There has been lots of breathless commentary in the financial press and the blogosphere over the SEC’s August 2021 filing of an insider-trading case involving so-called “shadow trading.” Shadow trading as defined in a 2020 academic paper occurs when someone possessing material, nonpublic information (“MNPI”) obtained from his or her employer uses it to trade in the securities of a competitor or economically-linked public company.[1]  This is in contrast to the more usual insider trading, in which the stock being traded is that of the subject company. In Panuwat, the defendant is charged with misappropriating MNPI from his employer and using it to trade in a competitor’s securities.[2]  Earlier this week, a district court in the Northern District of California denied a motion to dismiss the SEC’s complaint, allowing the enforcement action to proceed.[3]

According to the complaint, the defendant, Matthew Panuwat, learned of an impending merger involving the company he worked for, a mid-sized, oncology-focused biopharmaceutical company.  Within minutes, he bought short-term, out-of-the-money stock options in another mid-sized oncology-focused biopharmaceutical that investment bankers had identified as a competitor.  The defendant allegedly deduced that the announcement of the buy-out of his employer would lead to a rise in the price not only of his employer’s stock, but that of its competitor.

Commentators have universally labeled this case the first shadow trading enforcement action following the 2020 academic paper.  But is it truly unprecedented?  Not exactly.  In fact, a prior case that involved MNPI misappropriated from an employer and used to trade other companies’ securities went to a jury trial and resulted in liability for the trader.

Continue Reading SEC Complaint Upheld in Rare – But Not Unprecedented – Shadow Trading Case

On December 20, 2021, the SEC[1] and DOJ[2] each announced fraud charges against five Russian nationals. The five defendants are charged with a multiyear scheme of hacking into service providers that help public companies make quarterly and annual filings with the SEC through the EDGAR filing system.  By hacking the service providers, the defendants allegedly obtained material nonpublic information (MNPI) regarding earnings releases before those releases were made public.  The defendants then allegedly traded ahead of the release of the MNPI, reaping profits of some $82 million in the process.

When the MNPI consisted of positive news, the defendants bought shares of the companies at issue.  When the MNPI was negative, they sold shares of those companies short.  The statistical odds that the defendants could have obtained these trading results through random chance is approximately one in one trillion, according to the SEC.

The defendants allegedly obtained unauthorized access to the service providers’ networks by using malicious infrastructure capable of harvesting employees’ usernames and passwords.  Then they used stolen usernames and passwords to pose as employees and access the service providers’ information.  They also tried to conceal their activities by leasing proxy computer networks outside of Russia and subscribing to email addresses and payment systems used in furtherance of the attacks in others’ names.

They also allegedly used multiple brokerage accounts to carry out their scheme.  According to the SEC, from 2018 through 2020, the traders used 20 different brokerage accounts located in Denmark, the UK, Cyprus and Portugal to generate profits of at least $82 million using the stolen information to make trades before over 500 corporate earnings announcements.

One of the defendants, Ivan Ermakov, is a former officer in the GRU, a Russian military intelligence agency.  This is not Ermakov’s first federal criminal indictment.  He was charged in July 2018 for his alleged role in a hacking and influence scheme related to the 2016 U.S. elections.  And he was charged in October 2018 for his alleged role in hacking and disinformation aimed at international anti-doping agencies, sporting federations, and anti-doping officials.

Another defendant, Vladislav Klyushin, was arrested in Switzerland in March of this year and extradited to the United States on December 18.  The other four defendants remain at large.

The SEC’s charges include violations of the antifraud provisions of the federal securities laws.  The SEC seeks disgorgement of their ill-gotten gains, civil penalties, and injunctions against further violations.

The criminal indictment charges the defendants with obtaining unauthorized access to computers, wire fraud, and securities fraud.  They have also been charged with criminal conspiracy to engage in those prohibited acts.  Each count of wire fraud and securities fraud carries a maximum sentence of 20 years in prison, along with restitution and forfeiture.

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[1]  https://www.sec.gov/news/press-release/2021-265 

[2] https://www.justice.gov/usao-ma/pr/russian-national-extradited-role-hacking-and-illegal-trading-scheme

The United States Securities and Exchange Commission recently charged two individuals— Florida residents, Suyun Gu, and his friend, Yong Lee—for their involvement in allegedly fraudulent wash sales involving out-of-the-money options in “meme stocks.” So-called “meme stocks” [1] are stocks that were being actively promoted on social media in early 2021. Continue Reading SEC Charges Case Featuring Alleged Wash Sales Involving Options of “Meme Stocks”

Today the SEC [1] and the DOJ [2] announced civil and criminal charges involving an alleged brazen $8 million insider-trading scheme.   The trader, Dayakar Mallu, allegedly traded ahead of four public announcements by his former employer, Mylan N.V., between October 3, 2017, and July 29, 2019.  He allegedly obtained material nonpublic information from a friend who still worked at Mylar at the time.  The tipper is described only as a “Mylan insider” in the SEC press release, but the DOJ press release calls him an unnamed co-conspirator.

