A Bad Bet On Insider Trading

The recent insider trading case against William “Billy” Walters of Las Vegas is fascinating for all of the players involved, including him. Plenty has been written about the charges because it implicates pro golfer Phil Mickelson and former Dean Foods board member Thomas C. Davis. All three are implicated in insider trading. How did they get caught?

roulette by Chris Yiu

It looks like the getting caught was relatively straight forward. Walters made big, obvious trades around earnings releases and major news for Dean Foods and Darden Restaurants. In June 2008, Walters bought more than 4 million shares, which represented between 29 and 37% of the daily trading volume in the company during his two day buying spree. In April 2010 Walters bought 19% to 21% of the trading volume during his short buying spree.

The SEC linked Walters to Davis. Since Davis was on the board of Dean Foods and Darden Restaurants he was the obvious source of information. According to The Wall Street Journal, Davis is cooperating with the government.

The case also implicated pro golfer Phil Mickelson. Mickelson made some big, obvious trades that would have attracted the attention of a compliance review. He bought a $2.4 million position in Dean Foods, while the rest of this trading account only had $250,000 in assets. He was not a frequent trader and had not bought Dean Foods before.

That they got caught is no surprise. Most trade monitoring programs would flag that activity.

What is a surprise is that Walters made such obvious bets on the market when he is well know for hiding his gambling bets. A story in ESPN tells all the steps he takes to hide his positions in sport betting. He uses runners to make bets so it does not look like his bets. He buys on the opposite side of a bet to better the spread. The story tells of other steps he takes to conceal his positions. According to the SEC, he failed to do so in his securities trades.

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Roulette by Chris Yiu CC BY SA

Love For Your Mother Can Be Insider Trading

Lawrencia Afriyie took some risky bets in the market. She bought out-of-the-money options, but made $1.5 million in profits. It just so happens that her son, John, worked for for an investment firm that had material non-public information on the target of those options.

Cash in the grass.

According to the SEC complaint, John Afriyie worked at an investment firm involved in a going private deal for ADT. He accessed documents that were designated “confidential” or several variations of confidential. He must have seen a golden opportunity to make some money on the side.

Since Mr. Afriyie had signed the investment firm’s Code of Business Ethics that prohibits trading on material, non-public information, he could not trade on the information.

Mysteriously, his mother, Lawrencia, bought 2,279 options on ADT from January 28 through February 12. The options were out of the money, with strike prices between $32 and $34 a share, while the stock was trading between $24 and $28. She was most of the trading activity on these options on many days during that period.

On February 16, ADT announced its acquisition at a price of $42. Lawrencia made a profit of $1.5 million on $24,000 in options.

Based on the trading activity in Lawrencia’s account, I would assume the compliance officers on her account saw a big red flag: extremely well timed option trades just prior to a major announcement. The complaint does not say so, but I assume that this option trading was unusual for her account.

Then it was up to the regulators to tie her to the source of information. Did she rat out her son and tell the regulators that it was him trading on her account? Her son had just made her a big pile of cash.

Probably not. FINRA would have seen the suspicious name to the firms involved in the transaction. Someone at the investment firm would have matched the last names and asked John what his mother’s name was.  Then compliance would have looked closer, reported the problem and booted him out the door in short order.

Now the SEC has brought charges to recover the gains and the DOJ has brought criminal charges.

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The SEC’s Insider Trading Case Falls Further Apart

Five years ago, the SEC came crashing into the offices of Level Global Investors accusing it of engaging in illegal insider trading. The firm agreed to pay $21.5 million in settlement money to resolve that insider trading investigation. Now it wants its money money back.

SEC Seal 2

When it comes to insider trading, it’s not the firm doing the trading, it’s individuals. The individuals fought the charges of illegal insider trading. Anthony Chiasson, was implicated in the insider trading charges and was convicted at trial.

But the verdict was overturned and the federal appeals dismissed the charges. That ruling by the United States Court of Appeals for the Second Circuit (U.S. v. Newman and Chiasson, 773 F.3d 438 (2d Cir. 2015)), made it more difficult to pursue insider trading cases. The Newman decision changed the SEC’s view of what constitutes illegal insider trading. The government now requires the government to prove a higher level of benefit than before.

