Revisiting Managed Accounts

SEC IA Rule 204A-1 requires all of an investment adviser’s access persons to report, and compliance to review, their personal securities transactions and holdings periodically. Section (3)(I) has an exception for

(3) Exceptions from reporting requirements. Your code of ethics need not require an access person to submit:
(i) Any report with respect to securities held in accounts over which the access person had no direct or indirect influence or control;

Way back in 2015 the Division of Investment Management released Guidance 2015-03 about what it means for an access person to have no direct or indirect influence or control over the account for purposes of relying on the reporting exception.

There are three themes that fail the exception:

  • suggesting purchases or sales of investments to the trustee or third-party discretionary manager;
  • directing purchases or sales of investments; or
  • consulting with the trustee or third-party discretionary manager as to the particular allocation of investments to be made in the account.

Effectively, the SEC asks compliance to do some diligence on the account and the person running the account to make sure the access person is blocked from making investment decisions.

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The One with the Divorce

We’ve seen many insider trading cases involving friends, spouses, domestic partners, and dates. We can guess what the end result would be. I think the Tyler Loudon case is the first one that has taken us all the way to the end.

Tyler and Mrs. Loudon lived in Houston. Mrs. Loudon worked as a mergers and acquisitions manager at BP p.l.c., the big energy company. As many couples did during the pandemic, they worked in home offices and in relatively close proximity to each other. Mrs. Loudon was working on BP’s acquisition of TravelCenters of America.

Apparently, Mrs. Loudon shared some of the acquisition information with Tyler. Of course, she expected that he would not do something stupid with the information.

He did. He did do something stupid.

Tyler bought shares in TravelCenters. That alone of course is illegal. Then he took the stupidity to a higher level. He sold all of his other positions in his brokerage account and Roth IRA and put all of that money into purchasing TravelCenters shares. I’m sure that was flagged by his brokerage firm as suspicious activity.

FINRA opened an investigation. Tyler confessed to his wife. Mrs. Loudon told her BP supervisor about he husband’s trading. BP fired Mrs. Loudon. Mrs. Loudon moved out of the marital home and filed for divorce.

We generally assume that a violation of spousal secrets to do stupid insider trading is going to lead to relationship issues. This is the first SEC complaint I remember that has take us all the way to the end of the marriage.

Besides divorce, Tyler is also facing up to five years in prison and a $250,000 fine with the Department of Justice and possible more in SEC fines. Of course, Tyler also had to forfeit all of the trading profits.

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Shadow Insider Trading Theory Lives On Again

A summary judgment motion in the shadow insider trading case was denied.

The Securities and Exchange Commission brought charges against Matthew Panuwat a business development executive at Medivation. Panuwat had 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.

The Securities and Exchange Commission thinks this should be considered insider trading and brought charges against Mr. Panuwat for his 2016 trade.

Mr. Panuwat brought a motion for summary judgement hoping to dismiss the charges based on the facts. The judge said there were genuine disputes of material fact concerning

The judge had previously ruled at the earlier motion to dismiss phase that information may be material to more than one company and that information does not need to come from the issuer of the security to be material. The SEC charges survived this facial attack on shadow insider trading.

  1. whether Mr. Panuwat received nonpublic information,
  2. whether that information was material to Incyte,
  3. whether Mr. Panuwat breached his duty to Medivation by using its confidential
    information to personally benefit himself, and
  4. whether Mr. Panuwat acted with scienter.

As for materiality:

“Changes in stock price after previously unknown information is disclosed to the market is “strong evidence” of how reasonable investors understand the significance of that information. … The SEC has shown that Incyte’s stock increased by 7.7% after the market learned that Pfizer acquired Medivation. See Oppo. Ex. P. Panuwat responds that Incyte’s stock prices had changed “by at least 7.7% in one day over 400 times during the time Incyte has been a publicly traded company.” … Again, it is possible that the stock price increase was unrelated to the Medivation sale. But a jury could reasonably find that it was further indication of the two companies’ connection in the market, and therefore probative of materiality. There is at least a material dispute whether the information Panuwat received in the Hung Email was material to Incyte.”

The judge found that Mr. Panuwat potential breached at least one of his three separate duties to not use this confidential information. The first was the Medivation insider trader policy that covered “securities of another publicly traded company”. Mr. Panuwat argues that Incyte was not one of the enumerated relationships in the policy. Second, Mr. Panuwat signed Medivation’s confidentiality agreement and the SEC argued that it created a duty with the Incyte information. Third, the SEC argues that there is a common law duty for an employee with regards to company information. The judge ruled that it was up to the jury to rule on potential breach.

The case is far from over. The question is whether Mr. Panuwat wants to continue fighting and has the financial resources to keep fighting the SEC charges.

