the firm assembling the basket, rather than paying the closing price.
For its part, Merrill says the investor might lose if the so-called volume weighted average price afforded big investors were used to set the initial offering price for the trusts. "The 'VWAP' price can be significantly above the close so it's not clear that investors would benefit by using the that," says Mr. Bodurtha. "For example, he says, "on Friday, Amgen closed at 71 5/16. But its 'VWAP' was 74.65." Amgen is the largest stock in Merrill's biotechnology trust.
So far, however, the stocks included in Merrill's trusts have risen steadily throughout the day before the trust began trading.
Earlier, the stocks included in an Internet-stock trust put together by Merrill on Sept. 22 rose an average of 7.14% the day before trading began. Shares included in a biotechnology trust assembled on Nov. 22 rose an average of 6.07%.
"I'm not sure [investors are] getting best execution," says John Coffee, Columbia Business School professor. "If you were trying to comply with the normal principle of best execution you wouldn't just give them the closing price. You would search the market and try to find the best price you could get."
BTW, Nice play on CMGI today...
Regards,
JM |