The SEC appealed to the US Supreme Court, but it decided not to hear the appeal.

With the underlying charges gone, the Level Global feels it’s entitled to get its settlement back. The SEC is not contesting and a federal judge agreed to vacate the settlement.

Although the Supreme Court decided not to hear the Newman appeal, it did agree to hear another insider trading case with a similar issue.

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When a Compliance Officer Breaks Bad

There has been considerable discussion in the compliance community around the Securities and Exchange Commission bringing charges against compliance officers. There are three areas that the SEC feels it is justified in bringing charges: (1) when the compliance officer is involved in the wrongdoing; (2) when the compliance officer impedes the examination or investigation; and (3) when the compliance officer is in wholesale failure. The latest SEC charges against a compliance officer fall into the first area.

Breaking Bad long

Yue Han was an associate in the compliance department of Goldman Sachs. That gave him access to the emails of the investment bankers to look for potential misconduct. The SEC claims that Mr. Han broke bad and used the information he gathered from those emails to spot upcoming M&A activity for his own personal gain.

Mr. Han has not settled the charges so this story is based only the SEC’s allegations. He left the country and may not dispute the charges. The SEC has gotten an asset freeze, so he will have to fight the claim if he wants the cash back.

The SEC claims that its case stems from its Market Abuse Unit’s Analysis and Detection Center, which uses data analysis tools to detect suspicious patterns. The SEC claims that its enhanced detection capabilities enabled SEC enforcement staff to spot Han’s unusual trading activity in two different accounts.

Four companies are at the center of the SEC’s case: Yodle, Zulily, Rentrak, and KLA.  In each case, he bought out-of-the-money options cheaply just before an acquisition was announced and recognized a big gain after an acquisition was announced. Goldman Sachs was an adviser in each of the deals.

In one of the Han trading accounts, the broker-dealer barred him from acquiring further trading in the account. I assume the firm noticed the suspicious trading.

The complaint leaves out whether or not Mr. Han cleared his trades with Goldman. I would assume not since the firms would have been on the blocked list.

I would guess that Mr. Han is not going to dispute the charges and try to re-gain his trading profits.

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Outside Trading Defendants Settle

A month ago, the Securities and Exchange Commission brought charges against a large network of 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. Two traders, who made $25 million in the scheme, settled the charges against them and returned the profits.

New_Toronto_Stock_Exchange_trading_floor

Ukrainian-based Jaspen Capital Partners Limited and CEO Andriy Supranonok agreed to pay the SEC $30 million to settle the charges. That’s a 20% premium on the $25 million that the firm made on the trades. The firm’s assets and accounts were frozen when the charges were brought. I assume that shut down business that went through the United States.

The scheme was based on hacks into Marketwired of Toronto, PR Newswire in New York, and Business Wire of San Francisco. The hackers got an early look at the press releases and traded on the likely movement of the stock.

At times, the scheme has been labeled “insider trading”, but that seems to be a bad label to me. The defendants were using stolen data for their trading strategies. They did not get the information through working inside or for the companies involved. John Reed Stark was one of the first to use the “outside trading” label.

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What’s in your Wallet? Insider Trading

Jennifer_Garner_Capital_One

It’s clearly insider when a company’s high-level executive trades on pending earnings data not yet released to the public. It’s clearly not insider trading when you count cars in a retailer’s parking lot to get insight to sales. A recent SEC case falls somewhere in the middle.

The Securities and Exchange Commission brought charges against two men who worked at a credit card company. The two crafty traders tracked credit card use to determine revenue trends for retailers and then traded based on that data.

Their plan was solid. They made over $2.8 million on a $147,300 investment, a return of 1,819%, according to the complaint. Those returns are too good. I would bet that their brokerage accounts were flagged by compliance.

The credit card company was not disclosed in the complaint, but Capital One has acknowledged that they’ve “been working closely with the SEC on this investigation, which involves two former employees.”

This case reminds me of the Railroad Insider Trading case where an employee noticed a bunch of “suits” walking around the railroad and some unusual activity in the office. He surmised that the railroad was getting sold, traded on that assumption, and made some money on the trade. The SEC thought he was engaged in illegal insider trading. A jury thought otherwise.

