Research on Insider Trading

Just to revive any anger you have left from the 2008 financial crisis and its aftermath, a new academic paper found evidence of insider trading among corporate insiders at leading financial institutions during the Financial Crisis. That’s on top of other research that brokers leak information or front run trades.

One research paper on political connections comes from the private meetings between government officials and financial institutions during the financial crisis which eventually lead to the Troubled Asset Relief Program.

Any corporate insiders with knowledge of those discussion could have known how much money was involved and which financial institution would get it. With financial institutions staring into a pit on destruction and some being dangled a rope to safety, one could have made a good chunk of cash if you knew which company to bet on and which ones to avoid.  The government was making hundreds of billions of dollars available.

The paper examines conduct at 497 financial institutions between 2005 and 2011. The researchers focused on individuals who had previously worked in the federal government. In the two years prior to the TARP, these people’s trading gave no evidence of unusual insight. But in the nine months after the TARP was announced, they achieved particularly good results. The paper concludes that “politically connected insiders had a significant information advantage during the crisis and traded to exploit this advantage.”

The other research paper on order flow leakage uses data from 1999 to 2014 from Abel Noser, a firm used by institutional investors to track trading transaction costs. The data covered 300 brokers, but the researched focused on the 30 biggest. 80-85% of the trading volume flowed through those 30.

The researchers found evidence that large investors tended to trade more in periods ahead of important announcements. That would be hard to explain, unless they have access to inside information.

The most innocent access to information would be brokers that “spread the news” of a particular client’s desire to buy or sell large amounts of shares. That helps with market-making. A less innocent explanation is that they give this information to favored clients to boost their own business.

Of course, large institutions can be both beneficiaries and victims of this  information leakage. But in general they are net gainers to the lowly retail investor who does not have access to this information. It further leads to a conclusion that the markets are rigged and they should not participate at all.

One common theme to these papers is the use of big-data and analytics to find these trends and identify weaknesses in the systems. We have seen cases from the SEC’s Division of Economic and Risk Analysis attacking frauds. It may be useful for the SEC to focus on these systemic problems.

Sources:

  • Insider trading has been rife on Wall Street, academics conclude in The Economist
  • Political connections and the informativeness of insider trades by Alan D. Jagolinzer, Judge Business School, University of Cambridge; David F. Larcker, Graduate School of Business, Rock Center for Corporate Governance, Stanford University; Gaizka Ormazabal, IESE Business School, University of Navarra; Daniel J. Taylor, the Wharton School, University of Pennsylvania. Rock Center for Corporate Governance at Stanford University, Working Paper No. 222.
  • Brokers and order flow leakage: evidence from fire sales by Andrea Barbon, Marco Di Maggio, Francesco Franzoni, Augustin Landler. National Bureau of Economist Research, Working Paper 24089, December, 2017; and “The Relevance of Broker Networks for Information Diffusion in the Stock Market” by Marco Di Maggio, Francesco Franzoni, Amir Kermani and Carlo Summavilla. NBER Working Paper, No 23522, June, 2017

More Changes to Insider Trading Law

With the ground-shaking decision in Newman, insider trading law became a bit murky. Cases have been filling in the gaps left in its wake. The Mathew appellate Martoma decision helped fill in some more.

From a compliance perspective, this is all chasing butterflies and tilting at windmills. It was clear that Mr. Martoma was involved in insider trading. It was just a question of whether it was illegal. He knew the information he was getting was not supposed to be disclosed to the public. He should not have pushed for its disclosure and he should not have traded on it. At least not according to any self-respecting compliance professional at a trading firm.

But I’m sure enforcement professionals are very interested to see if they can find a way to keep their insider trading clients from going to jail.

For me, the current status of the law is that the Newman decision said the government needed to prove the tipper gained a tangible reward, or “personal benefit,” for providing insider information. The 2016 Supreme Court ruling in Salman v. U.S., said proving a tipper and trader were relatives was enough to meet the “personal benefit” standard.

In the Martoma case, the Second Circuit describes the the “misappropriation theory” of insider trading:

“that a person . . . violates § 10(b) and Rule 10b‐5[] when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.” Id. at 652. It is thus the breach of a fiduciary duty or other “duty of loyalty and confidentiality” that is a necessary predicate to insider trading liability.

