Category: Insider Trading

Sitting Congressman Indicted and Arrested for Insider Trading

In a startling announcement, the Department of Justice and the Securities and Exchange Commission filed charges against Congressman Christopher Collins from New York.

There has long been controversy around lawmakers and their staff trading on information obtained during their government service. That resulted in the passage of the Stop Trading on Congressional Knowledge (STOCK) Act in 2012.  That law prohibits the use of non-public information for private profit, including insider trading by members of Congress and other government employees. Members of Congress are no longer allowed to use information garnered through official business for personal reasons

That is separate from Congressman who gain material non-public information outside the scope of their governmental jobs. They are still bound by the complex web of what is illegal insider trading.

Congressman Collins, a U.S. Congressman representing, the 27th Congressional District of New York sat on the board of Innate Immunotherapeutics, Ltd. Innate was developing a drug to treat multiple sclerosis. The results of the drug’s clinical trial were to be released between June 5 and July 11 and the board members were instructed not to trade during this period. On June 22, the CEO told the board there was bad news. The results indicated a clinical failure.

According to the SEC complaint, the email with this news came as Congressman Collins was attending an official event on the south lawn of the White House. While still at the event, he began calling his son, Cameron Collins. He knew his son had invested in millions of Innate shares. That night Cameron, his girlfriend, and his girlfriend’s parents all entered orders to sell shares in Innate. Their selling volume accounted for more than half of the trading volume that day and exceeded the 15-day average trading volume by more than 1,454%.

It’s a very clear cut case of trading on material non-public information. Christopher Collins, as a member of the board of directors clearly knew he was not supposed to share this material non public information.

Was the trading illegal insider trading?

Under Newman the U.S. Court of Appeals for the 2nd Circuit said that the insider must “also receive something of a ‘pecuniary or similarly valuable nature’ to prove illegal insider trading. The US Supreme Court, in Salman v. US, made it clear that the passing material non public information to a friend or relative is still illegal insider trading.

“In these situations, the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds. Here, by disclosing confidential information as a gift to his brother with the expectation that he would trade on it, Maher breached his duty of trust and confidence to Citigroup and its clients—a duty acquired and breached by Salman when he traded on the information with full knowledge that it had been improperly disclosed.”

That leaves the case against Collins as being clearly illegal insider trading, assuming the SEC and DOJ have the evidence to back up their complaint and indictment.

Congressman Collins would not be the first sitting Congressman to be indicted. There have been been more than two dozen indicted since 1980. Looking back at charges, Cogressman Collins may be the first indicted on insider trading.

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Two Tales of Insider Trading to Avoid Losses and Make Money

I found the two recent cases of insider trading to be clear violations that should be easy to spot. Matthew Brunstrum worked at a company with specific restrictions on trading the company’s stock. Yao Li worked a different company, but one that also had restrictions on trading the company’s stock.

In both cases, the two employees learned of negative news about the company that would most likely cause the stock price to drop. Both avoided losses by selling their holdings of the company stock before the news became public. They each made some money through derivatives or short selling the company stock.

Matthew Brunstrum was a second generation employee of Stericycle. His dad was executive at the company and his mother held a bunch of Stericycle stock. In April 2016, Matthew learned of material, non-public information about Stericycle. To avoid insider trading or even the perception of insider trading, Stericycle imposes a blackout period for trading around the company’s earnings announcements.

Brunstrum went ahead and sold his stock and bought out-of-the-money puts. Based on drop in stock price and his trading, he avoided losses and made money on the puts. He also convinced his mother to sell her stock and buy puts.

Yao Li worked at Alliance Fiber Products. The company had an insider trading policy that imposed black out periods around earnings announcements and prohibited short selling. But that did stop Li from doing just that in Q2 2014, Q3, 2015 and Q4 2015. Li sold his stock holdings ahead of bad earnings announcements and short sold stock to earn cash from the decline in stock price.

