Category: Insider Trading

Another Tale of Golf Course Stock Tips Ending Up in a Sand Trap of Insider Trading

golf insider trading compliance

The Securities and Exchange Commission brought another insider trading case where the tips were allegedly traded on the golf course.

“Country clubs or similar venues may give people a false sense of security that leads them to think they can get away with trading on unlawful stock tips,” said Paul G. Levenson, director of the SEC’s Boston Regional Office. “But as in any social setting, people who trade securities based on confidential information they receive are taking a huge risk that their illegal tipping and trading will be identified by the SEC.”

Robert Bray triggered the FINRA warning lights with a large order of a thinly traded stock. According to an SEC complaint, Bray placed an order for 25,000 shares in Wainwright Bank & Trust Company. That was several days worth of volume in that stock. He started his buying spree on June 14. It several days to accumulate that much stock for his order.

On June 28 Wainwright announced that it was going to be acquired by Eastern Bank for a share price almost double what Bray had paid. That put almost $300,000 of profit in his pocket when the acquisition closed on November 18.

Of course that kind of excessive trading close to a transaction is going to trigger a FINRA inquiry. Bray’s name was on a list of 30 individuals who purchased Wainwright stock during the pre-announcement period. That list was circulated to employees at Eastern Bank for them to disclose if they knew anyone on the list.

According to the SEC, J. Patrick O’Neill, a Senior Vice President at Eastern Bank did not respond to the initial request. O’Neill also did not respond to the second request. Then he called in sick. Finally, he met with his supervisor who demanded that O’Neill respond or be subject to employment-related discipline. O’Neill resigned the next day. He also transferred title on his house to his wife that same day.

Now the SEC had a trader in one hand and in the other hand had an employee with access to the inside information who was acting suspiciously. The SEC just needed to find the link. O’Neill had the information but did not trade. Bray had the trading profits but no direct connection or confidential obligation to the inside information.

The SEC found the connection at the country club. Both O’Neill and Bray were members of the same local county club. The SEC also found a tiny business arrangement between Bray and O’Neill’s son.

That is all the SEC had to build its case. When questioned about his relationship with Bray, O’Neill pleaded the fifth and didn’t answer the SEC questions during his testimony. Bray did the same when he was questioned by the SEC. Apparently that really annoyed the SEC because they forwarded the case on to the Justice Department who brought criminal charges against O’Neill.

Once again, the cliche is proven. But it sounds like the SEC will have a hard time proving the transfer of information from O’Neill to Bray.

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A Cliche Is Proven

golf insider trading compliance

One cliche thrown around is that tipping a golf buddy to material non-public information is an insider trading violation. The Securities and Exchange Commission just filed a case that proved that cliche true.

Eric McPhail learned the expected earnings and major pending corporate developments at American Superconductor through a friend who is (was?) an executive at that company. They were good friends and golfed together at the same country club. Confidentiality was expected.

However, Mr. McPhail took that information and tipped it to six of his other golfing buddies. At least according to the SEC complaint. Four of the golfing buddies consented to judgement, returned their trading profits, and paid fines.

Mr. McPhail is not accused of trading in the stock. He is charged with illegal tipping.

Unfortunately for the golfing buddies, their communication about the stock was not limited to the golf course. The SEC complaint is full of email messages discussing the stock and material non-public information. In one email, Mr. McPhail hopes to be paid back by his golfing buddies with pinot noir and steak.

The American Superconductor executive is not named in the complaint.

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Cleaning Up An Oil Spill Is Insider Trading

oil platform and compliance

Keith A. Seilhan was 20-year employee of BP and a senior responder during the 2010 Deepwater Horizon oil spill. Seilhan directed BP’s oil skimming operations and its efforts to contain the expansion of the oil spill. What he saw scared him so he sold his entire portfolio of BP stock.

The Securities and Exchange Commission charged him with insider trading. The SEC’s view was that he had confidential information about the magnitude of the disaster. BP was telling the public that the spill was only 5,000 barrels of oil per day. Seilhan obtained information that the magnitude of the oil spill and BP’s potential liability and financial exposure, was likely to be greater than had been publicly disclosed. The truth was more than ten times that publicly reported amount.

This case reminded of the railroad case where workers in the railroad yard noticed unusual activity around the railyard and came to the conclusion that the railroad was up for sale. They made a stock bet on their conclusion and won. But the SEC charged them with insider trading, but lost the case.

In the oil case, Seilhan knew the company was lying about the scope of the spill. The information was not publicly available because BP was purposefully deceiving the public and regulators.

You could argue that the information is more like the counting of cars in a retailers parking lot to see how business in doing. Anyone could jump in a plane and see the scope of the oil spill. The news organizations were doing just that. I assume it would take a trained eye to notice that the spill was being misjudged by an order of magnitude.