Mallu’s alleged insider trading enabled him to generate gains and avoid losses totaling over $8 million through well-timed options trades.  The SEC’s complaint maintains that Mallu obtained material nonpublic information about Mylan’s unannounced earnings, drug approvals by the FDA, and impending merger with another company.  According to the SEC, he then shared a portion of his trading profits with the tipper by making cash payments abroad.

The SEC alleges that Mallu attempted to conceal his trading scheme by using secure messaging apps and foreign cash payments.    The SEC press release said that these attempts failed because of “the agency’s ability to use sophisticated data analysis to detect suspicious trading pattern and identify the traders behind them.”

Mallu has consented to the entry of an injunction against further violations of Section 10(b) of the Securities Exchange Act and Exchange Act Rule 10b-5 and a bar from serving as an officer or director of a public company.  In the parallel criminal case, Mallu pleaded guilty to insider trading and aiding in the preparation of a false tax return.  He is scheduled to be sentenced on January 24, 2022.  There is no word yet as to charges facing the tipper/unnamed coconspirator.

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[1] SEC Announcement | SEC Charges Former Pharmaceutical Global IT Manager in $8 Million Insider Trading Scheme

[2] DOJ Announcement  |  Former Information Technology Executive Pleads Guilty to Insider Trading and Aiding in the Preparation of a False Tax Return

On August 16, 2021, the financial thresholds specified in the definition of “qualified client” under Rule 205‑3 of the Investment Advisers Act of 1940 (“Advisers Act”) will increase (i) from $1 million to $1.1 million (assets under management test), and (ii) from $2.1 million to $2.2 million (net worth test).  Contracts entered into prior to August 16, 2021 will be “grandfathered” in and will not be subject to the adjusted dollar amounts, unless a client who was not a party to such contract becomes a party following this effective date.  Investment advisers and fund managers should consider whether their agreements must be updated to reflect the new thresholds.

Continue Reading SEC Increases Financial Thresholds for Qualified Clients

Reuters reported today that the SEC is investigating last year’s hack of SolarWinds, focusing on whether SEC registrants failed to disclose that they had been impacted by the cyber breach.[1]   According to the article, the SEC sent voluntary requests for information to “a number of public issuers and investment firms…”  The SEC is reportedly investigating whether SolarWinds customers had been victims of the hack and failed to adequately disclose that fact.

As is customary in these investigations, the SEC is reportedly inquiring whether such hacking victims had suffered from internal-controls deficiencies.  The SEC is also looking for unusual or opportunistic trading patterns suggestive of potential insider trading.  And of course the SEC is inquiring into potential violations of Reg SP to determine whether the companies have policies designed to protect customer information and data privacy.

If the hacking victims respond to the SEC by disclosing information about the breaches, they could avoid facing enforcement action “relating to historical failures,” according to the article.

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[1] The article can be accessed at: U.S. SEC probing SolarWinds clients over cyber breach disclosures -sources | Reuters

“Naked short selling” is often claimed by struggling public companies to be the source of their woes.  But there have been relatively few cases addressing naked short selling.  Recently, however, on   May 19, 2021, the SEC charged a broker-dealer (“BD”) with violating the order-making and locate provisions of Regulation SHO.[1]  Regulation SHO regulates short sales of securities and, broadly speaking, is aimed at minimizing naked short selling, failures to deliver, and other practices.

What is Short Selling?
According to the SEC’s Complaint, “[s]hort selling occurs when an investor borrows a security and sells it on the open market, planning to buy it back later for less money.”[2]  Thus, short sellers profit from a decline in the price of a security.  This is in contrast to “long” investors, who profit from an increase in the price of a security.  Short selling is very risky: losses are unlimited because the price of a security can always increase.

What is Regulation SHO?
Regulation SHO, enacted in 2005, established “locate” and “close-out” requirements.  Rule 200(g) of Regulation SHO requires BDs to mark all orders to sell stock as “long,” “short,” or “short-exempt.”[3] Continue Reading SEC Brings “Naked Short Selling” Case

On April 1, 2021, the Texas State Securities Board (TSSB) announced the entry of a Consent Order against an SEC registered investment adviser named Independent Financial Group, LLC (“Independent”). The TSSB’s action may represent a large shift in investment adviser regulation and enforcement considerations for SEC-registered investment advisers. (Emphasis on “may.”) Continue Reading SEC Investment Advisers: Texas says “April Fools!” to Federal Preemption?