These are both easy to spot, problematic trading patterns that the brokerage compliance groups should have spotted and flagged for FINRA and the SEC.

I found it interesting that in the Li case, the SEC claims that its Market Abuse Unit’s Analysis and Detection Center discovered Li’s trades and started the case. I think it would be great if the SEC had that capability. But I found it curious that the claim relates to activities that happened so long ago. The Brunstrum trades happened in 2016 with no mention of the SEC’s fancy analysis capability. Li’s first suspicious trades happened two years prior to that.

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Pan Mass Challenge
On Pan-Mass Challenge weekend, August 3 – 5, I will bike across Massachusetts to raise money for life-saving cancer research and treatment at Dana-Farber Cancer Institute. 100% of your donation will go to cancer research and treatment at Dana-Farber Cancer Institute through its Jimmy Fund. I have made a personal commitment to raise $8000.00. I hope, that as a reader of Compliance Building, you will support my fundraising effort. You can donate through any of the following links:

Thank you,
Doug

Another Insider Guessing Case

The Securities and Exchange Commission and the DOJ filed another case against an Equifax employee who figured out that the breach remediation plan was actually for Equifax and not a client. Sudhakar Reddy Bonthu, like Jun Ying in the earlier case, Bonthu was working on Project Sparta which was identified as a fast-breaking opportunity for an unnamed potential client. Bonthu was tasked with developing the online user interface and tools.

The SEC makes a big jump, with little to back it up, that Bonthu knew or was reckless in not knowing that Project Sparta was actually for Equifax and that the company had suffered a massive data breach. The sole proof the SEC offered was that Bonthu received a dataset file entitled: “EFXDatabreach.postman_collection.”

It sounds to me like this case goes into the “insider guessing” bucket. According to the SEC, Bonthu had a matrix of information that lead him to conclude the true nature of his project. THe tough part will be the SEC convincing a jury.

In the earlier case The SEC against Jun Ying, a former senior technology executive at Equifax with insider trading, Ying exercised his stock options and sold his Equifax stock holdings ahead of Equifax’s announcement that it had suffered a major data breach.

Bonthu was more sophisticated. He bought put options with a September 15 expiration. Equifax announced the breach on September 7. He bought them in an account in his wife’s name instead of one with his name. Equifax had a policy that prohibited employees trading derivatives, including put options.

I think that trading looks works than Ying’s sale of his stock. So that may a jury less sympathetic if he is hoping for a result like the railroad workers.

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Insider Guessing

Back a few years ago there was blue collar insider trading case. Some workers on a railroad noticed a lot of guys in suits walking around the rail yards. Their boss made some unusual requests about equipment. The two workers put to and two together and took a guess that the railroad was for sale. They backed their guess up with cash and bought some of the railroad stock.

The railroad did sell, the two made some good gains, and the Securities and Exchange Commission accused them of insider trading. They were clearly insiders because they were company  employees. The SEC failed to show that they gained access to information that betrayed company confidentiality. At least a jury determined that.

The SEC brought a white collar version of the case. The SEC (and the DOJ) accused Jun Ying, a former senior technology executive at Equifax with insider trading. He exercised his stock options and sold his Equifax stock holdings ahead of Equifax’s announcement that it had suffered a major data breach. The SEC says that Ying used confidential information to conclude that his company had suffered a massive data breach.

Ying claims that he merely guessed.

In Ying’s case, he was told about Project Sparta which was setting up a website for consumers to determine if they were affected by a breach and deploying tools for them. The discussion was that Project Sparta was for unnamed client that had experienced a breach. Ying’s boss made some weird statements and Ying got suspicious that the breach was actually of Equifax itself. He backed up his suspicions with cash and sold hie Equifax stock.

Matt Levine coined the term “insider guessing” for this type of situation and asks if it’s illegal.

It certainly looks illegal. That’s why Ying is subject to charges.