It then goes on to the seminal insider trading case of Dirks v. S.E.C., 463 U.S. 646 (1983)

the Supreme Court held that a “tippee”—someone who is not a corporate insider but who nevertheless receives material nonpublic information from a corporate insider, or “tipper,” and then trades on the information—can also be held liable under § 10(b) and Rule 10b‐5 but “only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.” Id. at 660.2 “[T]he test” for whether there has been a breach of a fiduciary duty or other duty of loyalty and confidentiality “is whether the [tipper] personally will benefit, directly or indirectly, from his disclosure” to the tippee. Dirks, 463 U.S. at 662.

It goes on to cite its own United States v. Newman, 773 F.3d 438 (2d Cir. 2014)

To the extent Dirks suggests that a personal benefit may be inferred from a personal relationship between the tipper and tippee, where the tippee’s trades ‘resemble trading by the insider himself followed by a gift of the profits to the recipient,’ we hold that such an inference is impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.

The Second Circuit comes out with this standard:

Thus, we hold that an insider or tipper personally benefits from a disclosure of inside information whenever the information was disclosed “with the expectation that [the recipient] would trade on it,” … and the disclosure “resemble[s] trading by the insider followed by a gift of the profits to the recipient,” … whether or not there was a “meaningfully close personal relationship” between the tipper and tippee.

For my simplistic compliance perspective, this means that if the tippee pays money or gives something valuable to the tipper in exchange for money, the tippee risks going to jail.

Martoma gave his tipper money through an expert network agency. As a result, his conviction stands.

I think this leaves golf buddies possibly able to trade on insider knowledge, unless they are relatives or betting on the results.

I should point out that there was a blistering dissent in the case and I’m not sure if Mr. Martoma still has enough cash to appeal to the Supreme Court. We may see more in the Martoma case.

I’m sure that you will be reading many more nuanced discussions about this case and its implications from those much more versed in insider trading than me. But, I think this case does little to change the compliance view on insider trading.

If you want more information on the Martoma case or the SAC Capital attack, read Black Edge. It’s well worth the time if you have any interest in the area.

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The One With The Incriminating Internet Searches

The case against Fei Yan was a fairly straight-forward insider trading case involving leaky M&A transactions. In this case, the leaks came from a junior corporate associate working on the transactions. We can only guess that she told her husband, Mr. Yan, about her day at work and revealed too much information.

While Mr. Yan was working as a postdoctoral associate at the Massachusetts Institute of Technology’s electronics research lab. He apparently had enough free to time to trade stocks and advance into options. He did so in an account in his mother’s name, using leaked information from his wife. At least that is what the SEC and DOJ are going to try to prove.

Mr. Yan started trading in Mattress Firm just forty-five days before the announcement of its acquisition by Steinhoff International. His gifted trading netted him almost $10,000.

The next transaction was the acquisition of Stillwater Mining by Sibanye Gold. With Mr. Yan’s now advanced trading skills, he moved to the higher leverage of options. He acquired a slate of call options within 30 days of the transaction’s announcement. With the additional leverage, he generated a profit of over $100,000.

The case ended up with criminal charges as well. I was curious about what escalated it to make it worthy of criminal prosecution.

The SEC complaint noted two Google searches:

“how sec detect unusual trade”
“insider trading with international account”

And further notes the Mr. Yan reviewed several items in the search results, including “Want to Commit Insider Trading? Here’s How Not to Do It.”

That article noted the 2013 Badin Rungruangnavarat insider trading case where his trading was most of the trading activity in the options and futures involved. It also involved a lot more money.

Mr. Badin made $3.2 million which makes him a much juicier target for prosecution. Mr. Yan’s $120,000 in profits are going to cost him a much larger amount in legal fees to defend the civil case and the criminal case to keep him out of jail. According to reports, he used a court-appointed attorney at the bail hearing. If convicted, he could face up to 25 years in prison and as much as $5 million in fines for the security fraud charges, and 20 years in prison and up to a $250,000 fine for the wire fraud charge.

I assume the Google searches made the federal prosecutors see that Mr. Yan had criminal intent, clearly knowing what he was doing was illegal and taking steps to hide the trading activity.

Given the small amounts, how did he get caught? I would guess the brokerage compliance team noted the suspicious activity and reported it to the SEC.

Sources:


On Pan-Mass Challenge weekend, August 4 – 6, I will saddle up to ride with 6,200 other cyclists 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 you can you will support my fundraising effort. Please give generously with one of the following links:

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Doug

 

The One With the Fake Fitbit Steps and Fake News

The quest of any insider trader is to get a stock bet in place before a big announcement is made. Robert W. Murray thought he could just make his own announcement and sell out of his trade. The target was Fitbit.