Regardless of my thoughts about the case, Mr. Seilhan felt it was better to settle the charges than fight the SEC. A month after the trade he received a reminder memo from BP legal to not trade on the stock based on an employee’s possession of price sensitive information. That prohibition was in BP’s code of conduct. Seilhan replied to legal and wanted to discuss his trade, but never followed up or disclosed.

Seilhan agreed to return $105,409 of allegedly ill-gotten gains, plus $13,300 of prejudgment interest, and pay a civil penalty of $105,409.

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Image is Thunder Horse Semisub by Andyminicooper
CC BY SA

Do Law Firms Need Compliance Programs? Part 2

Earlier this month it was accounting fraud. This week it’s insider trading. Law firms seem to pose the same risks as any other firm.

Do as I say; Not as I do.

A clerk at a law firm trolled the document management system for information on mergers when the firm was representing one of the parties. The clerk passed the information onto an unnamed Middleman, who passed the information on to a stockbroker. Everyone made money. the behavior was repeated for a dozen other transactions involving the law firm.

The SEC put together a graphic to help understand the flow of money and information. The three went through some rather elaborate steps to hide their tracks. As you can see from the graphic, Metro, the law firm clerk, would meet the Middleman at coffee shops to pass along the information. The Middleman would meet with Eydelman, the stockbroker, at the clock at Grand Central station to pass along the information.

eydelman graphic

Initially it surprised me while reading the SEC’s complaint that Middleman was not identified and not charged. The description of the Middleman’s information exchanges including Metro pointing to data on a mobile device and Middleman making Eydelman eat the paper with the information on it. It seems clear that Middleman is cooperating with the SEC and federal prosecutors. In the criminal complaint, Middleman was wearing a wire and had begun cooperating with authorities.

The law firm was in charge of sensitive information about its clients. It sounds like the firm failed secure the information. Metro may have worked on some of the transactions, but should not have had access to key information like timing and pricing. He probably should not have had access to the parties names.

It sounds like the law firm failed to take reasonable steps to isolate information to those who need to know.

Until the charges were filed, the law firm did not know about the transgressions. Metro was fired the day the charges were brought. You also have to wonder how often the law firm employees were reminded of not engaging in insider trading.

The SEC has fired a warning shot and has stated that it is focused on law firms:

 “We are continuing to combat serial insider trading schemes, particularly by law firm employees and other professionals who are entrusted with extremely sensitive market-moving information.”

– Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit

Attorney Matthew Kluger was sentenced to 12 years in prison, the longest term ever imposed in an insider-trading case, for stealing corporate merger tips from four law firms over 17 years. Two Ropes & Gray LLP lawyers in New York went to prison for leaking tips to former Galleon Group LLC trader Zvi Goffer.

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The Darth Vader Defense to Insider Trading

luke i am your father

Frank Hixon Jr. is trying to evade insider trading charges by denying he knew his father. His father is not a malevolent cyborg. His name is even easier to decipher than Darth Vader; It’s Frank Hixon Sr.

Hixon is challenging the charges so I have only the government’s version of the facts. Perhaps he has some better explanations or perhaps the SEC and DOJ do not have the evidence to back up their charges.

Hixon was investment banker focusing on the mining, metals and materials industries. According to the SEC complaint, there was suspicious trading around a few of the deals he worked on, including his own company’s earnings announcements. FINRA inquired and his firm circulated a list of suspicious traders. Frank Hixon Sr. of Duluth, Georgia and Destiny Robinson of Austin, Texas were on the list.

According to the SEC, Hixon denied realizing that those two people on a list of suspected transactions were his father and the mother of his child.

His father had lived in the same home for two decades. In 2006, the area incorporated as Johns Creek. Hixon claimed that “Hixon” was a common name in the South and that his father lived in Johns Creek, not Duluth. Duluth and Johns Creek share a zip code.

Vader: No, I am your father.
Skywalker: No. No! That’s not true! That’s impossible!
Vader: Search your feelings; you know it to be true!
Skywalker: NOOOOOOO! NOOOOOOOO!!!

As for Ms. Robinson, Hixon claimed he only knew her as Nicole, not Destiny. The SEC complaint de-bunks this lame defense because it has text messages that makes it clear he knew her by both names. The FBI also found checks he had written to her using “Destiny” name. The SEC alleges that Hixon was using the insider trading profits to pay child support to Ms. Robinson. The trading logs tie many of the suspicious trades back to the IP address of Hixon’s firm.

Hixon was fired by his firm. The Department of Justice must have thought that Hixon’s lies were egregious because the U.S. Attorney has also brought criminal charges. The DOJ brought seven charges of securities fraud and a false statement charge.

