ETF Insider Trading: It’s BHH

February 11, 2011

The Financial Times has a story out on how the SEC is investigating how certain traders may be using ETFs to mask insider trading. All they really need to do is look.


They call the practice “ETF stripping,” where a trader discovers a hidden piece of information on a stock, buys an ETF that holds the stock and then (maybe) shorts all the other underlying securities. They get the benefit of long exposure to their illegal info, and (maybe) avoid the scrutiny of the regulators.

On the outside, this seems like a fundamentally stupid, or at least impractical idea. Imagine you know the iPad 2 cures cancer. You try to do this with Apple (NasdaqGS: AAPL), buying QQQQ to get the AAPL exposure and then shorting everything else in the QQQQs. For every share of Apple you get exposure to, you end up with commissions and margin interest on the other 99 shorts. Huge pain, huge commissions, and with an audit trail as wide as autobahn. It also seemed to me like a waste of time, so I set out to debunk the theory. I decided to pull a list of the most viable ETFs for this practice. I limited my search to funds with fewer than 20 underlying securities—more than that and the process of shorting all the other tickers for one long exposure seems ridiculous.

Once I eliminated asset allocation ETFs holding only other ETFs (ONEF, EQL, etc.), I was completely unsurprised to see a list of HOLDRs.

Ticker Name # Holdings 30-Day Average Volume AUM ($M)
BHH B2B Internet HOLDRS 2 299,727 $7.83
IIH Internet Infrastructure HOLDRS 8 24,771 $13.36
BBH Biotech HOLDRS 12 14,317 $260.49
TTH Telecom HOLDRS 12 20,523 $130.25
HHH Internet HOLDRS 13 14,166 $116.87
SWH Software HOLDRS 13 11,325 $77.01
IAH Internet Architecture HOLDRS 14 5,783 $36.18
OIH Oil Services HOLDRS 14 5,025,442 $2,358.94
PPH Pharmaceutical HOLDRS 15 389,705 $580.00
BDH Broadband HOLDRS 16 46,923 $12.75
WMH Wireless HOLDRS 16 440 $16.13real
RKH Regional Bank HOLDRS 17 406,659 $107.08
RTH Retail HOLDRS 18 876,285 $362.35
SMH Semiconductor HOLDRS 18 6,210,581 $751.67
UTH Utilities HOLDRS 18 8,061 $56.27


HOLDRs, created back during the height of the dot-com era, are the bastard stepchildren of ETFs, living outside the traditional ’40 Act structure and its pesky diversification requirements. They’re small, unitized baskets of stocks. No cash, no management fees, no nothing. A few of the larger HOLDRs, like the Oil and Semiconductor HOLDRs, remain huge trading vehicles.

From our data, however, one unlikely fund has generated a surprising amount of trading volume. The B2B Internet HOLDRS ETF (NYSEArca: BHH) traded an average of 300,000 shares over the last 30 days.

That’s pretty impressive when you consider the fund only holds two stocks.

I actually assumed BHH died as a useful product long ago. Back in the day, I sat on a trading desk and regularly used it to gain access to a group of hot stocks right at the height of the boom. Its composition was a who’s-who of dot-com startups back in 2000.

One by one, each company folded under the weight of the bubble’s burst or got rolled inside someone else until only two companies remained: Ariba Inc. (NasdaqGS: ARBA), making up 91 percent of the fund’s assets; and Internet Capital Group (NasdaqGS: ICGE), one of the last “public VC” firms from the era, representing the other 9 percent.

A trading volume of 300,000 for a tiny, forgotten fund? Something’s going on.



BHH Trading Over 1 Year


Source: Bloomberg


The giant upswing in volume was driven by Ariba’s earnings call on Jan. 30, where earnings topped analysts' expectations and its stock jumped 9 percent.

The real noise started after the 8K filing after market on Jan. 27, as you might expect. But the big share accumulations in December beg the quetion: Why BHH?

BHH Shares Outstanding

BHH Shares Outstanding

Source: Bloomberg

Gee. Why would anyone go and buy 600,000 shares of BHH for a dollar a share and pay 20 times the per-share commission, when they could have just bought Ariba? And why would someone want diluted exposure to Ariba?

I mean, does anyone really want 9 percent of ICGE so badly that the HOLDRs package of convenience made up for the huge difference in handle?

Hardly. It seems inconceivable to me that the 600,ooo in volume, and previous high-volume days in the month or two prior to the Ariba surprise, weren’t the function of someone with an inside-peek and a (clearly misguided) belief that nobody would notice if they just loaded up in the HOLDR, instead of the stock itself. Because a quick look at BHH shares outstanding will show you that yes, Virginia, someone’s been loading up.

The beauty of the scam, at least from the point of view of the scammer, is that there’s almost no need to unload the ICGE exposure. At just 9 percent dilution and a very high correlation to Ariba, why even bother shorting it out?

Is it likely this is a widespread practice? Nah. It’s just too hard a game to play once you add a few dozen securities to the portfolio. But for the thinnest of the thin HOLDRs, it’s definitely playable.

It’s good to know these icons of a bygone era get to live on, even if it’s in infamy.



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