Firms have 10b5 plans to avoid this situation. Stock trading is set for pre-determined times to avoid any indication that the employee is trading on inside information.

As a company employee you have access to non-public information. It’s hard to prove that you didn’t know about a particular piece of key information. It’s hard to prove the difference between insider guessing and insider trading.

Obviously, it’s easier to prove insider trading if there is the document or email that shows the knowledge exists. You’re likely to cause the SEC to dig relentlessly to find that document or email or take a document or email out of context to prove its case. I expect the SEC is spending a bunch resources looking for the document or email that would prove that Ying did not merely guess.

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Research on Insider Trading

Just to revive any anger you have left from the 2008 financial crisis and its aftermath, a new academic paper found evidence of insider trading among corporate insiders at leading financial institutions during the Financial Crisis. That’s on top of other research that brokers leak information or front run trades.

One research paper on political connections comes from the private meetings between government officials and financial institutions during the financial crisis which eventually lead to the Troubled Asset Relief Program.

Any corporate insiders with knowledge of those discussion could have known how much money was involved and which financial institution would get it. With financial institutions staring into a pit on destruction and some being dangled a rope to safety, one could have made a good chunk of cash if you knew which company to bet on and which ones to avoid.  The government was making hundreds of billions of dollars available.

The paper examines conduct at 497 financial institutions between 2005 and 2011. The researchers focused on individuals who had previously worked in the federal government. In the two years prior to the TARP, these people’s trading gave no evidence of unusual insight. But in the nine months after the TARP was announced, they achieved particularly good results. The paper concludes that “politically connected insiders had a significant information advantage during the crisis and traded to exploit this advantage.”

The other research paper on order flow leakage uses data from 1999 to 2014 from Abel Noser, a firm used by institutional investors to track trading transaction costs. The data covered 300 brokers, but the researched focused on the 30 biggest. 80-85% of the trading volume flowed through those 30.

The researchers found evidence that large investors tended to trade more in periods ahead of important announcements. That would be hard to explain, unless they have access to inside information.

The most innocent access to information would be brokers that “spread the news” of a particular client’s desire to buy or sell large amounts of shares. That helps with market-making. A less innocent explanation is that they give this information to favored clients to boost their own business.

Of course, large institutions can be both beneficiaries and victims of this  information leakage. But in general they are net gainers to the lowly retail investor who does not have access to this information. It further leads to a conclusion that the markets are rigged and they should not participate at all.

One common theme to these papers is the use of big-data and analytics to find these trends and identify weaknesses in the systems. We have seen cases from the SEC’s Division of Economic and Risk Analysis attacking frauds. It may be useful for the SEC to focus on these systemic problems.

Sources:

  • Insider trading has been rife on Wall Street, academics conclude in The Economist
  • Political connections and the informativeness of insider trades by Alan D. Jagolinzer, Judge Business School, University of Cambridge; David F. Larcker, Graduate School of Business, Rock Center for Corporate Governance, Stanford University; Gaizka Ormazabal, IESE Business School, University of Navarra; Daniel J. Taylor, the Wharton School, University of Pennsylvania. Rock Center for Corporate Governance at Stanford University, Working Paper No. 222.
  • Brokers and order flow leakage: evidence from fire sales by Andrea Barbon, Marco Di Maggio, Francesco Franzoni, Augustin Landler. National Bureau of Economist Research, Working Paper 24089, December, 2017; and “The Relevance of Broker Networks for Information Diffusion in the Stock Market” by Marco Di Maggio, Francesco Franzoni, Amir Kermani and Carlo Summavilla. NBER Working Paper, No 23522, June, 2017

More Changes to Insider Trading Law

With the ground-shaking decision in Newman, insider trading law became a bit murky. Cases have been filling in the gaps left in its wake. The Mathew appellate Martoma decision helped fill in some more.

