Betting on The Law

With black box algorithms, the overwhelming number of hedge funds (with an even greater number of analysts and managers), and the myriad ways to make swap bets is it possible that there is an alternative investment strategy which hasn't been tapped into yet? Is there yet some fertile ground where a new approach could take hold, allowing its sowers to reap glorious profits? At least one well-known lawyer thinks so.

Ted Frank, a class action specialist and fellow blogger believes that investors have been very slow to catch on to a very easily accessible and very public source of information which could greatly impact share values. From his blog Pointoflaw:

"Over the years I've been surprised when the stock market strongly reacted to judicial decisions that seemed like obvious outcomes. This surprises me: I don't have inside information; institutional investors have the ability to process the same public information that I do; the efficient market hypothesis predicts that this public information should already be reflected in the stock price; thus, if I can predict a ruling, the market can, too, and shouldn't treat it as a surprise when, say, the Illinois Supreme Court reverses a multi-billion-dollar judgment against Philip Morris, which bounced over 5% that week in December 2005. But apparently, the trial lawyer strategy to artificially depress stock prices to pressure defendants into settlements has an effect of creating market inefficiencies.

I'm very confident that Wal-Mart v. Dukes will result in a reversal of the class certification in the enormous multi-billion dollar class action against it. But the things that make me confident in that result—the briefs, the tenor of the oral argument, the language in AT&T Mobility v. Concepcion about the importance of protecting the rights of unnamed class members—did not produce movement in the market price of Wal-Mart stock. This leads me to suspect that the market is undervaluing the probability of reversal, and will be surprised when the Supreme Court does reverse later this month."

So, he believes that public information can assist its gatherers to come to certain conclusions about litigation, and even gives some reasons for why the market might not be processing it correctly. Sounds reasonable enough. Perhaps more impressively, Frank goes on to put his money where his mouth is:

"It's always bothered me when economists make clever predictions but aren't willing to bet on them, Julian Simon a notable exception. Here's a hypothesis that won't take twenty years to resolve; if I'm right, aren't I stupid if I don't make a quick profit on this predicted market inefficiency. So I've put my money where my mouth is: with the dip in stock prices last week, I invested a bit over 10% of my net worth in a leveraged bet that WMT stock will bounce this month when the Supreme Court releases its decision through purchases of July and September out-of-the-money call contracts."

Only time will tell whether this is a good bet or not. Frank also acknowledges that any number of extraneous factors could impact share prices between now and when his calls come due. However, and particularly in times like these when the Insider Trading Case of the Week can make it feel more than ever like the market is rigged against individual investors, it is a nice thought that there could be some untapped information out there which is fully accessible to the public.

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