Monday, October 16, 2006
The SEC filed a civil insider trading action against foreign purchasers of call options in CNS Inc., the maker of consumer health products such as the Breathe Right nasal strip, in advance of the disclosure that the company agreed to be taken over by GlaxoSmithKline PLC. The defendants traded through Swiss accounts by purchasing out-of-the-money CNS call options in the week before the announcement of the deal, given them a profit of over $650,000. The SEC Litigation Release (here) quotes from the Commission's complaint:
Between September 27 and October 2, 2006, Unknown Purchasers bought a total of 1186 out-of-the-money CNS call option contracts. These purchases represented approximately 67% to 100% of the daily volume of the various CNS options series on the days purchased.
The Unknown Purchasers' trading coincided with key non-public and confidential events leading up to the announcement that Glaxo would acquire CNS. Specifically, Glaxo was one of several companies contacted by investment bankers on behalf of CNS in August 2006. After Glaxo had executed a confidentiality agreement, Glaxo was invited to submit a binding offer for CNS by September 29, which it did. On October 2, the CNS Board met to review the offers, and Glaxo was informed that it was one of two finalists and that it should submit a best and final offer by October 4.
On Monday, October 9, 2006, before the opening of the New York securities markets, CNS and Glaxo announced the execution of an agreement whereby Glaxo would acquire CNS for a price of $37.50 per share - a 31% premium over the closing price of CNS stock on Friday, October 6. On the date of the announcement, CNS shares closed at $36.72 - a 28.5% increase over the closing price of CNS stock on Friday, October 6.
On October 9 and 10, 2006, following the announcement of the merger between CNS and Glaxo, the Unknown Purchasers sold the CNS options in both accounts and realized net profits of approximately $651,895.
As is common in cases involving foreign purchasers, the SEC sought a freeze order to keep the funds from leaving the United States, which was granted by the U.S. District Court for the Eastern District of Pennsylvania.
The trading in CNS call options is similar to a recurrent pattern of insider trading, particularly by foreign purchasers. In August 2005, the SEC filed against then-unknown purchasers of Reebok call options before a takeover by Adidas, a case that turned out to be part of a much larger insider trading network. More recently, in June 2006, the Commission filed suit against defendants in Argentina who purchased Maverick Tube call options before an announced takeover by Tenaris. What made the trades particularly suspicious is that the options were out of the money at the time of the purchases and had fairly short expiration dates, making them especially risky -- unless the purchaser knew that the price of the company would increase significantly due to a pending extraordinary announcement. Given the frequency with which these types of insider trading cases occur, particularly when it involves overseas purchasers, it is starting to sound like repeat episodes of Desperate Housewives. (ph)