Classic behavioral and trading trails that make market abusers easy prey for today’s technologically-empowered law enforcers.
Insider trading has a considerable history in capital markets, and features some of the most fantastical examples of traders, portfolio managers and even the already rich and famous dreaming up colourful plots in their often extreme pursuits of wealth.
There was a time it wasn’t unlawful to manipulate markets, and indeed JFK’s father Joseph P Kennedy made light of his own rigging exploits before he was appointed the first chairman of the Securities and Exchange Commission with a mandate to clean up Wall Street.
Things are very different now, and a retrospective of the most notorious cases of insider trading reveals a growing degree of sophistication among those determined to refine their approach and cover their tracks.
However, the enforcers rapidly are catching up, and extraordinary advances have been made in detecting arguably this form of capital markets distortion. Regulators all over the world are honing trigger alerts with greater sums of data, coordinated action, and investment in extremely powerful automated analysis of trading patterns and behavior.
The US Financial Industry Regulatory Authority (FINRA) revealed recently that it runs almost 200 algorithmic “patterns” to look for more than 300 potential threat scenarios, including market manipulation, fraud, customer abuse, insider trading, abusive short selling, inaccurate trade reporting, and other rule violations.
Here are some classic insider trading cases that were cracked open with technology:
Phone a friend
The temptation to take advantage of material nonpublic information (MNPI) before it reaches the rest of the market is sometimes too hard to resist. In 2017, US Congressman Christopher Collins received negative news about clinical trials for a drug being developed by Innate, an Australian biotech company of which he was a director. He immediately rang his son, who then told his girlfriend’s father that evening in person.
The next day, the latter pair placed orders ahead of the market opening to sell stock, and continued to trade out over the next 48 hours. Two days later, the market heard the news and the stock plummeted 92 percent. Steven Peikin, co-director of the US Securities and Exchange Commission (SEC) Enforcement Division, said “the investigation yielded a detailed footprint left by the defendants, revealing their frantic efforts to sell shares and warn others before Innate announced bad news.”
Phil Mickelson can do no wrong in the eyes of many a golfing fan for his talent and entertainment, but he almost came unstuck in 2016 when trading in Dean Foods, a Dallas-based dairy company. The golfer was dragged into a tri-party insider trading investigation due to his connection to the legendary sports gambler, Billy Walters, who was himself very close to Tom Davis, a board member at Dean Foods.
Walters and Davis, in significant financial trouble, devised a scheme to allow Walters to trade in Dean Foods based on information provided by Davis, and in two years, Walters made $43m from it.
Mickelson became involved in trading Dean Foods and bought stock for the first time in three of his accounts (before trading a total of 23 times in Dean Foods in his and his wife’s account), just two weeks before a very favorable announcement about the sale of a subsidiary. The stock leapt 40 percent and Mickelson made close to $1m overnight.
The ambiguity of insider-trading law in the US at that time, where the tipper and tippee were clearly Davis and Walters, meant that Mickelson was not directly implicated has he had no direct connection to the insider.
The defense lawyer for Walters later revealed how the SEC examines all unusual trading around corporate announcements to see who was trading around the news in unusually large amounts. Mickelson was later named as a relief defendant by the SEC in a separate civil case, which stated that he made profit from insider trading in Dean Foods even if he had not engaged in it himself. He settled in full and gave back his trading profit plus interest. So just a double bogey for Phil on that hole.
Compliance folks and ex-regulators can get caught out
David Aufhauser, former group general counsel for UBS, made it into the highest political echelons as former general counsel of the US Treasury before moving to the commercial side.
His downfall came following allegations he learned of MNPI relating to the Swiss bank’s problems in the auction-rate securities market. After he received an email about the problems from UBS’ chief risk officer on a Friday evening train from New York to Washington on December 14, 2007, he forwarded it to two other UBS lawyers, requesting a meeting to discuss the issues. Minutes later, while still on the train, Aufhauser called his own financial adviser with instructions to unload all of his auction-rate securities. He repeated this instruction the following Monday to the broker, who sold his $250,000 worth of securities.