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Insider Trading to Make your Ex-Girlfriend Hate You, Lose your Job, and Go to Jail

Seth Markin stumbled across a sure thing for investing his money. Pandion Therapeutics was going to be acquired by Merck & Co. He knew the acquisition price per share was going to be over twice what the shares were currently trading. He made $82,000 in trading profits in February 2021.

In June 2021 he got a phone call from his ex-girlfriend. (I have to assume it was a very angry phone call.) Mr. Markin’s name had shown up on an inquiry from by the Financial Industry Regulatory Authority. His ex-girlfriend was a lawyer working on the Pandion-Merck transaction. FINRA had asked her whether she knew any of the names on a list of people who bought Pandion stock leading up to the transaction announcement.

She, FINRA, the SEC, and the DOJ all assume that Mr. Markin had come across the transaction information while they were dating. He lied to her and told her that he had not traded in Pandion stock. (I don’t think they got back together.)

At this time, Mr. Markin was training as a new agent at the FBI Academy. He was interviewed the FBI agents about the Pandion trading, and Mr. Markin lied to them. (I don’t think he kept the job at the FBI.)

Clearly the FBI didn’t believe him. He was arrested in July 2022. Earlier this week he plead guilty to securities fraud based on that insider trading. Now He’s facing jail time.

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The One with the Girlfriend’s Laptop

The Securities and Exchange Commission actually uses the term “romantic partner”, not girlfriend in this complaint. I guess the SEC doesn’t want to impose labels on the relationship. Based on this case, I assume the relationship is over. The COVID pandemic was hard on a lot of relationships with couples isolated at home. Stealing information from your “romantic partner” seems likely to end the relationship.

That’s just what Steven Teixeira did. While working at home during the pandemic, Teixeira would access her laptop while she was out of the room or outside their Queens apartment.

She was an executive assistant at an investment bank. She was responsible for scheduling meetings of the investment bank’s valuation and fairness committees concerning potential transactions involving the investment bank’s clients. She had access to material nonpublic information relating to dozens of the investment bank’s transactions.

Teixeira had a friend who knew a guy who was a stock trader, Jordan Meadow. The three met and Teixeira offered up his access to the information to Meadow. The three plotted an insider trading scheme, with Meadow offering to buy Teixeira and the third friend Rolex watches. Teixeira and Meadows began trading on the flow of transaction information that Teixeira was snooping from his romantic partner’s laptop.

Their aggressive trading caught the attention of the regulators and Meadow’s compliance department. The scheme came to an end in January 2023 when the romantic partner returned to working in the office rather than from home.

Teixeira pled guilty in a cooperation agreement. The DOJ and SEC are pursuing more serious charges against Meadow.

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The One with Insider Trading, Pharma and the Police Chief

Joseph Dupont was a senior executive at Alexion Pharmaceuticals and reserve officer with the Dighton police force. (Dighton’s most notable attraction is Dighton Rock, covered in petroglyphs.) Dupont worked on Alexion’s acquisition of Portola Pharmaceuticals.

Dupont knew he couldn’t trade in the stock of Portola with all of the inside information he had. But that apparently didn’t stop him from leaking the information to his buddy, Shawn Cronin, who was a sergeant on the Dighton police force. (He has since become Chief.) Cronin then told two other mutual buddies, Stanley Kaplan and Jarett Mendoza. Kaplan then told a colleague, Paul Feldman, who spread the information even further.

The SEC Complaint and US Attorney Indictment have some compelling facts. Dupont had Alexion meeting to hammer out the details of the acquisition on April 8. That night Dupont had a long conversation with Cronin. Cronin texted Kaplan that night:

“Good evening, sir. If you need something to take your mind off of the everyday battle, remember that stock I told you about? Good time to buy.”

Cronin then opened a new brokerage account and placed an order to buy shares in Portola. Kaplan did the same. They continued to buy more shares in the following weeks.

The criminal indictment has a bunch of incriminating messages among the defendants:

“I need more inside information.”
“Knowing of a buyout or an news beforehand is gol[d].”
“Let’s hope our golden goose will continue laying golden eggs!”

When the acquisition was announced the stock price of Portola jumped 130%.

All of this suspicious trading caught the attention of the regulators after the merger and launched an inquiry. Alexion was forced to ask its employees whether they knew any of the names on the list of suspicious traders. Cronin lied and said he didn’t know any, even though Cronin, Kaplan and Mendoza were on the list.

The gains they made:

  • Cronin – $72,000
  • Mendoza – $39,000
  • Kaplan – $472,000
  • Feldman – $1.73 million (He put the most money in)

All are facing disgorgement of the gains, civil penalties and significant jail time. Mendoza has already plead guilty.

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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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