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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