Three days ago, Forbes national editor Michael Ozanian created a national frenzy when he published this article detailing how the New York Knicks could land LeBron James. He wrote that James should consider the Knicks because he would be eligible to purchase stock in the public company MSG, which owns the Knicks.
The premise of this article is quite interesting. But in the end, it is flawed. I’ll build you two hypothetical cases to show you why.
First, some background. Madison Square Garden, Inc. (NASDAQ: MSG) is a U.S. based company that spun-off from Cablevision on February 9, 2010.
MSG is divided into three entities: MSG Sports, MSG Media and MSG Entertainment.
MSG Sports is the division that owns and operates four sports franchises, including the New York Knicks of the NBA, the New York Rangers of the NHL, the New York Liberty of the WNBA, and the Hartford Wolf Pack of the AHL. The Knicks, Rangers and Liberty play their home games at Madison Square Garden.
MSG Entertainment is the division that owns the Madison Square Garden arena. MSG Media consists of the MSG Network, the regional sports network that broadcasts Knicks games locally.
Here’s a brief breakdown of the profitability of MSG by division:
Extracting the contribution of the Knicks from the MSG Sports division is quite a difficult task. According to a December 2009 Forbes report on NBA team valuations, the New York Knicks had the following standalone financial performance for the seasons ended June 30:
According to these cursory figures, the Knicks would appear to contribute meaningfully to the overall profitability of the company. However, in practical reality, it is almost certain that the financial statements of the Knicks organization contains various expenses not captured by Forbes such the reported profitability is far less than those presented above.
Now on to the cases.
Case 1: LeBron trades in MSG stock before announcing his intention to sign with the Knicks
The first question is whether doing so would be considered a violation of insider trading laws.
The purchase or sale of a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, non-public information about the security is a crime. Section 10(b) of the Securities Exchange Act of 1934 allows the SEC to recover up 3x any profits made from the use of inside information. Additional criminal prosecution could lead to up to 10 years in prison. So we’re talking serious stuff here.
Despite the appearance of impropriety, how LeBron would fit within the above description has been the subject of much debate. Clearly LeBron would be in possession of material, non-public information (i.e., his decision to join the Knicks). Whether or not he can be considered an insider within the confines of the law is less clear. Relevant case law for this type of situation simply doesn’t exist. Consider the situation. How often can one man who has absolutely no affiliation with a company materially affect the performance of its stock? James hasn’t even been contacted by the Knicks, let alone been offered a contract.
The courts have expanded the meaning of the word “insider,” and its definition is set up to evolve and adapt to an ever expanding array of possible crimes. Utilizing my own legal background, I would be inclined to believe James would have significant exposure.
It doesn’t matter anyway.
The second question is whether the NBA would allow it. And the answer is no. The NBA has publicly declared it would not accept such trading, as it would be considered a circumvention of the salary cap rules.
Case 2: LeBron trades in MSG stock after announcing his intention to sign with the Knicks
From an NBA standpoint, there wouldn’t be any issue. In fact, the collective bargaining agreement explicitly states:
“During the term of this Agreement, no NBA player may acquire or hold a direct or indirect interest in the ownership of any NBA Team; provided, however, that any player may own shares of any publicly-traded company that directly or indirectly owns an NBA Team.”
From an SEC standpoint, there would be larger issues at stake. The SEC would certainly monitor any trades LeBron makes, in accordance with Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. He would also be subject to SEC reporting requirements (at a certain level of ownership) as well as the company’s own compliance regulations. However, ownership in and of itself would not appear to be problematic.
These two cases depict why the author’s logic may be a bit flawed.
Once LeBron becomes a Knick (an event upon which he would not be allowed to trade), the stock price will adjust to reflect the revised earnings potential of the company. Any further stock price appreciation thereafter would be based on the company’s ability to meet those revised expectations, for which LeBron would be no more qualified than any other investor to determine. He would gain no advantage over anybody who would otherwise view MSG as a solid investment opportunity. And if he did gain an advantage, he wouldn’t legally be allowed to trade on it.
But the article is thought-provoking and creative. Think about it. This one article got so much attention, the NBA felt the need to step in and make a public comment about it.