This case caught my attention because of the yelling about “fake news” and Fitbit. I became a fan of the Fitbit products a few years ago when I wanted to lose some weight. I managed to drop 25 pounds using my Fitbit (and watching what I ate and exercising more).

Mr. Murray had no inside information, so he decided he could make some money by manufacturing his own announcement. He did some research and thought he could put a fake filing on EDGAR, the SEC filing system. According to the SEC complaint, Mr. Murray figured out how to do a fake filing by research at least two prior EDGAR manipulation cases:  the 2015 Nedko Nedev Case and the 2016 Nauman Aly case.

Mr. Murray bought some out-of-the-money call option cheap the filed a fake tender offer for Fitbit, Inc. on EDGAR. It worked. The stock price spiked by 10% on news of the tender offer. The stock came back down after Fitbit made an announcement that it had received no communications about a tender offer.

Mr. Murray had a great ROI on his call options of 351%. He did not have much money at risk. He only spent $887 on the options and realized a gain of $3,118.

Mr. Murray was able to disguise his IP address for his filing. However, he used his real email as a backup recovery email for the EDGAR account. He booked a hotel reservation using that account. There was a recovery email for the the first recovery email that tied back to Mr. Murray’s employer.

Assuming the facts in the complaints turn out to be true, Mr. Murray spent a lot of time and energy to create the fake steps and fake news for a $3200 profit. Looks like he is going to use all of that up in legal fees, and then a lot more to try to keep himself out of jail.

Sources:

The One With The Pilfering Lawyer and The Document Management System

The SEC and the DOJ broght charges against Walter C. Little and his neighbor Andrew M. Berke for illegal insider trading. This particular case caught my attention because Mr. Little was a law firm partner and he found the information by searching through his law firm’s document management system.

According to the complaints, Mr. Little obtained material, nonpublic, confidential information about seven issuers and 11 corporate announcements through his access rights on law firm’s internal computer network. However, Mr. Little did not work for those clients or on those transactions.

Mr. Little and Mr. Berke have not settle the claims. Mr. Little is going to have an uphill battle because the law firm disclosed the data about Mr. Little accessing the confidential documents.

In one case, the law firm was serving as legal counsel to Pentair on a possible merger with ERICO Global in a transaction that the firm called Project Lionel.

The damning timeline:

  1. On August 4, The document management system shows Mr. Little accessing documents titled “Pentair – Commitment Letter” and “Lionel Goldman Sachs Engagement Letter”.
  2. On August 5, Mr. Little and Mr. Berke exchange text messages and phone calls.
  3. On August 6, Mr. Berke starts buying call option on Pentair stock.
  4. On August 11, Mr. Litte accessing a document entitle “Project Lionel – Form 8-K(Execution of Merger Agreement)”
  5. On August 11 and over the next few days, Mr. Little buys Pentair call options.
  6. On August 17, Pentair issues a press statement announcing the merger.

A partner at a big law firm knows that accessing merger information about firm clients is wrong and trading on that information is illegal. The trading would be flagged as suspicious by the brokerage firm and sent the information to FINRA. If there was enough suspicious activity around the merger, FINRA would send a query to the law firms involved. The law firm would see the partner’s name and turn over all of the relevant information.

The only question I have is how well did Mr. Little disguise his trading. Since the trading happened over the course of a year with several different clients, I assume he did a good job of hiding the trading. I would guess that it was the last deal with Hanger, Inc. that caught the regulators attention. Once in their sights, the regulators were able to trace back to Mr. Little’s trading on other law firm clients.

Mr. Berke seems to have a more defensible position. The prosecutors will need to prove the information was passed to him and that the trading was not just a coincidence. Then, it’s into the post-Newman world of whether he needed to know the information was supposed to be confidential or whether the relationship between the two needed some level of significance.

Then there is the law firm leaving documents unprotected. This is common. It’s tough to balance the sharing needs of a sprawling team against the information security impositions in the document management system.

At a minimum it’s an embarrassment to the law firm. I would assume the law firm has changed its document security settings, defaulting to limited rights, instead of defaulting to a public setting. I’m sure there is plenty of complaining because it makes it hard to work collaboratively when document security gets in the way.

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The Case of the Security Guard with Ketchup on his Hands

With the flow of announcements from the Securities and Exchange Commission, odd things will catch my eye for further review. For the insider trading case against Todd David Alpert, it was because the SEC said that he “worked as a security professional at the home of a Heinz board member.” A tilt of my head left me wondering what kind of securities professional was working at the home of a board member.

