Researchers Could've Made a Lot of $$$ Off Volkswagen Debacle

Published Sept. 23, 2015 at 7am PST by Travis Deyle

Volkswagen is all over the news recently for lying about their diesel vehicle emissions. Something like 11 Million cars are emitting 40x the allowable EPA limits for NOx -- one of the most gnarly greenhouse gases (100-300x worse than CO2 in global warming potential). And the most eggregious part: Volkswagen setup their vehicles to automatically detect when they were being tested for emissions (eg. on a dyno), and alter their engine behavior to fool the testing apparatus.

Basically, they're in a world of hurt. As of COB yesterday, they have already lost 33% of their market cap ($25B) in just the last two days:

Some colleagues at work asked me what I think about the situation. My reply:

The researchers who reported Volkswagen to the EPA missed out on a HUGE opportunity!

Note: I am not a lawyer and your mileage may vary! Consider this a hypothetical thought experiment rather than investment or legal advice!

Instead of reporting the impropriety to the EPA, the researchers (discussed here) should have done the following:

Massively short the stock. A simple short would've been fine; but leveraging with options would be even better (or play it safer with a straddle). But perhaps best of all: partner with a wealthy, charismatic benefactor (eg. Mark Cuban) to bankroll the trade in exchange for some portion of the eventual earnings (eg. 5-10%). In the case of VOW, you could probably short upwards of $1B directly and through leverage.
After carefully vetting your data, setup a press conference and loudly announce your findings to the world. Share all the original research data. This is where having a charismatic benefactor like Mr. Cuban really helps -- way more people will listen to him than me.
Wait for the fallout and then cover your trade. In this example, you would've earned ~30% ($300M), of which the researchers would see $15-30M.

And it's perfectly legal!

Some might say, "What, how can that be legal?!" Based on my understanding, this does NOT run afoul of any trading laws, such as insider trading. It is wholly-independent, factual research and then trading on your knowledge. By analogy, it's equivalent to recognizing abnormalities in an Enron-like company and shorting the stock while making your research public.

The only possible gotcha: You'd better be damn-sure your assessments are accurate before making them public. Because if you make false statements, it's either fraud (if done knowingly) or libel (with massive, easily-measured damages). So this hypothetical isn't without risk...

Actually... now that I think about it, there might be an opportunity to do this more systematically (eg. Goldman Sachs). They could setup a special investment arm which accepts independently-researched tips (carefully vetted to avoid insider trading) in exchange for profit sharing with the researchers. The investment arm could then independently verify the claims and trade based on the research and its release timing. Seems like a good arbitrage opportunity, great for the researchers, and good for the public. Plus, there are a lot of examples over the years -- just a few that come to mind: Paxil's ineffectiveness, Lumber Liquidators' formaldehyde debacle that caused a 50% stock drop, etc.

Can you find holes in this idea...? Shoot me an email (see above) if you have any thoughts.

Updated Sept 25: Apparently this is legal and has been done before -- even in the Lumber Liquidators case I mentioned.