David Einhorn Tells His Side Of The Story On The FSA’s Insider Trading Fine

David Einhorn

Prominent hedge fund manager David Einhorn, who is known for seeing problems at Lehman Brothers and publicly shorting the stock prior to the bank’s demise, was fined yesterday by the U.K. Financial Services Authority.

Einhorn and his fund Greenlight Capital, which has about $8 billion AUM, were slapped with a $11.2 million penalty by the FSA for trading stock in Punch Taverns PLC on inside information back in 2009.

While the hedge fund manager said that he completely disagrees with the FSA’s decision, he said his fund will not seek further litigation.

“We doubt our chances of having a fair hearing,” he said during a conference call Wednesday afternoon.

In fact, Einhorn had “quite a lot to say” during the 54-minute call to get his side of the story out there.

“I agree this is a serious matter, but not for the same reasons as the FSA. The FSA says this was an act of ‘insider dealing.’ This resembles insider dealing as much as soccer resembles football,” Einhorn said.

First, here’s the FSA’s side of the story:

On 9 June 2009, Einhorn was a party to a telephone conference in which it was disclosed to him by a corporate broker acting on behalf of Punch Taverns Plc that Punch was at an advanced stage of the process towards a significant equity fundraising. This was inside information and Einhorn should have appreciated this.

A matter of minutes after the telephone conversation had concluded and on the basis of that inside information Einhorn gave instructions to sell all of Greenlight’s holding in Punch. At the time these instructions were given Greenlight held 13.3% of Punch’s issued equity.

Over the next four days Greenlight sold 11,656,000 Punch shares, thereby reducing its holding in Punch from 13.3% to 8.89%.

On 15 June 2009, Punch announced a fundraising of £375 million. Following the announcement the price of Punch shares fell by 29.9%. Greenlight’s trading had thereby avoided losses of approximately £5.8 million for the funds under Greenlight’s management.

The FSA accepted that Einhorn’s trading was not deliberate because he did not believe that it was inside information. However, this was not a reasonable belief. Investment professionals are expected to handle inside information carefully regardless of whether they have been formally wall-crossed. This was a serious case of market abuse by Einhorn and fell below the standards the FSA expects, particularly due to Einhorn’s prominent position as President of Greenlight and given his experience in the market.

Now, here’s Einhorn’s side of the story.

At the time, Greenlight was one of the largest shareholders in the pub and bar operator.  Einhorn said his firm was approached by Punch’s investment bank about signing a non disclosure agreement (NDA), which means you’re given confidential information and by signing one you agree not to disclose that information.

Einhorn explained there are several reasons why you would want to sign an NDA, especially if you think you can assist the management or influence the company in a positive way.

Greenlight declined to sign an NDA. 

“We had no interest in becoming an insider,” he said recalling that he told the company he would be “happy to talk to management, but not interested in receiving information to trade stock.”

The banker pressed the NDA issue, but Einhorn said he continued to decline. 

During an “open, unrestricted” phone call with Punch’s CEO, CFO and investment banker Einhorn said he learned that the “best way to describe Punch was it was a company with a serious heart condition — if it quit smoking and lost weight and started exercising it would be OK….There’s a good chance that without a transplant it would die.” 

Einhorn said that Punch’s CEO began the phone call saying that the company had sold 11 of its pubs that morning.  The CEO also said he wanted to consider “strategic options” including raising equity, Einhorn recounted.

“I thought it was a terrible idea,” said Einhorn adding, “I said it was a lousy deal for Greenlight and shareholders such as Greenlight.” 

The hedge fund manager said he proceeded to ask the company’s CEO what he thought the stock was currently worth.  According to Einhorn, the CEO, who he recalls sounded “pessimistic,” said he thought it was “fair” at the moment.

“This was an extraordinary statement… the CEO not in the position of telling shareholders the stock is ‘fully valued.’ We were talking about a stock that was trading at a deep discount to the company’s book value — down substantially,” Einhorn said.

Hearing the chief executive say that had an impact on Einhorn.

“I’d be less surprised to hear my mother-in-law describe her grandchildren as ‘just average,'” he explained. “It was a sobering moment. Now that it’s two years later, I’d be engaging in hindsight bias to suggest that I decided to sell the stock right then and there – and based on the rest of the call – I clearly hadn’t processed it fully yet – but it’s hard to imagine wanting to continue to own it, either.”

According to Einhorn, Punch’s CEO kept talking in “general terms” and not “specifics.” 

What really struck a chord with Einhorn is the CEO also said the company might need to raise $350 million to manage the company’s risk.

“That sounded like a big number,” Einhorn said, adding that he told the CEO he was contemplating selling his shares.

“The CEO offered a more detailed conversation, but it is not possible to do that without having to sign an NDA,” Einhorn said. “That’s just a legal requirement.”

So Einhorn said he decided to sell the shares and relayed the order to his traders through his analyst.

Einhorn’s recalled his analyst saying, “We want to sell our shares and we would like to sell all of them. It’s price sensitive and it’s rather timely….We think there are a bunch of shareholders who know secret bad things… We might have a window to sell before bad news comes out and the stock plummets.”

Greenlight was able to sell 1/3 of its shares before its filing were made public.  In reaction to Greenlight’s trade, the stock tanked.

“I cancelled the remainder of the order.  I didn’t think there was any hurry to sell.” 

Einhorn is confident that he did not engage in insider dealing.  He said he refused to sign an NDA, declined to receive inside formation, indicated that he might like to sell his stake and that there was no obvious statement on inside information.

What’s more is he said he wanted to make sure he was not only following just the letter of the law, but also the “spirit” of the law.

“This FSA action is indeed truly frightening.”