From a compliance perspective, this is all chasing butterflies and tilting at windmills. It was clear that Mr. Martoma was involved in insider trading. It was just a question of whether it was illegal. He knew the information he was getting was not supposed to be disclosed to the public. He should not have pushed for its disclosure and he should not have traded on it. At least not according to any self-respecting compliance professional at a trading firm.

But I’m sure enforcement professionals are very interested to see if they can find a way to keep their insider trading clients from going to jail.

For me, the current status of the law is that the Newman decision said the government needed to prove the tipper gained a tangible reward, or “personal benefit,” for providing insider information. The 2016 Supreme Court ruling in Salman v. U.S., said proving a tipper and trader were relatives was enough to meet the “personal benefit” standard.

In the Martoma case, the Second Circuit describes the the “misappropriation theory” of insider trading:

“that a person . . . violates § 10(b) and Rule 10b‐5[] when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.” Id. at 652. It is thus the breach of a fiduciary duty or other “duty of loyalty and confidentiality” that is a necessary predicate to insider trading liability.

It then goes on to the seminal insider trading case of Dirks v. S.E.C., 463 U.S. 646 (1983)

the Supreme Court held that a “tippee”—someone who is not a corporate insider but who nevertheless receives material nonpublic information from a corporate insider, or “tipper,” and then trades on the information—can also be held liable under § 10(b) and Rule 10b‐5 but “only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.” Id. at 660.2 “[T]he test” for whether there has been a breach of a fiduciary duty or other duty of loyalty and confidentiality “is whether the [tipper] personally will benefit, directly or indirectly, from his disclosure” to the tippee. Dirks, 463 U.S. at 662.

It goes on to cite its own United States v. Newman, 773 F.3d 438 (2d Cir. 2014)

To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the insider himself followed by a gift of the profits to the recipient,’ we hold that such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.

The Second Circuit comes out with this standard:

Thus, we hold that an insider or tipper personally benefits from a disclosure of inside information whenever the information was disclosed “with the expectation that [the recipient] would trade on it,” … and the disclosure “resemble[s] trading by the insider followed by a gift of the profits to the recipient,” … whether or not there was a “meaningfully close personal relationship” between the tipper and tippee.

For my simplistic compliance perspective, this means that if the tippee pays money or gives something valuable to the tipper in exchange for money, the tippee risks going to jail.

Martoma gave his tipper money through an expert network agency. As a result, his conviction stands.

I think this leaves golf buddies possibly able to trade on insider knowledge, unless they are relatives or betting on the results.

I should point out that there was a blistering dissent in the case and I’m not sure if Mr. Martoma still has enough cash to appeal to the Supreme Court. We may see more in the Martoma case.

I’m sure that you will be reading many more nuanced discussions about this case and its implications from those much more versed in insider trading than me. But, I think this case does little to change the compliance view on insider trading.

If you want more information on the Martoma case or the SAC Capital attack, read Black Edge. It’s well worth the time if you have any interest in the area.

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The One With The Incriminating Internet Searches

The case against Fei Yan was a fairly straight-forward insider trading case involving leaky M&A transactions. In this case, the leaks came from a junior corporate associate working on the transactions. We can only guess that she told her husband, Mr. Yan, about her day at work and revealed too much information.

While Mr. Yan was working as a postdoctoral associate at the Massachusetts Institute of Technology’s electronics research lab. He apparently had enough free to time to trade stocks and advance into options. He did so in an account in his mother’s name, using leaked information from his wife. At least that is what the SEC and DOJ are going to try to prove.

Mr. Yan started trading in Mattress Firm just forty-five days before the announcement of its acquisition by Steinhoff International. His gifted trading netted him almost $10,000.

The next transaction was the acquisition of Stillwater Mining by Sibanye Gold. With Mr. Yan’s now advanced trading skills, he moved to the higher leverage of options. He acquired a slate of call options within 30 days of the transaction’s announcement. With the additional leverage, he generated a profit of over $100,000.

The case ended up with criminal charges as well. I was curious about what escalated it to make it worthy of criminal prosecution.