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Working on the Railroad is Not Insider Trading

railroad

Gary Griffiths was a vice president and chief mechanical officer at Florida East Coast Railway. Cliff Steffes was a trainman at the Bowden Rail Yard for the company and the nephew of Gary. Gary and Cliff noticed there was a surprising number of tours of the rail yard by men in suits. Gary’s boss asked him to prepare a list of equipment owned by the company. They thought the company was for sale and thought they could profit from the sale.

The SEC thought their stock trading was illegal.

But a jury thought otherwise.

Certainly, the trading conduct of Griffiths’ and Steffes’ families was unusual. They made out-sized bets on a rise in stock price using options and stock purchases. Before the date of the family’s trades, they had never purchase a stock option.

But trading on information is not illegal, unless there is an obligation to not trade. Griffiths and Steffes were both restricted from trading based on the railway’s code of conduct. That prohibits them from trading based on material information about the company which had not been publicly disclosed.

The big question the SEC would have to answer for the jury was that the information discovered by Griffiths and Steffes was the kind of information that should prevent them trading. A bunch of suits walking around the train yard is not necessarily indicative of an impending increase in stock price. Given the open nature of train yards, many non-employees could have witnessed the behavior.

When talking about material non-public information I often go to the urban legend of the fund manager who would count cars in a retailer’s parking lot as measure of financial performance. That parking lot count is clearly not information subject to prosecution for illegal insider trading. Reading an earnings release before it’s public likely would be. The trainmen’s situation sounds a lot more like the parking lot situation than the earnings release.

I would guess that the SEC saw the suspect behavior and was hoping to find something more as the case developed. According to the jury, the SEC did not find enough.

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Image is Railroads. Men working on locomotive by Horydczak, Theodor, approximately 1890-1971

You Can’t Hide Your Insider Trading in Your Spouse’s Account

insider trading

Steven M. Dombrowski was the former director of internal audit at Allscripts Healthcare Solutions. Through his position he learned that the company’s first quarter 2012 financial results were much worse than expected. Despite restrictions, he decided to profit from his company’s misfortune.

He clearly knew that he couldn’t trade in the stock, so he decided to hide the trades in his wife’s account. Dombrowski began his insider trading by selling short 1,000 shares of Allscripts stock, and purchasing 50 Allscripts May $15 put option contracts. He kept buying more put options as he learned more and more about the upcoming earnings announcement. Of course, the stock price fell and the trading paid off. Dombrowski’s insider trading resulted in $286,211.55 in illegal profit.

How did he get caught? The complaint leaves out the details. But I noticed that the Options Regulatory Surveillance Authority played a role in the investigation. The options trading looked suspicious. I would guess that there are not that many options in Allscripts stock being traded. Dombrowski’s trades were probably outside of the norm for the stock and happened around the earnings release. That should easily raise the red flag for a stock like Allscripts that does not have a deep pool of liquidity.

Hiding the trading activity in his wife’s account was not going to work once regulators focused on the trades. That’s an easy one.

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The SEC Tries to Make an International Case on Insider Trading

red flags

The BHP – Potash merger in 2010 was a bit leaky. The SEC has an ongoing investigation into suspicious trading ahead of the the August 17, 210 public announcement of BHP Billiton’s acquisition of Potash Corporation. The latest SEC points the SEC’s accusatory finger at two Spanish citizens.

At first I though the SEC had merely re-published an old story. In August of 2010, the SEC brought a case against two citizens. The SEC alleged that Juan Jose Fernandez Garcia and Luis Martin Caro Sanchez had material, non-public information and purchased hundreds of “out-of-the-money” call option contracts for stock in Potash in the days leading up to the public announcement. Mr. Garcia, a former employee of the an adviser to the merger gave up and disgorged his illicit windfall. Mr. Sanchez fought and the SEC failed to find the smoking gun that turned the suspicious trade into insider trading.

The latest case pits the SEC against Cedric Cañas Maillard, who served as an executive advisor to Banco Santander’s CEO, and his close personal friend Julio Marín Ugedo.

The SEC alleges that Cañas purchased 30,000 Potash Contracts-for-Difference, a highly leveraged derivative, from August 9 to August 13 based on material, non-public information he learned about BHP’s offer to acquire Potash. Cañas liquidated his entire CFD position in Potash following the August 17 public announcement for an illicit profit of $917,239.44. Cañas also communicated frequently with Marín that month, and Marín has admitted that he and Cañas discussed investing in Potash prior to his purchase of 1,393 shares of Potash common stock through two Spain-based brokerage accounts. By trading Potash stock based on material, non-public information, Marín generated net trading profits of $43,566 (a 28.47 percent return) in just one week.

Clearly, these are suspicious trades. .