Aufhauser agreed to pay $6m to New York prosecutors that he had been due to receive as a bonus from UBS, plus a further $500,000 civil penalty.
Gene Levoff, Apple’s senior director of corporate law and corporate secretary traded on material nonpublic information about Apple’s earnings three times during 2015 and 2016, according to the SEC. On more than one occasion, Levoff ignored his own company’s “blackout” period for stock transactions, selling or buying stock worth tens of millions of dollars.
Before his termination, part of his role was ensuring Apple’s compliance with securities laws and Apple’s insider trading policies; he sent, or supervised the sending of, notification emails to the list of individuals subject to trading restrictions around Apple’s quarterly earnings announcements, and determined the criteria for their placement on the blackout list. In 2011, while updating Apple’s insider trading policy, he sent an email to all employees stating: “REMEMBER, TRADING IS NOT PERMITTED, WHETHER OR NOT IN AN OPEN TRADING WINDOW, IF YOU POSSESS OR HAVE ACCESS TO MATERIAL INFORMATION THAT HAS NOT BEEN DISCLOSED PUBLICLY.”
Don’t google “How do I inside trade without getting caught?”
In 2017, a research scientist who searched the internet for “how SEC detect unusual trade” and “insider trading with an international account” was charged after later making a trade flagged as suspicious. Massachusetts Institute of Technology associate Fei Yan loaded up on stocks and options in advance of two corporate acquisitions in 2016 based on confidential information obtained from his wife, an associate at the law firm working on the deals, Linklaters.
Yan made approximately $120,000 in illicit profits by selling his holdings in Mattress Firm and Stillwater Mining, following announcements that they would be acquired by other companies. He attempted to conceal his activity by placing the trades in a brokerage account in the name of his mother, who lived in China. The SEC collared him after identifying the profitable trades in deals advised by Linklaters and tracing them back to Fei.
In 2017, Equifax suffered a significant data breach which damaged its stock price; the business attempted to restrict information on the hack to as few employees as possible before it was officially released to the market. However, two people on the IT side figured out that the confidential project they were asked to work on related to their own employer.
One of those, Jun Ying, the company’s former chief information officer was later indicted and it emerged he had used a search engine to find information concerning the September 2015 cybersecurity breach at Experian, and the impact that breach had on Experian’s stock price. The search terms used by Ying were: (1) “Experian breach”; (2) “Experian stock price 9/15/2015”; and (3) “Experian breach 2015.”
He made trades based on the information he had found combined with his intuition that his own company had been hacked prior to the information going public, and his search history was soon exposed after he was caught out.
Go long and take a big synthetic position – job offers in return for inside information
In 2001, Arthur Samberg, chairman and CEO of Pequot Capital Management, was courting an employee of Microsoft who wanted to get into the fund management sector as an analyst, David Zilkha.
There were rumors in the market that Microsoft might miss its estimates for the first quarter of that year; Samberg shot an email to Zilkha before his official exit and start date at Pequot to get an inside view. Zilkha asked around internally and learned that Microsoft would meet or beat its estimates. Samberg bought call options, sold puts and the Pequot funds won big, making north of $14m from the trading. Pequot and Samberg were later both charged and agreed to pay nearly $28m to settle.
Unusual behavior tends to attract more attention
In late 2018, the SEC charged Hamed Ettu, an IT professional in Texas, over his part in an insider trading scheme perpetrated by a former Wall Street investment banking analyst, Damilare Sonoiki, who was a family friend. Ettu got tips on imminent mergers via text message, often in Yoruba, a Nigerian dialect. An NFL player, Mychal Kendricks, was also charged in connection with the same scheme.
