Don't Freeze the Arbs Out

Abstract

Arbitragers provide important productive services to investors, and the supply of these services is threatened by the current outpouring of self-righteousness and legal action in the wake of the Securities and Exchange Commission's prosecution of Ivan Boesky and others accused of insider trading. When takeover bids occur, arbs provide valuable services for target-firm investors who do not have the time, ability or inclination to gather information on takeover bids for companies in which they hold stock. Arbs help direct resources to their highest-valued use. In doing so, the arbs provide three critically important services: 1) they help value alternative offers (including the plans of target management), 2) they provide risk-bearing services for investors who do not wish to bear the great uncertainty that occurs between the announcement and final outcome of a takeover bid or restructuring, and 3) they help resolve the collective action or freerider problems of small, diffuse shareholders who cannot organize to negotiate directly with competing bidders for the target firm. The arbs do this by aggregating large blocks of shares for tender to the highest bidder and sometimes even negotiating with the bidder directly over the offer price. The third situation occurs when an individual produces valuable information and voluntarily shares it or sells it to others. Daniel Fischel of the University of Chicago Law School notes that this sharing of information is no different from any other exchange and should not be prohibited. After expending resources to produce valuable information for themselves about how a target company can be restructured to create value, takeover specialists can rationally decide to share that information with others prior to releasing it to the public. In this case trading on such shared information damages no one, and if such sharing is prohibited or discouraged as under current SEC policy, the very investors the SEC seeks to protect (non-insiders) will be harmed.