In this current case, the two men were subject to the credit card company’s rules on protection of this information. According to the SEC, they broke those rules.

They “knew or were reckless in not knowing that they owed their employer a fiduciary duty, or an obligation arising from a relationship of trust and confidence, to maintain the confidentiality” of the data.

In looking at the portions of Capital One’s insider trading policy, it probably should have addressed this particular topic. The portion of the code excerpted in the SEC complaint is a rather standard ban on illegal insider trading. It seems to fail to address the use of data at the company.

What the two traders did is certainly enough to get them fired. It was enough to get them charged by the SEC. It may be harder to get a jury to agree. Unlike some other recent insider trading cases, this one was filed in federal court. So it will be up to a jury, not one of the SEC’s administrative judges, to determine guilt.

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Another Tale of Golf Course Stock Tips Ending Up in a Sand Trap of Insider Trading

golf insider trading compliance

The Securities and Exchange Commission brought another insider trading case where the tips were allegedly traded on the golf course.

“Country clubs or similar venues may give people a false sense of security that leads them to think they can get away with trading on unlawful stock tips,” said Paul G. Levenson, director of the SEC’s Boston Regional Office. “But as in any social setting, people who trade securities based on confidential information they receive are taking a huge risk that their illegal tipping and trading will be identified by the SEC.”

Robert Bray triggered the FINRA warning lights with a large order of a thinly traded stock. According to an SEC complaint, Bray placed an order for 25,000 shares in Wainwright Bank & Trust Company. That was several days worth of volume in that stock. He started his buying spree on June 14. It several days to accumulate that much stock for his order.

On June 28 Wainwright announced that it was going to be acquired by Eastern Bank for a share price almost double what Bray had paid. That put almost $300,000 of profit in his pocket when the acquisition closed on November 18.

Of course that kind of excessive trading close to a transaction is going to trigger a FINRA inquiry. Bray’s name was on a list of 30 individuals who purchased Wainwright stock during the pre-announcement period. That list was circulated to employees at Eastern Bank for them to disclose if they knew anyone on the list.

According to the SEC, J. Patrick O’Neill, a Senior Vice President at Eastern Bank did not respond to the initial request. O’Neill also did not respond to the second request. Then he called in sick. Finally, he met with his supervisor who demanded that O’Neill respond or be subject to employment-related discipline. O’Neill resigned the next day. He also transferred title on his house to his wife that same day.

Now the SEC had a trader in one hand and in the other hand had an employee with access to the inside information who was acting suspiciously. The SEC just needed to find the link. O’Neill had the information but did not trade. Bray had the trading profits but no direct connection or confidential obligation to the inside information.

The SEC found the connection at the country club. Both O’Neill and Bray were members of the same local county club. The SEC also found a tiny business arrangement between Bray and O’Neill’s son.

That is all the SEC had to build its case. When questioned about his relationship with Bray, O’Neill pleaded the fifth and didn’t answer the SEC questions during his testimony. Bray did the same when he was questioned by the SEC. Apparently that really annoyed the SEC because they forwarded the case on to the Justice Department who brought criminal charges against O’Neill.

Once again, the cliche is proven. But it sounds like the SEC will have a hard time proving the transfer of information from O’Neill to Bray.

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A Cliche Is Proven

golf insider trading compliance

One cliche thrown around is that tipping a golf buddy to material non-public information is an insider trading violation. The Securities and Exchange Commission just filed a case that proved that cliche true.

Eric McPhail learned the expected earnings and major pending corporate developments at American Superconductor through a friend who is (was?) an executive at that company. They were good friends and golfed together at the same country club. Confidentiality was expected.

However, Mr. McPhail took that information and tipped it to six of his other golfing buddies. At least according to the SEC complaint. Four of the golfing buddies consented to judgement, returned their trading profits, and paid fines.

Mr. McPhail is not accused of trading in the stock. He is charged with illegal tipping.

Unfortunately for the golfing buddies, their communication about the stock was not limited to the golf course. The SEC complaint is full of email messages discussing the stock and material non-public information. In one email, Mr. McPhail hopes to be paid back by his golfing buddies with pinot noir and steak.

The American Superconductor executive is not named in the complaint.

