One disturbing feature of the ongoing wave of corporate tender offers and takeovers has been a pattern of price rises in the shares of target companies prior to the announcement of an actual bid.
This has raised suspicions that some investors are getting advance wind of an offer and are trading on that infofmation to reap profits on the sharp price jumps that usually occur after a bid is announced.
The Securities and Exchange Commission has been monitoring these situations, but now, however is looking at a case where investors - rather than buying stock - may have purchased options of a company based on inside information regarding a planned tender, and may have tripled and quadrupled their money in a matter of days as a result.
The case involves Carrier Corp., which is being sought by United Technologies in a hostile tender offer that the Justice Department yesterday said it would oppose on antitrust grounds.
According to informed sources, both the SEC, through its Chicago office, and the Midwest Stock Exchange, where Carrier call options in the week just prior to the Sept. 18 announcement by United Technologies that it was seeking Carrier.
Sources said the investigation was prompted by complaints from market makers on the Midwest Exchange, several of whom found themselves out of business when the price of Carrier stock shot up following United's proposal.
In the week of Sept. 11 to Sept. 15, options trading in Carrier Corp., which makes air conditioners and heating equipment, was far heavier than usual, even taking into account that it was the week when the September series of options was expiring, an event which normally raises turnover.
During the five-day period in question, 33,356 Carrier $20 call contracts - each representing 100 shares of Carrier stock - were purchased on the Midwest Exchange.
This exceeded the entire month of August total of 30,452 contracts, and was double the one-week total of just under 16,000 contracts registered in June when the last Carrier option series expired.
Call options give investors the opportunity or "option," to buy shares of a stock at a preset price during the period until the option expires. Put options are the inverse of calls, and give investors the right to sell shares at a preset price.
A December Carrier 20 call, for example, gives the investor the right to buy 100 shares of Carrier at $20 a share up to the December expiration. For this privilege the investor pays a per-share premium, which is the cost of the option.
Carrier has both puts and calls trading on the Midwest with expirations during the period in question in September, December and March. The strike prices are $15, $20 and $25.
However, the overwhelming amount of volume during the Sept. 11-15 week was in the $20 call options, and these are the ones under scrutiny.
Sources say the focus is on the December and March options which climbed steadily during the week on heavy volume, although the rest of the stock marked was in a deep slide, with a 30-point drop in the Dow Jones industrial average and a widespread collapse in options prices for many other stocks.
Some 12,340 Carrier December 20 calls were sold, and the pre-share premium price rose from $1375 a share the week before to $225 on Friday. The March 20 calls showed a 1584-contract turnover, and the premium price climbed from $1875 to close the week at $2875.
On the following Monday (Sept. 18), United Technologies Chairman Harry Gray met with Melvin Holm, chairman of Carrier, and made him the type of offer that in the takeover business is known as a "bear hug".
Either Holm would recommend to his shareholders to merge with Unted Technologies in a $1 billion stock swap or United Technologies would proceed with a $28-a-share "unfriendly" bid for 49 percent of the company's stock.
At the time, Carrier's stock was trading at just over $20. A week later, when the New York Stock Exchange allowed trading in Carrier stock to resume, it shot up to nearly $27.
But the increase was modest compared to what happened to the options which are highly leveraged and therefore magnify any gains in the underlying stock.
The Dec. 20 call option, which had had a striking price of $225 on September 15 when it last traded, jumped to $7.125 for a gain of 317 percent. And the March 20 call option, which had closed on Sept. 15 at $2.825, climbed to $7 for a gain of 247 percent.
Anyone who had purchased one of the Carrier call options earlier in the week before United Technologies announced its takeover intentions could have gained as much as 475 percent.
Spokesmen for the SEC and the Midwest Stock Exchange declined to comment on the status of the investigation. And officials of both Carrier and United Technologies also said they had no comment or explanation for the unusual trading activity in the Carrier options.
Theodore Levine, an official in the SEC's enforcement division in Washington, however, acknowledged that the problem of the improper use of advance information to trade in a company's shares prior to a takeover was getting priority attention from the commission.