Do Hedge Funds Trade on Private Information? Evidence from Upcoming Changes in Analysts’ Stock Recommendations


April Klein


New York University (NYU) – Department of Accounting, Taxation & Business Law

Anthony Saunders


New York University – Leonard N. Stern School of Business

Yu Ting Forester Wong


Columbia Business School – Accounting, Business Law & Taxation; Columbia University

April 7, 2014Two large financial institutions recently settled allegations of selective disclosure of private information from supply-side analysts to hedge fund clients. These allegations lead us to explore two research questions: How widespread is this transfer of private information between analysts and hedge funds? Is there evidence that hedge funds trade advantageously on this private information? Using quarterly hedge funds holdings, April Klein, Anthony Saunders and Yu Ting Forester Wong find evidence consistent with the view that large hedge funds traded profitably on upcoming analysts’ recommendation changes.

Hedge Funds Wintergreen

In this paper, we examine whether there is evidence consistent with large hedge funds trading opportunistically on the leakage of future analysts’ stock recommendation changes. Our research question is motivated by recent reports of large brokerage house sell-side analysts providing private information to large hedge funds. In 2013,  Citigroup Global Markets Inc. agreed to pay $30 million to the Commonwealth of Massachusetts (CMOSC) to settle charges that one of its analysts improperly shared private research with four large investors one day in advance to the analyst’s release of his research report on Apple Inc. (NASDAQ:AAPL)’s demand for iPhones (CMOSC, 2013). According to the Consent Decree (CMOSC, 2013), three of these institutions traded on this information prior to its public disclosure. 2 In 2014, BlackRock, Inc. (NYSE:BLK) reached a settlement with the New York attorney general’s office to end its “global analyst survey program” aimed at “front running” changes in sell-side analysts’ recommendations (OAGNY, 2014; Morgenson, 2012). According to Morgenson (2012), hedge funds exploited their access to this private information by buying upgrades and selling downgrades prior to the public release of these recommendation changes. We refer to these transfers of nonpublic information as an information leakage from analyst to hedge fund.

Our main question is: are these are isolated cases, or, conversely, has a larger group of hedge funds traded prior to analysts’ recommendation changes? To answer this question, we gather announcement dates for over 70,000 analysts’ recommendation changes from 2006 through 2011, inclusive, for the seven large brokerage firms identified by Morgenson (2012). Using SEC Form 13F filings, we select all 57 hedge funds managing investments of at least $10 billion, and then examine their trading patterns prior to and after the public disclosure of these recommendation changes.

Using the FirstCall database, we are able to identify the exact date of the recommendation change. Hedge fund trading dates, however, are not available because hedge funds are required to report their holdings on a quarterly basis only through a Form 13F filing. Thus, in any quarter, we can observe a change in holdings for that quarter, but we are unable to identify the timing of the trades.

Full study Via SSRN

H/T  Wesley Grey of Turnkey Analyst