NPS Pharma (Nasdaq: NPSP) CEO Francois Nader told market-moving news about an M&A rumor to a private room of Wall Street investors yesterday nearly six hours before disclosing the info to everyone else. I wanted to start off with that fact so the problem this article covers could not be any clearer.
After things like the book Flash Boys and recent insider trading scandals, people have been asking a lot lately about whether the stock market is fair to ordinary investors. Through the example of what NPS did, I will describe a common practice on Wall Street that many investors outside of the industry probably do not know much about, but one that is grossly unfair and needs to be reformed. I am talking about private breakout rooms at investment conferences.
What is a breakout room?
Publicly traded companies present their stories at investment banking conferences all the time. As you can imagine, most of these are exclusive events where you need to have a relationship with the host bank in order to attend. Though the format can vary by bank, most start out by having CEOs give a 30-minute presentation about their company. Having listened to thousands of these presentations, I can safely say 95% are canned summaries that do not provide any newsworthy information. However, a key aspect, and this is very important, is that they are usually webcast out of fairness so that anyone can listen in from afar. That way, if something important is said, everyone can hear it.
Where the inequity comes into play is what happens immediately afterwards at some conferences. Right after the 30-minute canned, and webcast speech is over, the investors who are in attendance are next invited to a nearby room called the “breakout room.” This is where Q&A happens, and of course there are almost never microphones recording a webcast in that room. This means that only investors in attendance, a.k.a. clients of the bank, get to pose questions to, and hear answers from, the presenting company’s CEO. This is a recipe for fair-disclosure disaster, but especially so for a stock making big headlines like NPS was yesterday (more on that later).
I have personally attended many breakout rooms. The great thing about them is how casual the discussions are inside since it is off the record. While I have rarely seen blatant disregard for disclosure rules, the truth is that everyone there feels a little looser in what they can say knowing that it is not being recorded. However, a problem lies in the fact that this type of environment is not always in the best interest of the people outside of the room. When talk is casual, it is only human nature to lower your guard and sometimes forget that you are required to treat all investors equally. In my opinion, that is exactly what Mr. Nader, an otherwise excellent CEO, did yesterday. His lack of discretion goes to show that the breakout room format needs to be changed.
How NPS illustrates breakout rooms gone wrong
The NPS story stems from a rumor that started on Friday suggesting that London-based Shire (Nasdaq: SHPG) was interested in acquiring NPS. While details were scant, this still bumped NPS’s stock from around $27 to $31, or by $400 million. However, things really went into overdrive on Sunday night when the British daily newspaper The Times reported that Shire had arranged $5 billion in financing to help pay for the deal. With specific details like that, more people believed a buyout could truly be in the works so NPS’s stock opened around $38 on Monday, a gain of another $700 million. Nothing gets Wall Street more excited than mergers and acquisitions talk, and this story was no different. All eyes were on NPS and Shire Monday morning.
With perfect timing, NPS’s CEO, Francois Nader, was scheduled to present at the Jefferies Global Healthcare Conference in New York at 11:30 EDT Monday morning. In line with tradition, he gave the standard canned presentation dutifully. However, what was not said at any point during his main presentation was anything about Shire, the topic that was on everyone’s mind. You can listen to a replay of the webcast of his presentation here to confirm.
Since Jefferies is one of the conferences that does host a private breakout room after each presentation, that is exactly where Mr. Nader headed next. It is not hard to guess what followed. Given the high interest in the takeover rumor, ‘what is going on with Shire?’ was one of the questions he was asked there. I am aware of that because I saw somebody who was in the room tweet about it. Mr. Nader’s response was something to the effect that NPS has not received any communication from Shire. In my opinion, such news direct from the CEO is a highly relevant and material disclosure that all investors deserve to hear, not just those in a breakout room. Recall that the stock went up over $1 billion based on the rumors, and it went down throughout the day after he spoke. As it turned out, NPS eventually agreed that it was material news as well.
NPS takes cover for Mr. Nader’s selective disclosure
The company ended up doing a very interesting thing later in the day. Around 5:30 EDT, or nearly six hours after the Jefferies talk, NPS’s General Counsel, Christine Mikail, filed this 8-K with the SEC providing similar details to what Mr. Nader said in the breakout room. 8-Ks are important because, along with press releases, they are the most common way companies go about legally disclosing material information to all investors in a fair manner. Here is the main info from NPS’s 8-K:
"Although it is generally NPS Pharmaceuticals, Inc.’s (“NPS”) policy not to comment on media speculation and market rumors, in light of the erroneous press reports that Shire Plc (“Shire”) has had communications with NPS concerning a purported offer by Shire to acquire NPS, NPS confirmed that to date NPS has not had any communication with Shire or any representative of Shire concerning the acquisition of NPS by Shire. NPS intends to continue its policy of not commenting on media speculation and market rumors and undertakes no obligation to update the information contained in this Report."
The problem with this disclosure, in my opinion, is that it is blatantly dishonest. I think Ms. Mikail’s filing has nothing to do with stepping outside of their normal disclosure policy and everything to do with trying to take cover for having already disclosed the info to a select group of investors earlier in the day. We knew six hours previous to this filing that NPS does in fact comment on media speculation and market rumors, but apparently just off the record and in breakout rooms. Regardless, by doing the filing, they are confirming that the Shire news is indeed material information, so Mr. Nader clearly should not have disclosed it in such a limited setting.
NPS shows that the breakout room format needs to be changed
Mr. Nader’s lack of discretion shows that the breakout room format needs to be changed. While his is an extreme example because NPS was a focus in the news and he should have known better, there is still too much room for people to let slip something they should not be discussing in these places.
Fortunately, there are a few options that would easily fix the problem. Probably the most obvious one is just to webcast the breakout room as you would any other presentation. At the annual JP Morgan Healthcare Conference, for example, companies are given the option to do just that. JP Morgan deserves a lot of credit for taking a step in the right direction, but unfortunately not many companies take them up on it. This is why webcasting the breakout room should probably be a mandatory policy for these banks going forward. That simple fix would still keep the discussion fresh, but also allow everyone to listen in out of fairness.
Another option is just to do Q&A following the main presentation as one continuous webcast. There are a handful of banks that already do it that way.
Probably the most innovative thing I have seen lately goes to the healthcare team at Deutsche Bank, who allows you to anonymously email questions directly to the analyst so he or she can ask them during Q&A sessions at their conferences. That takes care of another inequity, which is that only some investors get to ask the questions by virtue of the fact that they are there. What the Deutsche Bank team does is really going the extra mile.
The bottom line is that the breakout room is one of those antiquated practices where Wall Street still has a big advantage over ordinary investors. As the NPS story clearly illustrates, discussions in those rooms should be webcast, or otherwise not take place at all.