Supreme Court Information Markets, Timing the Stock Market, and Ted Frank Putting his Money where Mouth Is

June 5th, 2011

Ted Frank, the macha of the Center for Class Action Fairness, knows how to put his money where his mouth is. Ted is so confident that the Supreme Court will reverse the 9th Circuit in Wal-Mart v. Dukes that he made a leveraged bet–of 10% of his net assets–that WMT (Wal-Mart’s symbol) will bounce.

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.

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.

Kudos to Ted for taking this risk based on his sense of how the Court will act. He bases his decision on “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.”

While I commend Ted, his individual gut instinct is less than perfect. Like Yogi Berra said, people are very bad about making predictions; especially about the future. A Prediction Market, with a proven track record, that taps into the wisdom of the crowds would be a more sound basis to make such a big investment. Fortunately for Ted, such a market exists–, and currently 76% of members predict a reversal.

Larry Ribstein has more along the same line, with respect to information service products.

I agree with Ted about the risks, particularly including the risk the market’s already priced this given Wal-Mart’s huge float and analyst following, and about the costs of making the bet.  On the other hand, Ted’s post illustrates the costs of arbitrage, and therefore why markets could be wrong. It also illustrates how making betting against the market cheaper would increase market efficiency (and, as Ted notes,counteract a trial lawyer strategy).

But my main point here concerns my views about a potentially expanded role for legal information experts in capital markets. Here’s an excerpt from Kobayashi & my Law’s Information Revolution (footnotes omitted):

Law-related matters generate many types of information which can have significant market value because of the potentially high stakes of legal outcomes. In particular, litigation significantly affects asset values.  All firms have some litigation risk, and some firms have a lot riding on actual or potential tort or intellectual property litigation.  * * * This suggests a market demand for legal analysis in connection with firm valuation.

I look forward to Ted’s newly-found fortune, and his gumption for relying on the Supreme Court to bolster his net worth.