The SEC complaint noted two Google searches:

“how sec detect unusual trade”
“insider trading with international account”

And further notes the Mr. Yan reviewed several items in the search results, including “Want to Commit Insider Trading? Here’s How Not to Do It.”

That article noted the 2013 Badin Rungruangnavarat insider trading case where his trading was most of the trading activity in the options and futures involved. It also involved a lot more money.

Mr. Badin made $3.2 million which makes him a much juicier target for prosecution. Mr. Yan’s $120,000 in profits are going to cost him a much larger amount in legal fees to defend the civil case and the criminal case to keep him out of jail. According to reports, he used a court-appointed attorney at the bail hearing. If convicted, he could face up to 25 years in prison and as much as $5 million in fines for the security fraud charges, and 20 years in prison and up to a $250,000 fine for the wire fraud charge.

I assume the Google searches made the federal prosecutors see that Mr. Yan had criminal intent, clearly knowing what he was doing was illegal and taking steps to hide the trading activity.

Given the small amounts, how did he get caught? I would guess the brokerage compliance team noted the suspicious activity and reported it to the SEC.

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On Pan-Mass Challenge weekend, August 4 – 6, I will saddle up to ride with 6,200 other cyclists to raise money for life-saving cancer research and treatment at Dana-Farber Cancer Institute. 100% of your donation will go to cancer research and treatment at Dana-Farber Cancer Institute through its Jimmy Fund. I have made a personal commitment to raise $8000.00. I hope you can you will support my fundraising effort. Please give generously with one of the following links:

Thank you,
Doug

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The One With the Fake Fitbit Steps and Fake News

The quest of any insider trader is to get a stock bet in place before a big announcement is made. Robert W. Murray thought he could just make his own announcement and sell out of his trade. The target was Fitbit.

This case caught my attention because of the yelling about “fake news” and Fitbit. I became a fan of the Fitbit products a few years ago when I wanted to lose some weight. I managed to drop 25 pounds using my Fitbit (and watching what I ate and exercising more).

Mr. Murray had no inside information, so he decided he could make some money by manufacturing his own announcement. He did some research and thought he could put a fake filing on EDGAR, the SEC filing system. According to the SEC complaint, Mr. Murray figured out how to do a fake filing by research at least two prior EDGAR manipulation cases:  the 2015 Nedko Nedev Case and the 2016 Nauman Aly case.

Mr. Murray bought some out-of-the-money call option cheap the filed a fake tender offer for Fitbit, Inc. on EDGAR. It worked. The stock price spiked by 10% on news of the tender offer. The stock came back down after Fitbit made an announcement that it had received no communications about a tender offer.

Mr. Murray had a great ROI on his call options of 351%. He did not have much money at risk. He only spent $887 on the options and realized a gain of $3,118.

Mr. Murray was able to disguise his IP address for his filing. However, he used his real email as a backup recovery email for the EDGAR account. He booked a hotel reservation using that account. There was a recovery email for the the first recovery email that tied back to Mr. Murray’s employer.

Assuming the facts in the complaints turn out to be true, Mr. Murray spent a lot of time and energy to create the fake steps and fake news for a $3200 profit. Looks like he is going to use all of that up in legal fees, and then a lot more to try to keep himself out of jail.

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The One With The Pilfering Lawyer and The Document Management System

The SEC and the DOJ broght charges against Walter C. Little and his neighbor Andrew M. Berke for illegal insider trading. This particular case caught my attention because Mr. Little was a law firm partner and he found the information by searching through his law firm’s document management system.

According to the complaints, Mr. Little obtained material, nonpublic, confidential information about seven issuers and 11 corporate announcements through his access rights on law firm’s internal computer network. However, Mr. Little did not work for those clients or on those transactions.

Mr. Little and Mr. Berke have not settle the claims. Mr. Little is going to have an uphill battle because the law firm disclosed the data about Mr. Little accessing the confidential documents.

