The Non-Compliant Compliance Officer

You hate to see a peer break bad.

The Securities and Exchange Commission charged Jose Luis Casero Sanchez, a former Senior Compliance Analyst who worked in the Warsaw, Poland office of an international investment bank, with insider trading involving at least 45 corporate events with the investment bank’s clients. 

Ugh. He’s giving compliance a bad name.

For an investment bank, a role of compliance is to maintain a list of restricted companies for trading because of material non-public information. It should be held tightly and lovingly. Not used to profit.

The SEC didn’t want to drag the investment bank into the litigation press releases and complaint. The press identified it as Goldman Sachs, who confirmed.

Mr. Sanchez was a Spanish national, worked in Poland and did his illegal trading in US-based brokerage accounts. The accounts were in the name of his parents. He had accounts at Schwab, Interactive Brokers and Tastyworks. I have to admit that I hadn’t heard of Tastyworks before. Apparently if I make 750 referrals to the firm I get a Tesla. (anyone? anyone?)

This is a clear case of insider trading under US law. It’s clear that Goldman had the policies in place prohibiting this kind of behavior. The kind of behavior that Mr. Sanchez was supposed to prevent or stop.

The SEC got IP logs for access to the accounts. Those logs are not always that exact. But in this case they were traced back to Poland. It doesn’t need to be more exact than that to show that Mr. Sanchez was running the accounts, not his parents.

In his first account at Interactive Brokers, the compliance people at Interactive Brokers clearly saw stuff they didn’t like. Mr. Sanchez was trading options and doing really well. I assume they flagged the account, reported it and shut it down.

Undeterred and unafraid, Mr. Sanchez moved on to Schwab and Tastyworks. He continued his options trading. I’ll assume he was taking aggressive positions. For some reason he went back to Interactive Brokers and opened a new account in his mother’s name this time. He churned through companies on the Goldman Grey List of companies being advised.

The last trade mentioned in the complaint was at Interactive Brokers in May 2021. Who wants to bet that the compliance people at Interactive Brokers flagged this account and brought it to the attention of the SEC? I’m willing to bet good money that they did the heavy lifting for the SEC of identifying bad behavior. That’s what good compliance people are supposed to do.

I’m sure the SEC did a great job of then tying the companies involved in the account’s trades back to Goldman. They got the IP addresses from the broker showing that Poland was involved. Goldman looked at the last name on the account and the employees in Poland. (How many Spaniards work at Goldman in Poland?)

Boom!

Then they checked Mr. Sanchez’s browser history and noticed Schwab and and Tastyworks (did I earn that Tesla yet?).

Boom! Boom!

They got you Mr. White.

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Shadow Insider Trading

Matthew Panuwat was a business development executive at Medivation, an oncology-focused biopharmaceutical company. Panuwat 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.

Should this be insider trading?

The Securities and Exchange Commission thinks so. It brought charges against Mr. Panuwat for this 2016 trade. I’m sure your noticing the big time gap. The SEC filed just before the expiration of the statute of limitations.

The SEC seems to be hanging its charges on Medivation’s insider trading policy:

“Because of your access to this information, you may be in a position to profit financially by buying or selling or in some other way dealing in the Company’s securities…or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company.”

A company’s definition of insider trading shouldn’t be the standard for a government action. Should it?

The SEC states:

Panuwat’s undisclosed, self-serving use of Medivation’s information to purchase securities, in breach of his duty of trust and confidence, defrauded Medivation and undermined the integrity of, and investor confidence in, the securities markets.

Panuwat did make an aggressive trade. He purchased 578 out-of-the-money call options with less than a month left to expiration. The options had strikes from $80 to $85 when Incyte’s stock was trading at $76. I’m sure that triggered some compliance review at his brokerage and probably got red flagged for further review.

The SEC is claiming that Panuwat used confidential information he acquired from his employer. That seems right. The question is how far should that dome of limiting action should spread. The SEC seems to think it should be a big dome. It should reach out to peer/competitor companies.

Given how long this has been sitting around, there must be some hand wringing at the SEC. The complaint is bit short on facts given that there has been five years to gather information.

In compliance, how do you deal with this potential expansion of the insider trading limits? It sounds like insider trading polices and monitoring would have to include peers of the company. Of course, this all assumes this case comes out in favor of the SEC.

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The One with TheBull

The Dark Web and bitcoin are the tools of the trade for online criminals these days. Apostolos Trovias is alleged to be one of those criminals. He operated online under the pseudonymous online avatar “TheBull”. Mr. Trovias is alleged to have engaged in a deceptive scheme to offer and sell what he called “insider trading tips” on the Dark Web, offering purchasers an unfair advantage when trading securities.

Mr. Trovias claimed that he had order-book data from a securities trading firm that was provided to him by an employee of the trading firm. This would seem to be material, nonpublic information that was supposed to be kept confidential.