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Cleaning Up An Oil Spill Is Insider Trading

oil platform and compliance

Keith A. Seilhan was 20-year employee of BP and a senior responder during the 2010 Deepwater Horizon oil spill. Seilhan directed BP’s oil skimming operations and its efforts to contain the expansion of the oil spill. What he saw scared him so he sold his entire portfolio of BP stock.

The Securities and Exchange Commission charged him with insider trading. The SEC’s view was that he had confidential information about the magnitude of the disaster. BP was telling the public that the spill was only 5,000 barrels of oil per day. Seilhan obtained information that the magnitude of the oil spill and BP’s potential liability and financial exposure, was likely to be greater than had been publicly disclosed. The truth was more than ten times that publicly reported amount.

This case reminded of the railroad case where workers in the railroad yard noticed unusual activity around the railyard and came to the conclusion that the railroad was up for sale. They made a stock bet on their conclusion and won. But the SEC charged them with insider trading, but lost the case.

In the oil case, Seilhan knew the company was lying about the scope of the spill. The information was not publicly available because BP was purposefully deceiving the public and regulators.

You could argue that the information is more like the counting of cars in a retailers parking lot to see how business in doing. Anyone could jump in a plane and see the scope of the oil spill. The news organizations were doing just that. I assume it would take a trained eye to notice that the spill was being misjudged by an order of magnitude.

Regardless of my thoughts about the case, Mr. Seilhan felt it was better to settle the charges than fight the SEC. A month after the trade he received a reminder memo from BP legal to not trade on the stock based on an employee’s possession of price sensitive information. That prohibition was in BP’s code of conduct. Seilhan replied to legal and wanted to discuss his trade, but never followed up or disclosed.

Seilhan agreed to return $105,409 of allegedly ill-gotten gains, plus $13,300 of prejudgment interest, and pay a civil penalty of $105,409.

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Image is Thunder Horse Semisub by Andyminicooper
CC BY SA

Do Law Firms Need Compliance Programs? Part 2

Earlier this month it was accounting fraud. This week it’s insider trading. Law firms seem to pose the same risks as any other firm.

Do as I say; Not as I do.

A clerk at a law firm trolled the document management system for information on mergers when the firm was representing one of the parties. The clerk passed the information onto an unnamed Middleman, who passed the information on to a stockbroker. Everyone made money. the behavior was repeated for a dozen other transactions involving the law firm.

The SEC put together a graphic to help understand the flow of money and information. The three went through some rather elaborate steps to hide their tracks. As you can see from the graphic, Metro, the law firm clerk, would meet the Middleman at coffee shops to pass along the information. The Middleman would meet with Eydelman, the stockbroker, at the clock at Grand Central station to pass along the information.

eydelman graphic

Initially it surprised me while reading the SEC’s complaint that Middleman was not identified and not charged. The description of the Middleman’s information exchanges including Metro pointing to data on a mobile device and Middleman making Eydelman eat the paper with the information on it. It seems clear that Middleman is cooperating with the SEC and federal prosecutors. In the criminal complaint, Middleman was wearing a wire and had begun cooperating with authorities.

The law firm was in charge of sensitive information about its clients. It sounds like the firm failed secure the information. Metro may have worked on some of the transactions, but should not have had access to key information like timing and pricing. He probably should not have had access to the parties names.

It sounds like the law firm failed to take reasonable steps to isolate information to those who need to know.

Until the charges were filed, the law firm did not know about the transgressions. Metro was fired the day the charges were brought. You also have to wonder how often the law firm employees were reminded of not engaging in insider trading.

The SEC has fired a warning shot and has stated that it is focused on law firms:

 “We are continuing to combat serial insider trading schemes, particularly by law firm employees and other professionals who are entrusted with extremely sensitive market-moving information.”

– Daniel M. Hawke, chief of the SEC Enforcement Division’s Market Abuse Unit

Attorney Matthew Kluger was sentenced to 12 years in prison, the longest term ever imposed in an insider-trading case, for stealing corporate merger tips from four law firms over 17 years. Two Ropes & Gray LLP lawyers in New York went to prison for leaking tips to former Galleon Group LLC trader Zvi Goffer.

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