How To Profit From Backdating

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MarketWatch's Alistair Barr has a good backgrounder on short-sellers, in the news these days in part because of allegations of naked-short selling of Vonage.
We haven't seen anyone mention this so we're just going to go ahead and bring it up ourselves. Shouldn't there be a good deal of money to be made shorting yet-to-be-discovered backdaters? Each time the SEC or the Wall Street Journal points the backdating spotlight at a public company, the company's stock price drops. The method the Wall Street Journal (and presumably the SEC) uses to sniff out the back-daters is relatively straight forward--the WSJ is pretty explicit and its been published in academic articles--although the research might take a bit of time.
If a short-seller got an analyst on this stuff, they should be able to come up with some good bets. All they would have to do is short the stock and wait for a journalist or the SEC to make the same discover. (Or, if that was taking too long, simply announce the finding themselves.)
Now that we've spelled it out, its so obvious that we guess it's got to already be happening. But no one else seems to be talking about it.
[More on the Journal's methodology after the jump.]


Finding the backdaters is surprisingly simple. The WSJ started by asking Erik Lie, the University of Iowa finance professor who wrote the first academic papers on backdating, to come up with a list of companies that granted stock-options and then saw a large rise in the price of their stock. Anyone who spends time on Edgar and any of the freely available sites providing historical information about stock prices can do this.
If there is a multiyear pattern of the stock price jumping after the grants, you might well have a backdater on your hands. The work of Lie and others has shown that such outcomes are highly unlikely in ordinary circumstances.
It gets a bit more complex after that, but nothing that cannot be duplicated. Here's how the WSJ explains exactly how it finds the potential backdaters.

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