A trader (may be termed an investor by some) from South-East Asia made newspaper headlines late last year when he was found involved in insider trading.
The case was of particular interest because it spanned three different countries, including the United States. Also, the regulator in question, the US Securities Exchange Commission (SEC) took an intriguing approach to track down the conspirators, and fined them eventually.
This interesting story began with the trader opening an account with a broking house in the United States in the second quarter of 2013. After this account was approved, he transferred US$3mil to his personal account and started accumulating a significant amount of a US-listed stock.
At the same time, he bought a large number of “out of the money” call options.
Just by looking at the transactions made, it was evident that the trader was making a strong bet that the US-listed company’s stock price was going to increase its value substantially. Once the trader purchased the call options, he had to post a margin of nearly US$1.3mil. This margin is to cover the percentage required of the future contracts’ cumulative value.
The trader was not perturbed by the fact that his call options purchases represented a significant chunk of the traded volume of the options cleared for the contracts in the US-listed company. This was the first red flag.
The trader continued to buy aggressively, as his “out of the money” call options contracts cleared for July and September 2013 were 100% of all volume traded. This was red flag No. 2.
It would have been obvious to any observer of these transactions that the buyer of these call options and futures was attempting to corner this stock. A quick back-of-the-envelope calculation showed clearly that with these call options and single-stock futures (that is, an obligation to purchase 100 shares per contract at a particular date), the trader suddenly controlled nearly one-third of the company’s total volume in the month of March alone.
Just days after these very ambitious purchases, the US-listed company announced that it would be acquired by a Chinese company for billions of dollars. This announcement sent its share price rocketing. The trader’s account thus rose considerably; he made a striking 3,400% return.
Any regulator would not only monitor the sizeable bet but also the high percentage of volume traded. In this situation, the regulator could also see the amount of percentage gain that the trade had made in just over four months.
After the SEC reviewed these activities, it immediately filed for a court order to freeze the trader’s assets. It did so even though the trader was living in his own Asean-based country, and was not residing in the US.
The US court ordered the freezing of the proceeds from the trader’s purchases, and also granted the SEC expedited discovery as well as prohibited the trader from destroying any evidence relevant to the case.
The SEC alleged that the trader had bought thousands of “out of the money” call options and single-stock futures between May 21 and May 29, 2013. The SEC alleged further that the trader had purchased these assets based on material, private information about the possible acquisition, also commonly known as insider trading.
After profiting from his timely information, the trader sought to withdraw more than US$3mil from his US account on June 3 that year. The SEC also alleged that the buyer had violated Section 10(b) of the Securities Exchange Act of 1934 and its Rule 10(b)-5.
Besides the emergency relief it sought under this Act, the SEC also sought disgorgement of all ill-gotten gains, with pre-judgment interest, a financial penalty and a permanent injunction against the trader. The Market Abuse Unit of the SEC’s Enforcement Division investigated the trader with the assistance of the options regulatory surveillance authority.
The SEC’s successful court action against the trader was achieved very quickly from the time the trader committed the illicit acts. This showcased how effective the SEC’s recent efforts were to employ more sophisticated techniques to root out market fraud. Such an approach to enforcement seems to be paying off.
What was particularly fascinating about the SEC’s more sophisticated approach was that the method that the regulator probed the trader’s link with an employee of one of the investment banks that was a party to the early negotiations on the deal. The SEC was able to do so by checking their social network “friends list”. That was how it found that the bank employee had tipped the trader or his friend off.
When confronted, the trader admitted that he had done wrong and agreed to forfeit his gains. He also paid millions of dollars in penalties.
In the old days, those involved in insider trading exchanged information illicitly by making anonymous calls in phone booths in the street. Or they would create and use code words for their transactions.
Today, social media networks have enabled financial insiders to engage in such shady deals even more stealthily – that is, until regulators use their own tools against them. Be mindful who you list your friends as.
© CORSTON-SMITH ASSET MANAGEMENT SDN BHD 2014