Tag: Interactive Brokers

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

Smells Like Insider Trading

Apparently Blue Horseshoe loved Zhongpin Inc., a China-based pork processor whose shares trade in the U.S. The SEC jumped on the accounts of six Chinese citizens and a British Virgin Islands entity. (Apparently the Chinese prefer to use British Virgin Islands entities. It’s the second largest investor in China after Hong Kong.) The facts stink of insider trading, but I would wager the SEC will lose this one.

According to the SEC’s complaint, the seven defendants bought substantial quantities of common stock and call options in Zhongpin between March 14 and March 26. Zhongpin’s stock price jumped 21.8% on March 27 when the company publicly announced a management buyout.

The SEC alleges that the purchases were inconsistent with the defendants’ financial situations and prior investment behavior.  In particular:

  • The defendants’ trades made up a significant portion of the trading in Zhongpin between March 14 and March 26, over 41% of the common stock trading in this period.
  • Only one of the defendants had traded in Zhongpin before March 14.
  • The purchases of Zhongpin securities equaled or exceeded their stated annual income.
  • Yang identified himself to his broker as an accountant in
  • Each of the defendants placed at least some of their trades from computer networks and hardware that other defendants also used to place trades.

“The defendants in this action – all with seemingly limited resources – suddenly and inexplicably purchased more than $20 million in Zhongpin securities just before an important public announcement,” said Merri Jo Gillette, Director of the SEC’s Chicago Regional Office. “The SEC’s swift action to secure a judicial freeze order prevented millions of dollars from moving offshore.”

At least temporarily.

What’s missing from the insider trading complaint is the insider. The charge is for trading while they were in possession of material, non-public information. The SEC needs to find that information and its source. That’s going to be very hard when the defendants all live out of the country.

We saw this recently in the SEC case against Luis Martin Caro Sanchez for trading in shares of Potash. The SEC failed to find the insider. No inside information, no insider trading.

The one hope for the SEC is that one of the defendants was employed at Baron Capital, Inc., a registered investment adviser. If Siming Yang was foolish enough to document the inside information in one of the Baron systems, the SEC may be able to find some evidence.  Yang’s position was terminated at Baron on March 30. I assume for violating the firm’s policy on personal security trading.

Perhaps the SEC is hoping the defendants will merely default. Some might. But Yang made over $7.6 million on the trades. I assume he will invest some cash in getting a lawyer and fighting the charge, leaving it up to the SEC to find the source of the inside information.  Unfortunately, the SEC will also be up against a language issue, given that the communication was likely in Chinese.

The SEC needs to try and hope the smoking gun is lying around. The trades stink of the insider trading. Perhaps the SEC can find a bigger case of insider trading in the company’s shares. You also have to wonder where Yang got $20 million to make the trades.

I have my doubts that the SEC can win this case. But you can’t win if you don’t play. The SEC can’t win if it just lets the cash go overseas.

As with the Sanchez case, Interactive Brokers held the accounts for three of the seven defendants.  It sounds like its compliance group is spotting suspicious trades, holding the cash before it goes overseas, and alerting the SEC.

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When Red Flags Are Not Enough

Purchase out of the money call options set to expire in two weeks, do not have any activity on that stock before, exclusively use options when you have rarely traded options in the account before, purchase those options just before the announcement of the company’s acquisition, and then quickly try to move the money off-shore.

Those red flags were enough for the Director of Compliance Operations at Interactive Brokers to put a hold on the account of Luis Martin Caro Sanchez. After reviewing the trades, the information was forwarded to the Securities and Exchange Commission for investigation. It reeked of insider trading, so the SEC obtained an immediate freeze on the account and charged Sanchez with insider trading.

Sanchez had bought several hundred of the risky Potash call options on August 12 and 13, 2010. A week later, the acquisition was announced causing a dramatic rise in the price of Potash stock. Sanchez managed to reap nearly $500,000 in profits at a handsome 1046% return. The actions seemed to be so blatant that I labeled it the perfect way to get caught insider trading. Of course one of the key elements of insider trading is having access to inside information.

Suspicious trades alone are not enough. In order for the SEC to win an insider trading case against a company outsider, the SEC must prove that an outsider made his trades based on material nonpublic information given to him by an insider. The SEC failed to find a connection.

Sanchez claimed he made became interested in Potash based on a technical signal “when he observed a crossover signal in the exponential moving average for the price of Potash stock.” He made the buy after

“there was a consolidation of the impulse of the cross of mediums, average, and that consolidation is known as pull-back, and consists of a slight drop in the price after a push for a higher price. And there was a hole that was filled – a gap that was produced during the increase – the previous increase.”

In fairness to Sanchez, he is from Spain and the interview was conducted without a certified, neutral translator. But to me, his explanation is just a bunch of mumbo-jumbo spewing out to make the SEC think he is a trading expert.

As much as the SEC tried, they could not link Sanchez to an insider. They could not even link him to his co-defendant, Juan Jose Fernandez Garcia. Both Garcia and Sanchez lived in Madrid and both made suspicious trades on Potash stock using accounts at Interactive Brokers. That was the only connection.

Garcia also happened to work at Banco Santander, who was an adviser to BHP in connection with its purchase of Potash. Garcia quickly settled with the SEC and forfeited his $576,032.00 in trading profits.

Sanchez was willing to fight for his windfall and challenged the SEC to prove he had inside knowledge. The SEC failed and Sanchez gets to keep his cash.

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Red Flags is Rutger van Waveren

How to Get Caught Insider Trading

Purchase out of the money call options set to expire in two weeks, be an employee of the company acting as an adviser in the merger, not have any activity on that stock before, use an account in your name, exclusively use option when you have barely traded options in the account before, and quickly try to move the money off-shore.

The SEC alleges 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 Corp. in the days leading up to the public announcement of BHP Billiton’s bid on August 17.

Juan Garcia is (was?) the head of equity derivatives research at Banco Santander which was advising BHP on its bid. It’s not clear how Luis Sanchez is related to Santander or Garcia. The daring duo made nearly $1.1 million in illegal profits based on $61,000 in option contracts.

How did they get caught?

The warning signs are obvious, but who saw them. Daniel M. Hawke, Market Abuse Unit Chief SEC Enforcement Division, gets his face on the press release. That’s some good publicity for the new structure of the enforcement division.

The complaint mentions the daring duo’s attempt to transmit the funds from that brokerage account back to Spain. It sounds to me like the compliance folks at Interactive Brokers are likely the ones who spotted the red flags and froze the accounts. Otherwise that money would be sitting in Spain and harder for the SEC to grab and demand disgorgement.

Let’s hand a glass of champagne to SEC’s Market Abuse Unit and the compliance department at Interactive Brokers

I agree with Felix Salmon that there is probably a much juicier story behind this incident.

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