In one case, the law firm was serving as legal counsel to Pentair on a possible merger with ERICO Global in a transaction that the firm called Project Lionel.

The damning timeline:

  1. On August 4, The document management system shows Mr. Little accessing documents titled “Pentair – Commitment Letter” and “Lionel Goldman Sachs Engagement Letter”.
  2. On August 5, Mr. Little and Mr. Berke exchange text messages and phone calls.
  3. On August 6, Mr. Berke starts buying call option on Pentair stock.
  4. On August 11, Mr. Litte accessing a document entitle “Project Lionel – Form 8-K(Execution of Merger Agreement)”
  5. On August 11 and over the next few days, Mr. Little buys Pentair call options.
  6. On August 17, Pentair issues a press statement announcing the merger.

A partner at a big law firm knows that accessing merger information about firm clients is wrong and trading on that information is illegal. The trading would be flagged as suspicious by the brokerage firm and sent the information to FINRA. If there was enough suspicious activity around the merger, FINRA would send a query to the law firms involved. The law firm would see the partner’s name and turn over all of the relevant information.

The only question I have is how well did Mr. Little disguise his trading. Since the trading happened over the course of a year with several different clients, I assume he did a good job of hiding the trading. I would guess that it was the last deal with Hanger, Inc. that caught the regulators attention. Once in their sights, the regulators were able to trace back to Mr. Little’s trading on other law firm clients.

Mr. Berke seems to have a more defensible position. The prosecutors will need to prove the information was passed to him and that the trading was not just a coincidence. Then, it’s into the post-Newman world of whether he needed to know the information was supposed to be confidential or whether the relationship between the two needed some level of significance.

Then there is the law firm leaving documents unprotected. This is common. It’s tough to balance the sharing needs of a sprawling team against the information security impositions in the document management system.

At a minimum it’s an embarrassment to the law firm. I would assume the law firm has changed its document security settings, defaulting to limited rights, instead of defaulting to a public setting. I’m sure there is plenty of complaining because it makes it hard to work collaboratively when document security gets in the way.

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The Case of the Security Guard with Ketchup on his Hands

With the flow of announcements from the Securities and Exchange Commission, odd things will catch my eye for further review. For the insider trading case against Todd David Alpert, it was because the SEC said that he “worked as a security professional at the home of a Heinz board member.” A tilt of my head left me wondering what kind of securities professional was working at the home of a board member.

That was me confusing “security professional” with “securities professional.” Of course, I realized that “security professional” was a fancy term for security guard. But by the time I realized my mistake, I was deep into the complaint against Todd David Alpert.

Once I realized he was a security guard I immediate thought of the railroad insider trading case. I was ready to give Mr. Alpert credit for leveraging his position. I assumed he had identified the comings and goings from his post and tied that into what was going on behind the scenes.

I was thinking of the defenses from the railroad workers noticing the action in the railyards or counting cars at WalMart.

Then my jaw dropped.

The problem was the board member. The unnamed board member would forward emails to the Mr. Alpert in his role as a security professional, and ask him to print the email and attachments.

The Board Member forwarded an email regarding the potential Heinz acquisition with a direction to “print now”. The attachments to the email contained materials that would be discussed on an upcoming Heinz board of directors’ call, including a copy of the revised acquisition proposal letter, which included the word “CONFIDENTIAL” in boldface and stated that the proposed price for Heinz for $72.50 per share.

From the timeline presented in the case, Mr. Alpert read the attachment and quickly bought Heinz stock and options.

I can’t believe the board member was forwarding this incredibly sensitive information to the security guard to print. Who was this board member that was too lazy or incompetent to print a document on his own?

I pulled up the list of board of directors to see.  I couldn’t pull the pieces together. Then I got distracted when I saw that Lynn Swann, the ex Pittsburgh Steeler was on the board. One of those 12 does not know how to print email attachments.

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