Ettu and Sonoiki made approximately $93,000 in illegal profits by using Ettu’s account to purchase call options of companies that were about to be acquired, and in one instance generated returns of more than 318 percent in under a month.
Although Ettu’s trades were much smaller than those of the professional football player, the SEC identified the overlap and trace the trades to a common inside source, one who was speaking in Yoruba, a dialect not overheard too frequently around Wall Street.
No one, however good, gets it right all the time
Steve Cohen, founder and main beneficiary of SAC Capital, is a legend; the inspiration for award-winning TV series Billions, and subject of the book Black Edge. Cohen’s firm was so successful, his hit rate so good, he attracted the scrutiny and considerable determination of US authorities who concluded that any firm generating returns of more than 30 percent repeatedly during a ten-year period must be doing something systematically illegal. In the end, the firm paid a fine of $1.8bn and two of its portfolio managers (Michael Steinberg and Mathew Martoma) were convicted for insider trading.
The allegation was that despite extreme care taken by Cohen to distance himself from the activity of, and information received by, his portfolio managers, there was one potential banana skin. He received an email forwarded by Steinberg from a source just as Cohen was starting to sell his stock in Dell.
Cohen’s legal team argued that there was no proof he had read the email, and if he did it was not proof it caused him to sell. They added that even if he had read it, and it had induced him to sell, he did not know the source or that it was nonpublic information, so it was not insider trading. They claimed that he got more than 1,000 emails each day and only read 11 percent of these. Cohen evaded successful prosecution. This case was proof that it really does pay to have the best lawyers.
Be brazen and they will come
Raj Rajaratnam was a larger-than-life character in the hedge fund world who cultivated a well-groomed network of executives at companies including Intel, IBM and Goldman Sachs.
These executives provided him with MNPI, and he used this to trade to the tune of $60m in illicit profits. In one example, on 23 September 2008, Warren Buffet agreed to pay $5bn for preferred shares of Goldman Sachs.
This information was not announced until 6pm. Prior to the announcement, Rajaratnam had bought 175,000 shares of Goldmans Sachs. The next day he sold his stock for $900,000 profit. A former Goldman Sachs manager had called Rajaratnam immediately after the deal was done in a board meeting.
Rajaratnam’s activity was primarily uncovered because of the FBI’s use of wiretapping, as well as the collection of various emails and phone records. Rajaratnam’s phone calls were matter of fact and made no attempt to conceal his scheme. In one call he said “I heard yesterday from somebody who’s on the board of Goldman Sachs that they are going to lose $2 per share. The Street has them making $2.50.”
Information was exchanged through use of encrypted memory sticks as well as unregistered mobile phones, encoded and encrypted records, safety deposit boxes and transferring benefit using cash and payments in kind.
As the data trail grows, the regulators and their machines see more and more
Operation Tabernula is arguably the UK authorities’ greatest success story in rooting out a highly organised insider trading operation that was one of the most professionally run schemes in enforcement history. The investigation took eight years, cost £14m and involved 140 personnel. The origin for the initial enquiry was a Suspicious Transaction Report, which showed that the trades of just two individuals, Ben Anderson and Iraj Parvizi, accounted for 26 percent of one company’s total trading volume on a particular day.
The case required extraordinary cooperation between the UK National Crime Agency (NCA) and the Financial Conduct Authority (FCA), who carried out hidden surveillance and providing niche capabilities, including the deployment and monitoring of a wiretap between the defendants. The FCA analysed trading, financial and communications data, documentary evidence from investment banks and material seized during searches under warrant.
In all, there were four separate strands of investigation that entailed vast amounts of data, including: 100 trading accounts; 500,000 entries of telecom data information; more than 500 hours of telephone conversations; 600 digital devices; and five terabytes of digital information.
A blog from the law firm Allen & Overy declared, “the use of surveillance tools by the NCA highlights how sophisticated apparatus will continue to assist the FCA in pursuing, and securing the convictions of, such individuals.”