That was me confusing “security professional” with “securities professional.” Of course, I realized that “security professional” was a fancy term for security guard. But by the time I realized my mistake, I was deep into the complaint against Todd David Alpert.

Once I realized he was a security guard I immediate thought of the railroad insider trading case. I was ready to give Mr. Alpert credit for leveraging his position. I assumed he had identified the comings and goings from his post and tied that into what was going on behind the scenes.

I was thinking of the defenses from the railroad workers noticing the action in the railyards or counting cars at WalMart.

Then my jaw dropped.

The problem was the board member. The unnamed board member would forward emails to the Mr. Alpert in his role as a security professional, and ask him to print the email and attachments.

The Board Member forwarded an email regarding the potential Heinz acquisition with a direction to “print now”. The attachments to the email contained materials that would be discussed on an upcoming Heinz board of directors’ call, including a copy of the revised acquisition proposal letter, which included the word “CONFIDENTIAL” in boldface and stated that the proposed price for Heinz for $72.50 per share.

From the timeline presented in the case, Mr. Alpert read the attachment and quickly bought Heinz stock and options.

I can’t believe the board member was forwarding this incredibly sensitive information to the security guard to print. Who was this board member that was too lazy or incompetent to print a document on his own?

I pulled up the list of board of directors to see.  I couldn’t pull the pieces together. Then I got distracted when I saw that Lynn Swann, the ex Pittsburgh Steeler was on the board. One of those 12 does not know how to print email attachments.

Sources:

The Supreme Court Weighs in Insider Trading

If you were expecting a tidal wave of changes from the Supreme Court, you will be disappointed. On Tuesday, the Court delivered its opinion in Salman v. U.SProsecutors can see a glimmer of upside because they do not have to prove that something valuable changed hands in order to prove the crime of insider trading.

Supreme Court

Newman was a setback because the U.S. Court of Appeals for the 2nd Circuit, that the insider must “also receive something of a ‘pecuniary or similarly valuable nature’ to prove illegal insider trading.

In a 1983 case, Dirks v. SEC, the Supreme Court had ruled that  someone who receives confidential information from an insider and then uses the information to trade can be held liable under insider trading laws when the insider violates his duty to shareholders by disclosing the information. But that depends on whether the insider receives “a direct or indirect personal benefit from the disclosure.” In Dirks, the Court said that jurors could infer a “personal benefit” when the insider either (1) receives something of value in exchange for the tip or (2) “makes a gift of confidential information to a trading relative or friend.”

Newman was under the first option. The prosecutors did not prove that the information was passed between friends or relatives and did not prove that there was an exchange of value. The Salman case is under the second option when the material non-public information was passed between friends and relatives.

The Court’s reasoning is simply that “giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.” You are not likely to give a gift to a stranger so there needs to be some other value. You are likely to give a gift to a friend or relative.

I think the Court used the Salman case to state that Dirks is still the standard for insider trading and Newman did not change it. The opinion was forcefully narrow and limited itself to insiders passing material non-public information to friends and relatives.

Sources:

Personal Benefit in Insider Trading

While Mr. Cooperman was accused of making millions on insider trading. Sheren Tsai made $23,914.41 on her illegal trades. The relatively small amount of the gains caught my eye in the press release, but a particular line in the pleadings made me think it was worth highlighting.

Ms. Tsai was (is?) in a romantic relationship with Colin Whelehan.  Both worked at different investment advisory firms. Mr. Whelehan was involved in a significant corporate event. He told this material non-public information to Ms. Tsai. She bought stock in the target company and made the above-mentioned $23,914.41 in profits.

The pleading that caught my eye was the statement about personal benefit:

“25. As a result of his tip, Whelehan received a personal benefit in the form ova gift to his closest personal friend, his live-in girlfriend and romantic partner, Tsai.”

Clearly, the SEC is trying to sort the law out in the post-Newman world.

Then there is the insider trading catch.

Ms. Tsai’s compliance group noticed the trades in her account. Clearly it looked strange to have the purchase so close to the announcement and spike in price. Most insider trading platforms will flag that trade.

The compliance group also had Ms. Tsai’s emails. Mr. Whelehan had sent an email from his work email to her work email  writing in part:

“one of Apollo’s portfolio companies would be buying out ADT.”

