Risk Arbitrage

(redirected from Merger arbitrage)
Also found in: Dictionary, Thesaurus, Financial, Wikipedia.

Risk Arbitrage

The purchase of stock in a corporation that appears to be the target of an imminent takeover in the hope of making large profits if the takeover occurs.

Risk arbitrage is practiced by investors called risk arbitrageurs. The strategy can return large profits if a takeover occurs but can also result in large losses if the transaction does not take place. Obviously, then, the more information an arbitrageur has about a possible takeover, the less risk the strategy involves. Buying Securities of takeover candidates on the basis of rumors is legal, but it is illegal for an arbitrageur to purchase securities based on inside, or nonpublic, information. Insider trading violates rule 10(b)-5 of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78a et seq., which is a federal law that governs the operation of the stock exchanges and over-the-counter trading.

To obtain information, arbitrageurs often develop relationships with investment banking firms and corporations, as well as with other sources of information and financial backing. These activities alone do not constitute a violation of the Securities Exchange Act, but if the risk arbitrageur uses these relationships or resources to gather information that is not available to the general public, the resulting purchase of securities is illegal.

In the late 1980s, the Securities and Exchange Commission (SEC) began to investigate several prominent risk arbitrageurs for their roles in insider trading. This action, combined with the increasing number of corporate takeovers, brought the issue of risk Arbitrage to the headlines of Wall Street and the world. Between 1980 and 1988 in the U.S. District Court for the Southern District of New York alone, fifty-seven arbitrageurs were criminally prosecuted for insider trading. One of the bestknown cases involved risk arbitrageur Ivan Boesky, who allegedly realized a $9.075 million net profit through stock trades he made based on nonpublic information about three different mergers and takeovers. As part of the settlement with the SEC and the federal courts, Boesky was barred from any future securities trading.

Because risk arbitrage can involve significant blocks of shares worth hundreds of thousands, even millions, of dollars, this practice can have a large impact on both the market and the value of the company's stock. Professionals in the securities field generally agree that risk arbitrage based on inside information has a negative effect on the market, as well as on the reputation of arbitrageurs in general. Many of these commentators, however, are concerned that existing securities laws do not reach risk arbitrageurs who do not owe a fiduciary duty to the people who are harmed by the arbitrageur's use of nonpublic information. The Securities and Exchange Act specifies that a violation of rule 10(b)-5 requires the accused violator to have breached a fiduciary duty to the injured party.

Chiarella v. United States, 445 U.S. 222, 100 S. Ct. 1108, 63 L. Ed. 2d 348 (1980), is one of the leading cases on rule 10(b)-5 liability. Vincent F. Chiarella was employed at a financial printer and, as part of his duties, handled a series of documents that detailed an upcoming takeover bid; although the names were left blank or falsified, Chiarella was able to figure out the companies involved. Then, without disclosing that he had inside information, he bought stock in the companies that were targeted in the takeover; when the takeover was made public, he sold the shares and made a profit of approximately $30,000. Shortly thereafter, Chiarella was indicted on seventeen counts of violating rule 10(b)-5. The U.S. Supreme Court reversed the conviction, however, on the grounds that Chiarella had not violated the rule because he was not a fiduciary and therefore did not have a duty to disclose.

Further readings

Hazen, Thomas Lee. 1989. "Volatility and Market Inefficiency: A Commentary on the Effects of Options, Futures, and Risk Arbitrage on the Stock Market." Securities Law Review 21.

Steckman, Laurence A. 1988. "Risk Arbitrage and Insider Trading—A Functional Analysis of the Fiduciary Concept Under Rule 10b-5." Touro Law Review 5 (October).

Cross-references

Mergers and Acquisitions.

Mentioned in ?
References in periodicals archive ?
The second sub-fund within the firm's Luxembourg based SICAV, GAMCO Merger Arbitrage will be offered outside of the US to institutional and retail investors and will initially register retail shares in Switzerland, Germany, and Italy.
Merger arbitrage specialists, which aim to profit from the spread between a target group s share price after a takeover announcement and the closing price at completion of the deal, have seen $841m in net inflows since January
We are pleased to offer access to a true merger arbitrage strategy delivered for the first time with the cost efficiency, transparency and liquidity of an ETF.
Launched in 2004 by Raymond J Murphy, ArbJournal has become an indispensable source for research and value-added analysis on merger arbitrage and event-driven trading situations.
M&A and hedge fund expert Gaurav Jetley, a vice president at Analysis Group who specializes in securities valuation, M&A analysis, and risk management, recently published an academic paper about merger arbitrage spreads, "The Shrinking Merger Arbitrage Spread: Reasons and Implications," in Financial Analysts Journal.
These three new indices broaden S&P DJI's event driven index family which includes merger arbitrage indices.
NEW YORK -- Cantor Fitzgerald announced that Scott Schefrin, formerly with Bear Stearns, has joined Cantor and will lead the firm's Merger Arbitrage business for the Global Equities Group.
NEW YORK, July 14, 2015 /PRNewswire/ -- Kellner Capital (Kellner), an alternative investment management firm with a specialization in merger arbitrage, is pleased to announce its flagship mutual fund, the Kellner Merger Fund (GAKAX, GAKIX), has celebrated its three-year anniversary.
Ceremony Marks the November 17(th) Launch of the First Merger Arbitrage Exchange-Traded Fund (NYSE Arca: MNA)
May 27, 2015 /PRNewswire/ -- CTFinancialNews, an M&A news service focused on major corporate developments - from event-driven investment topics and merger arbitrage to special situations - launched its expanded web and mobile offering to meet the demands of its leading investor client base.
IQ ARB Merger Arbitrage ETF is designed to provide exposure to accelerating global M&A activity; new fund is latest addition to IndexIQ's roster of alternative investment products
Credit Suisse X-Links Merger Arbitrage ETNs due October 6, 2020