If Mr. Trovias had actually acquired some or all of the tips from actual order-book data or if he had stolen the order-book data himself, then he had engaged in a fraudulent scheme to sell material, nonpublic information that he knew or was reckless in not knowing was obtained in violation of a duty of trust and confidence. That’s illegal.

If Mr. Trovias did not actually have this information, then his statements were materially false and misleading and made in furtherance of a scheme to deceive purchasers who wanted to trade on inside information. That’s also illegal.

What fascinated me about this case is that the Securities and Exchange Commission doesn’t have to prove that Mr. Trovias was actually selling or using insider information. The SEC wins either way.

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Fund Board Representation and Public Stock

Part of a private equity fund’s investment strategy is getting a seat at the table for a company they own. When that company’s shares also publicly traded, there are heightened compliance concerns. The fund’s management representative is likely to end up with material non-public information. The compliance challenge is to prove that the information does not make it to the fund’s trading desks.

Ares Management just got an SEC fine for failing to stop the information leak.

Based on the SEC order, Ares had invested several hundred million dollars in a public company and had two representatives on a public company’s board. One of those was a senior member of the investment team. This representative had access to:

  • “potential changes in senior management,
  • adjustments to the Portfolio Company’s hedging strategy,
  • efforts to sell an interest in an asset,
  • the Portfolio Company’s desire to sell equity and use proceeds to retire certain debt, and
  • the Portfolio Company’s election, as allowed under the terms of the loan agreement, to pay interest “in kind” and not in cash.”

All of that would reasonably be considered material non-public information. Ares compliance group had trades in the company’s stock under special watch. It had the power to impose information walls, but apparently did not do so in this case.

Ares made follow-on purchases of the company’s stock.

Ares’ compliance staff failed, in numerous instances, to document sufficiently that they had inquired with the Ares Representative and the members of the deal team as to whether any of them had received potential MNPI from the Portfolio Company, or to apply a consistent practice to the inquiries made, resulting in ambiguity whether, or if, inquiries were made in certain instances.

This a classic compliance problem of proving that you don’t know something when the information exists within the firm. As a result, the SEC order takes the position that Ares’ compliance staff “failed to document properly whether they had assessed the extent to which Ares deal team members had any information that had the risk of being MNPI.”

Part of this appears to be the unusual circumstance. Ares does not commonly hold director seats on the boards of publicly-listed companies. The compliance policies and procedures didn’t adequately address the issue and the compliance staff did not adequately document an area of heightened risk.

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Are you getting the right Zoom?

I’m going to guess that many of you are using Zoom for some aspects of communicating personally or professionally? I think it’s great. Business meetings work better when you can see each other.

Personally, it’s been great to get together with my cycling teams over Zoom. We aren’t riding together outside. I’m not riding outside at all. We have done some Zoom and Zwift rides. Nothing better than watch each other struggle up virtual bike climbs.

Maybe you like it so much that you think you should buy some stock in the company. You type in “Zoom.” See a quote and description.

Zoom Technologies, Inc., through its subsidiaries manufactures, researches, develops and sells electronic communication products for the mobile phones, wireless communication circuitry, and related software products.

So you hit “buy.”

It seems lots of people are doing this. Enough that the SEC put a trading suspension in place for Zoom Technologies. It’s ticker symbol is ZOOM.

The problem is that you were really interested in Zoom Video Communications. It’s ticker symbol is ZM.

Zoom Technologies also hasn’t filed any public disclosures since 2015 but still has a market value of around $30 million. Zoom Video has a market value of over $30 billion.

Zoom Tech’s price doubled to $20 in late March as we all brought Zoom Video into our personal and professional lives. It’s clear that there were a lot of poorly research trades in the mix

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Browns Don’t Lose, But a Player Does

For the first time in 13 years, the Cleveland Brown did not lose on their NFL opening weekend. Being the Browns, they didn’t win either. They had to compete without the help of Mychal Kendricks. The now former linebacker was cut by the Browns after charges of insider trading.

The $1.2 million in insider trading profits cost Kendricks $3.5 million from his Browns contract. Plus he faces a significant civil penalty from the SEC, Plus, the US Attorney’s Office in Philadelphia decided to bring criminal charges which could result in jail time.

Why did Kendricks do this? In the complaint, the SEC published a text message from Kendricks to Damilare Sonoiki.

I’m at a messed up place as far as my money is concerned I have enough money to live and to support myself but not enough money to avoid taxes … I don’t have enough money to buy a business and get the tax breaks I need.

How did they do this? Sonoiki worked at investment bank. It’s unnamed in the complaint, but based on the transactions it looks like it was Goldman Sachs. Sonoiki met Kendricks at a party. Sonoiki got information on M&A deals from work and passed them on to Kendricks. Kendricks gave him football tickets and cash in exchange for the inside information.

How did they get caught? Kendricks opened a trading account, but tried to have Sonoiki make the trades directly.  The firm flagged the account for having a mismatched IP address. Then the trades were just options with big short-term gains. I’m sure the brokerage account flagged the account and alerted the SEC.

It’s a very brazen case of insider trading. The only question is why it took so long to get caught.

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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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