Ms. Tsai later sent a message using her work email

“So when is it [target’s stock price] going to BOUNCE”

Both had compliance training and knew about insider trading. They are caught as about red-handed as you can get for insider trading.

Sources:

 

Is Cooperman The New Cuban?

The Securities and Exchange Commission brought charges against Mark Cuban for insider trading. The SEC claimed he was an insider based his status as a big shareholder in the company or that he had agreed to not trade on material non-public information disclosed to him.

The SEC brought charges against Leon Cooperman for trading on material non-public information. The SEC is alleging that Cooperman used his status as a big shareholder in Altas Pipeline Partners to obtain confidential details about an upcoming company transaction.

According to the SEC complaint, an executive at Atlas Pipeline shared confidential information with Cooperman believing he would keep in confidential and not trade on that information. That seems a lot like the Cuban facts.

The SEC alleges that the Cooperman explicitly agreed to not use the information to trade. Going back to the Cuban case, he never agreed to keep the information confidential.

The trading activity outlined in the SEC order shows Cooperman making a huge bet on Atlas Pipeline. At one point his activity was 95% of the daily volume of trading on a set of Atlas Pipeline call options.

It looks there was a parallel action of criminal charges. But the Newman case from the Second U.S. Circuit Court of Appeals sets a standard that a recipient of an inside tip must know the confidential information came from an insider and that the insider disclosed the information for a personal benefit.

The Salman case is before the Supreme Court and is looking at the Newman standard for criminal insider trading.  If that standard is upheld, it seems unlikely that Cooperman would be in an orange jumpsuit. According to reports, the DOJ has suspended its investigation into Cooperman until the Salman case is decided.

The civil charges from the SEC is based on misappropriation so it does not need to prove that the tippee received a benefit.

It seems like the case will hinge on the credibility of the Atlas Pipeline executive. That executive is not named in the complaint.

Assuming the SEC case passes the credibility standard, it will need to prove the legal standard that Cooperman’s trading should be illegal.

Given the recent history of the SEC bringing cases in front of its own administrative judges, this case was filed in federal district court.

I see two likely reasons. Cooperman demanded this venue in exchange for agreeing to the tolling of the statue of limitations. (The trading happened in 2010.) Or, the SEC is looking to set legal precedent.

References:

A Pair Of Pharma Insider Trading Cases

Pharmaceutical company stock is known to be volatile depending on success or failure of drug trials. As pharma companies become successful they become targets for larger pharma companies looking to supplement their lines. The Securities and Exchange Commission filed two actions recently for suspect trading in pharma companies.

Paxil by JustinLing CC BY

The first case is a bread and butter insider trading case where the SEC alleges that two brokers found a source inside a pharma company that was feeding them material non public information. In the second case, the SEC charged a doctor involved in a drug trial with trading on the non-public results of the trial.

In that first case, the SEC alleges that Paul T. Rampoldi was the ringleader of an the insider trading ring at his brokerage firm. They had an insider at Ardea Biosciences. The Ardea insider tipped one of the brokers with material non-public information in at least two instances. Once was ahead of the company’s announcement of an agreement to license a cancer drug and the second was in advance of its acquisition by AstraZeneca PLC. The SEC charged the other two brokers and the Ardea employee last year. To avoid detection by his brokerage firm, they traded in an account at a different firm.

As Sharon B. Binger, Director of the SEC’s Philadelphia Regional Office, said: “As a stockbroker, Rampoldi should have known better than to allegedly trade on tips about significant corporate events before they were announced.”

In the second case, Dr. Edward Kosinski was working on the clinical trials for Regado Biosciences. He started with a small holding in the company. Small enough to be below its compliance reporting level. I assume that Dr. Kosinski must have thought highly of the drug being test because he dramatically increased his holdings in the company.

The things took a turn for the worse. The company announced problems with the trial. Dr. Kosinski did what most people would do on hearing bad news: he sold his stock. The problem was that he had signed a confidential nondisclosure agreement that, according to the SEC’s allegation, prohibited from trading on the stock based on the trial. In selling the stock, Dr. Kosinki realized a small gain and avoided a huge loss. The stock tanked when the problems were announced to the public.

When further details were announced to the trial group, Dr. Kosinski did a worse thing. He shorted the stock, buying put contracts that would make him more money if the stock dipped even further. It did and he did.

Perhaps with selling his stock, Dr. Kosinski could have argued that he didn’t know better. But doing the second trade in options adds a level of scienter. That’s probably why the DOJ brought criminal charges on top of the SEC’s civil case.

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Image is by JustinLing