Category: Insider Trading

The One that Fools the Motley Fool

I’ve followed The Motley Fool from the early days of the internet. (Or at least my early days on the internet.) From a compliance perspective, I’ve always been fascinated with how their marketing gets passed by the compliance department. Whether you like them or not, their stock picks can move prices. The Motley Fool picks usually come out at noon on Thursday in a combination of the Fool services.

If you you could buy some of that stock before the recommendation was published, you could make a tidy profit by front-running the announcement. That is exactly what the Securities and Exchange Commission is accusing David Stone of doing illegally. They also charged one of his acolytes, John Robson, with the same front-running activity.

The classic crime of front running was the publisher of a newsletter buying the stock just before it announced a buy recommendation (or selling just before a sell recommendation).

The SEC complaint has a detailed account of the timing of the stock buys of Stone and Robson on one hand, and the recommendations of The Motley Fool on the other hand. Stone and Robson were clearly buying stocks just before the Fool recommendations came out for those stocks and sold shortly after. You look at it and clearly looks like insider trading.

The SEC also uncovered some emails between the two that make it even clearer that the Stone and Robson were front-running the Fool recommendations.

“I’m ok with sharing the weekly trades with you. I have used it so far to generate a
significant amount of money and I’m sure you will be able to as well. There is a small
possibility that what we are doing could be considered insider trading. The Motley fool
[sic] uses only public information about [sic] to make its recommendations and even the recommendations are behind a paywall so it is a stretch to call it insider trading but it
certainly behaves like it because it almost guarantees favorable price moves at a certain
time.”

The missing part is how Stone was getting the information. There is no mention in the complaint of how. I would guess that Stone had managed to hack the Motley Fool website to find the recommendations before they went live.

“Looks like tomorrow’s update is in video form which means I can’t see what is in ahead of time.”

I think the question will pivot on how the hack happened. Was the Fool just publishing pages, but not announcing and not publishing the link? In that case, maybe the information was not obtained illegally. It would just be poor security by the Fool. I doubt that is the case. It sounds more like Stone had hacked into the Fool webserver and could see the pages in development for the recommendation.

This looks a lot like the outsider trading cases that the SEC brought against traders who made a big pile of money by hacking into corporate press release websites and trading on the news before it was made public.

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MNPI Compliance Issues

For my fellow nerds, “May the Fourth” be with you.

For my fellow compliance nerds, hopefully you didn’t miss the new risk alert from the Securities and Exchange Commission’s Division of Examination on Material Non-Public Information.

Section 204A of the Investment Advisers Act requires all investment advisers, registered and unregistered, to have written policies and procedures that are reasonably designed to prevent the misuse of material non-public information (“MNPI”) by the investment adviser or any person associated with the adviser.

I hope it’s obvious that this is not a prohibition on insider trading. It’s a requirement to manage the information so it can’t be used for insider trading. (Of course, insider trading is not defined by statute and is it’s own creation by the SEC.)

Based on the SEC risk alert, examiners have been focused on how advisers, and I would guess especially hedge funds, are trying to get an edge to beat the market.

The SEC’s first target is “Alternative Data”. The classic alternative data is counting cars at Walmart to see if there are more customers this year than prior years to get indirect view of sales. I found the SEC’s view on the alternative data in the risk alert to be strange and seems to be circling around what it really wants to say. The main concern seems to be the lack of diligence around these providers and sources. I think what the SEC is getting at is that some of these providers are lacing inside information into the alternative data source or using the alternative data source as a cover for illegally obtained inside information.

This same theme carries over to “expert networks”. The same concern is that the subject matter expert is using illegally obtained MNPI in his or her take on the company. Or worse, the expert is an employee of the company.

The second half of the risk alert turns to traditional code of ethics problems and foot-faults. There are the usual misses on who is an “access person”, inadequate review of account statements and a failure to get everyone to sign the code.

Not a lot of new ground here. DOE has been focused on how advisers, and especially hedge funds, are trying to beat the market. Getting insider information illegally is something the SEC has been and will always be focused on.

This is the SEC staying in the trench and not needing a targeting computer.

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Insider Trading Cops

This insider trading case caught my attention because of the local setting. David Forte is an officer with the Needham Police Department. That’s the next town over from my town. I’m such a homer.

