'We broke it first'

Testing the Hypothesis 'breaking news stories are the same as inside information'

News Channels take pride in boasting ‘we broke the story, first’, particularly Business News Channels where the story and its timing of breaking the news matters. I have some concerns on ‘we broke it first’ kind of news and they ring an alarm bell in my head. Isn’t it “Inside Information” if you have prior information of some key event that is likely to effect the stock prices in a significant way; and aren’t we restricted from trading based on inside information?

The king of insider trading, Hedge Fund Galleon’s general partner Raj Rajaratnam used his ‘sources’ to extract inside information on technology companies and generate alpha. He is behind bars and FBI is still struggling to get to terms with his modus operandi. I’m not placing the business news channels and their breaking news stories in the same bracket as the ‘king of good times’, but I am just toiling with an idea of testing the hypothesis ‘whether breaking news stories are the same as insider information’.

Lets imagine a situation wherein an analyst of a leading news channel (lets say ABC News) is following Reliance Industries and through his ‘links’ get to know that Reliance is contemplating an acquisition in the energy sector in US. The information is classified but the news reporter is convinced that he’s got a breaking news. He report the news to his editor in the expectation that it will appear as a breaking news but at the same time also asks his broker to trade Reliance stock (let’s say he orders his broker to buy RIL, considering the acquisition is at low valuation and favorable to Reliance). The story doesn’t end here, the editor too tells his broker to trade Reliance (buy) before approving the telecast of ‘breaking news’. Some ‘Shiren Bhan’ or the ‘pretty damsel, Sonia’ (in the pic) might present the ‘breaking news’ but not before they have asked their broker to trade Reliance. They may be a lot more links in the chain than just the analyst, editor and presenter all of whom may share this inside and classified information to generate excess returns. It would not be wrong to assume in such a scenario that enough trading will take place based on the above inside information to influence the stock price of Reliance in a favorable direction. The inside information gets priced in the stock value and the stock price moves to a new level.

Let’s say we move ahead a couple of days and the deal indeed happens, Reliance buys an energy company in US at a cheap valuation and confirms it through a media briefing. There is frenzy for this news story all across business channels and newspapers. The retail investors believe this to be positive news and take a buy decision on the stock. However since the acquisition news has already been priced in the stock due to insider trading by the news channel and other links it generated, the stock does not show a favorable trend to this news when it is official made public.

Result, the retail investors gets screwed (again) and the news channel proudly proclaims ‘we broke the story first’. I have to say I fail to reject the null hypothesis that ‘breaking news stories are the same as insider information’ and as an investor I feel like a trumpet (vuvuzela) that anyone (including news channels, companies and other market participants) can blow at will.