What caught my eye was a jurisdictional question. This is an area I’m a bit fuzzy on.

Neither Cañas and Marín are citizens of the United States. Neither lives in the United States. According to the SEC complaint, both travel frequently to the United States and Cañas lived periodically in the United States prior to 2008.

Cañas made his bet using Contracts-for-Difference, a highly leveraged derivative, equivalent to 30,000 shares of Potash. The Contracts-for-Difference are not traded in the United States and Cañas used a Luxemborg based trading account at Internaxx.

I’m missing the nexus to the United States that would give the SEC jurisdiction.

The SEC complaint crafts an argument that Internaxx needed to purchase shares of Potash on a US exchange to hedge its risk against the Contracts-for-Difference. That seems very shaky to me from a jurisdictional perspective.

The SEC has an easy case on the inside information aspect because Banco Santander already conducted an internal investigation, found trading in violation of its policy, and fired Cañas.

The Marín case is easier to make. He opened a foreign account, but purchased Potash stock directly. That puts his trades on the NYSE and within the grasp of the SEC.

The SEC still needs to prove the use of inside information by Marín. That will be a tough battle.

According to the SEC complaint, the trades have lots of red flags and stink of insider trading. The Cañas case caught my eye because I don’t see how a US regulator can jump overseas and bring an enforcement action when there does not seem to be a substantial US nexus.

Maybe a reader knows more about the international jurisdiction of the SEC and can pipe in with some thoughts on what the SEC can do over the border.

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The Leaky Merger and Insider Trading

chattem

On December 21, 2009, Sanofi-Aventis, a French pharmaceutical company, announced a tender offer for Chattem, a Tennessee-based distributor of over-the-counter pharmaceutical products, at the price of $93.50 per share. Shares of Chattem closed 32.60% higher than the prior trading day’s close of $69.98 and volume increased more than 3,000% to 10.3 million shares. This may be one of the leakiest M&A transactions. So far the SEC has brought 8 insider trading cases that came from this transaction. The latest case is against Andrew W. Jacobs and his brother Leslie J. Jacobs II.

Andrew met with his brother-in-law who was the vice-president of marketing for Chattem. The brother-in-law leaked the news that Chattem was going to be acquired in the near future. He was apparently looking for career advice since the transaction was likely to affect his employment. Andrew had been through a similar experience when his company was acquired by a European company.

Even though the brother-in-law required Andrew to keep the conversation confidential, the SEC alleges that Andrew leaked the information to Leslie. He saw the opportunity and purchased 2,000 shares of Chattem and made a tidy profit of almost $50,000.

That’s not going to cover his legal bills.

The SEC charged Leslie with insider trading and Andrew for tipping the material non-public information. The brother to brother connection is a lot easier to prove than the Facebook friends sources of inside information the SEC used in the Badin Rungruangnavarat insider trading case.

Chattem was a leaky company when it came to information about the transaction.

Most of the insider trading cases are sourced to one conversation. A Chattem board member told his accountant, Thomas D. Melvin about the transaction. Melvin tipped a bunch of friends who traded on Chattem stock. Melvin, his friends, neighbors and brokers have all been charged with insider trading.

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Red Flags for Insider Trading

compliance and red flags

Badin Rungruangnavarat was very lucky. He invested a bunch of cash from May 21 to May 28. When the market closed on May 29 he had unrealized gains of over $3 million and had achieved a return in excess of 3000%. Now he is unlucky because the Securities and Exchange Commission froze his investment gain and labeled it the illegal fruits of insider trading.

Badin had put all of his money into derivatives based on the stock price of Smithfield Foods, Inc. On May 29, there was a public announcement that Shanghui International Holdings had agreed to acquire Smithfield. As you might expect, Shangui paid a premium on the traded stock price.

So maybe Badin wasn’t lucky. Maybe he had some material non-public information and was illegally trading on that information.

Badin opened the account at Interactive Brokers on May 10. Badin deposited $920,000 and only traded in Smithfield derivatives. All of the call options he purchased were out of the money. He purchased 80% of Smithfield’s options for the month of May. Through those derivatives, he controlled roughly 25% of the average daily volume of Smithfield’s stock.

The facts stink of insider trading. What’s missing is the inside information.

The SEC turned to Facebook to identify the source of insider information. (It looks like the SEC does not ban access to Facebook.) In the complaint, the SEC states that Badin has a Facebook friend who is an associate director at the investment bank that advised another bidder for Smithfield. That may not be the source, but at least it something for the SEC to grab a hold of in hopes of making its case.

This is at least the third time that Interactive Brokers has flagged an account for insider trading. See Zhongpin and Potash. The firm’s compliance surveillance seems to working for these egregious cases.

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Red flags by Rutger van Waveren CC BY ND