One of Forte’s brothers was the Chief Information Officer at Analog Devices. The brother discovered that Analog was going to buy Linear Technology Corporation in a transaction that would inevitably and rapidly raise the price of Linear stock. There was a phone call shortly before the merger between the brothers. Shortly after the phone call, Forte made some very aggressive trades on the stock of Linear.

What are aggressive trades?  Forte bought short-dated out-of-the-money call options on a merger target in an account that had never bought call option before or traded in that stock. I’m sure the compliance officer at Forte’s brokerage flagged the trades and reported them to the regulators as suspicious. The list of suspicious traders got shared with the companies and the shared last names were a sure giveaway.

Forte told two friends who also made aggressive trades and also got caught. All three were arrested and charged criminally for insider trading. 

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The Russian Hack of the EDGAR

A few years ago Ukranians hacked EDGAR to obtain nonpublic earnings information and used that information to trade stocks. The hackers made about $1.4 million and spread that information to associates for about $4.1 million in total profit. Now a bigger hacking plot has been discovered and it has bigger international implications.

The Securities and Exchange Commission brought fraud charges against five Russian nationals for engaging in a multi-year scheme to profit from stolen corporate earnings announcements obtained by hacking into the systems of two U.S.-based filing agent companies before the announcements were made public. These companies helped to “Edgar-ize” documents for filing in the EDGAR system. It looks like the SEC did a good job of securing its systems. This private provider did less so.

It was more lucrative. The SEC claims that the hacking group made over $80 million in profits. Maybe they made better use of the information than the Ukrainians did in their plot. Or maybe the five Russians had more capital.

The Russians hacked into the providers’ public company clients’ filings include, among other things, Forms 8-K and related exhibits, which consist of press releases containing the public companies’ earnings announcements. The Providers’ public company clients can use the platforms to create, edit, and submit their filings to the SEC through the EDGAR filing system. The weak security was at provider instead of the main database.

It looks like the hackers were not just hacking the SEC filings. Some of the five are implicated in the alleged hacking around the 2016 election.

One of them was just scooped up in Switzerland and has been extradited back to the United States for charges. Vladislav Klyushin. He had flown to Switzerland for a ski vacation at the Zermatt ski resort. It looks like US intelligence learned of the travel and had the Swiss pick up Klyushin at the airport. Russia and the US fought over extradition, with the US eventually winning and putting him on plane to face charges.

The five hackers worked at a Russian information technology firm called M-13 that specialized in penetration testing and other services. Looks like they were wearing white hats and black hats.

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The Non-Compliant Compliance Officer

You hate to see a peer break bad.

The Securities and Exchange Commission charged Jose Luis Casero Sanchez, a former Senior Compliance Analyst who worked in the Warsaw, Poland office of an international investment bank, with insider trading involving at least 45 corporate events with the investment bank’s clients. 

Ugh. He’s giving compliance a bad name.

For an investment bank, a role of compliance is to maintain a list of restricted companies for trading because of material non-public information. It should be held tightly and lovingly. Not used to profit.

The SEC didn’t want to drag the investment bank into the litigation press releases and complaint. The press identified it as Goldman Sachs, who confirmed.

Mr. Sanchez was a Spanish national, worked in Poland and did his illegal trading in US-based brokerage accounts. The accounts were in the name of his parents. He had accounts at Schwab, Interactive Brokers and Tastyworks. I have to admit that I hadn’t heard of Tastyworks before. Apparently if I make 750 referrals to the firm I get a Tesla. (anyone? anyone?)

This is a clear case of insider trading under US law. It’s clear that Goldman had the policies in place prohibiting this kind of behavior. The kind of behavior that Mr. Sanchez was supposed to prevent or stop.

The SEC got IP logs for access to the accounts. Those logs are not always that exact. But in this case they were traced back to Poland. It doesn’t need to be more exact than that to show that Mr. Sanchez was running the accounts, not his parents.

In his first account at Interactive Brokers, the compliance people at Interactive Brokers clearly saw stuff they didn’t like. Mr. Sanchez was trading options and doing really well. I assume they flagged the account, reported it and shut it down.

Undeterred and unafraid, Mr. Sanchez moved on to Schwab and Tastyworks. He continued his options trading. I’ll assume he was taking aggressive positions. For some reason he went back to Interactive Brokers and opened a new account in his mother’s name this time. He churned through companies on the Goldman Grey List of companies being advised.

The last trade mentioned in the complaint was at Interactive Brokers in May 2021. Who wants to bet that the compliance people at Interactive Brokers flagged this account and brought it to the attention of the SEC? I’m willing to bet good money that they did the heavy lifting for the SEC of identifying bad behavior. That’s what good compliance people are supposed to do.

I’m sure the SEC did a great job of then tying the companies involved in the account’s trades back to Goldman. They got the IP addresses from the broker showing that Poland was involved. Goldman looked at the last name on the account and the employees in Poland. (How many Spaniards work at Goldman in Poland?)

Boom!

Then they checked Mr. Sanchez’s browser history and noticed Schwab and and Tastyworks (did I earn that Tesla yet?).

Boom! Boom!

They got you Mr. White.

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Shadow Insider Trading

Matthew Panuwat was a business development executive at Medivation, an oncology-focused biopharmaceutical company. Panuwat learned from Medivation’s CEO that the company expected to be acquired by a major pharmaceutical company, Pfizer, within a few days, at a premium to the then-market price.  Panuwat did not trade in Medivation securities.  Rather, within minutes of hearing the news, Panuwat purchased out-of-the-money call options in Incyte Corporation, another oncology-focused biopharmaceutical company that he believed would increase in value when the Medivation acquisition was announced.

If Panuwat traded in Medivation’s stock or Pfizer’s stock, that clearly would have been insider trading.

But he didn’t trade in the stock in play. He traded in Incyte, a completely unrelated company that happened to be in the same industry and about the same size as Medivation. He bet that there would be increased interest in this space and the merger price of Medivation would float the value of similar companies.

Should this be insider trading?

The Securities and Exchange Commission thinks so. It brought charges against Mr. Panuwat for this 2016 trade. I’m sure your noticing the big time gap. The SEC filed just before the expiration of the statute of limitations.

The SEC seems to be hanging its charges on Medivation’s insider trading policy:

“Because of your access to this information, you may be in a position to profit financially by buying or selling or in some other way dealing in the Company’s securities…or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company.”

A company’s definition of insider trading shouldn’t be the standard for a government action. Should it?

The SEC states:

Panuwat’s undisclosed, self-serving use of Medivation’s information to purchase securities, in breach of his duty of trust and confidence, defrauded Medivation and undermined the integrity of, and investor confidence in, the securities markets.

Panuwat did make an aggressive trade. He purchased 578 out-of-the-money call options with less than a month left to expiration. The options had strikes from $80 to $85 when Incyte’s stock was trading at $76. I’m sure that triggered some compliance review at his brokerage and probably got red flagged for further review.

The SEC is claiming that Panuwat used confidential information he acquired from his employer. That seems right. The question is how far should that dome of limiting action should spread. The SEC seems to think it should be a big dome. It should reach out to peer/competitor companies.

Given how long this has been sitting around, there must be some hand wringing at the SEC. The complaint is bit short on facts given that there has been five years to gather information.

In compliance, how do you deal with this potential expansion of the insider trading limits? It sounds like insider trading polices and monitoring would have to include peers of the company. Of course, this all assumes this case comes out in favor of the SEC.

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The One with TheBull

The Dark Web and bitcoin are the tools of the trade for online criminals these days. Apostolos Trovias is alleged to be one of those criminals. He operated online under the pseudonymous online avatar “TheBull”. Mr. Trovias is alleged to have engaged in a deceptive scheme to offer and sell what he called “insider trading tips” on the Dark Web, offering purchasers an unfair advantage when trading securities.

Mr. Trovias claimed that he had order-book data from a securities trading firm that was provided to him by an employee of the trading firm. This would seem to be material, nonpublic information that was supposed to be kept confidential.

If Mr. Trovias had actually acquired some or all of the tips from actual order-book data or if he had stolen the order-book data himself, then he had engaged in a fraudulent scheme to sell material, nonpublic information that he knew or was reckless in not knowing was obtained in violation of a duty of trust and confidence. That’s illegal.

If Mr. Trovias did not actually have this information, then his statements were materially false and misleading and made in furtherance of a scheme to deceive purchasers who wanted to trade on inside information. That’s also illegal.

What fascinated me about this case is that the Securities and Exchange Commission doesn’t have to prove that Mr. Trovias was actually selling or using insider information. The SEC wins either way.

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Fund Board Representation and Public Stock

Part of a private equity fund’s investment strategy is getting a seat at the table for a company they own. When that company’s shares also publicly traded, there are heightened compliance concerns. The fund’s management representative is likely to end up with material non-public information. The compliance challenge is to prove that the information does not make it to the fund’s trading desks.

Ares Management just got an SEC fine for failing to stop the information leak.

Based on the SEC order, Ares had invested several hundred million dollars in a public company and had two representatives on a public company’s board. One of those was a senior member of the investment team. This representative had access to:

  • “potential changes in senior management,
  • adjustments to the Portfolio Company’s hedging strategy,
  • efforts to sell an interest in an asset,
  • the Portfolio Company’s desire to sell equity and use proceeds to retire certain debt, and
  • the Portfolio Company’s election, as allowed under the terms of the loan agreement, to pay interest “in kind” and not in cash.”

All of that would reasonably be considered material non-public information. Ares compliance group had trades in the company’s stock under special watch. It had the power to impose information walls, but apparently did not do so in this case.

Ares made follow-on purchases of the company’s stock.

Ares’ compliance staff failed, in numerous instances, to document sufficiently that they had inquired with the Ares Representative and the members of the deal team as to whether any of them had received potential MNPI from the Portfolio Company, or to apply a consistent practice to the inquiries made, resulting in ambiguity whether, or if, inquiries were made in certain instances.

This a classic compliance problem of proving that you don’t know something when the information exists within the firm. As a result, the SEC order takes the position that Ares’ compliance staff “failed to document properly whether they had assessed the extent to which Ares deal team members had any information that had the risk of being MNPI.”

Part of this appears to be the unusual circumstance. Ares does not commonly hold director seats on the boards of publicly-listed companies. The compliance policies and procedures didn’t adequately address the issue and the compliance staff did not adequately document an area of heightened risk.

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Are you getting the right Zoom?

I’m going to guess that many of you are using Zoom for some aspects of communicating personally or professionally? I think it’s great. Business meetings work better when you can see each other.

Personally, it’s been great to get together with my cycling teams over Zoom. We aren’t riding together outside. I’m not riding outside at all. We have done some Zoom and Zwift rides. Nothing better than watch each other struggle up virtual bike climbs.

Maybe you like it so much that you think you should buy some stock in the company. You type in “Zoom.” See a quote and description.

Zoom Technologies, Inc., through its subsidiaries manufactures, researches, develops and sells electronic communication products for the mobile phones, wireless communication circuitry, and related software products.

So you hit “buy.”

It seems lots of people are doing this. Enough that the SEC put a trading suspension in place for Zoom Technologies. It’s ticker symbol is ZOOM.

The problem is that you were really interested in Zoom Video Communications. It’s ticker symbol is ZM.

Zoom Technologies also hasn’t filed any public disclosures since 2015 but still has a market value of around $30 million. Zoom Video has a market value of over $30 billion.

Zoom Tech’s price doubled to $20 in late March as we all brought Zoom Video into our personal and professional lives. It’s clear that there were a lot of poorly research trades in the mix

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Browns Don’t Lose, But a Player Does

For the first time in 13 years, the Cleveland Brown did not lose on their NFL opening weekend. Being the Browns, they didn’t win either. They had to compete without the help of Mychal Kendricks. The now former linebacker was cut by the Browns after charges of insider trading.

The $1.2 million in insider trading profits cost Kendricks $3.5 million from his Browns contract. Plus he faces a significant civil penalty from the SEC, Plus, the US Attorney’s Office in Philadelphia decided to bring criminal charges which could result in jail time.

Why did Kendricks do this? In the complaint, the SEC published a text message from Kendricks to Damilare Sonoiki.

I’m at a messed up place as far as my money is concerned I have enough money to live and to support myself but not enough money to avoid taxes … I don’t have enough money to buy a business and get the tax breaks I need.

How did they do this? Sonoiki worked at investment bank. It’s unnamed in the complaint, but based on the transactions it looks like it was Goldman Sachs. Sonoiki met Kendricks at a party. Sonoiki got information on M&A deals from work and passed them on to Kendricks. Kendricks gave him football tickets and cash in exchange for the inside information.

How did they get caught? Kendricks opened a trading account, but tried to have Sonoiki make the trades directly.  The firm flagged the account for having a mismatched IP address. Then the trades were just options with big short-term gains. I’m sure the brokerage account flagged the account and alerted the SEC.

It’s a very brazen case of insider trading. The only question is why it took so long to get caught.

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