The recent arrest of Rep. Christopher Collins for alleged insider trading can teach traders a few key lessons: If you come across juicy non-public information about a listed company, don’t trade on it.
And don’t pass it on to someone else to trade on, either.
Finally, if law enforcement asks about the trading, don’t lie to the authorities.
Rep. Collins, the first congressional Republican to endorse President Donald Trump’s bid for the White House, was arrested on federal securities fraud charges last Wednesday. He has since suspended his bid for re-election.
Prosecutors allege Collins, who represents the 27th District of New York, his son Cameron, and the father of Cameron’s girlfriend, Stephen Zarsky, schemed to commit insider trading relating to securities of Innate Immunotherapeutics Ltd.
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an Australian biotechnology company. The Congressman was previously a member of the Innate board.
On Friday, the SEC also announced it had settled charges against Cameron’s girlfriend, Lauren Zarsky, and her mother, Dorothy Zarsky, for trading on nonpublic information.
Congressman Collins had material, nonpublic information about confidential drug trial results for Innate and provided it to his son, so that his son and others, including Cameron’s future father-in-law, could trade before the drug trial results were publicly announced, according to the SEC complaint.
Rep. Collins received an email about the results of the drug trial from Innate’s chief executive and wrote back, “Wow. Makes no sense. How are these results even possible???” He then called his son from an official event on the South Lawn of the White House on June 22, 2017, the complaint stated.
Cameron sold almost 1.4 million shares after Collins passed on the tip, according to Geoffrey Berman, U.S. attorney for the Southern District of New York. When later interviewed by the FBI, Congressman Collins, his son and Zarsky each allegedly lied to cover up the insider trading scheme.
The Securities and Exchange Commission also charged the trio. Collins left Innate’s board in May, the company said in a statement, adding “The U.S. media has inaccurately reported that Mr. Collins and colleagues were the beneficiaries of share issuances in the Company on privileged terms.”
You don’t have to trade stocks yourself to be guilty of insider trading
Rep. Collins, his son Cameron and Zarsky, have pled not guilty to the charges. Rep. Collins’ lawyers said in a statement they were confident he will be “completely vindicated and exonerated.”
“It is notable that even the government does not allege that Congressman Collins traded a single share of Innate Therapeutics stock,” his lawyers said.
But the individual can still get in trouble with the law if he or she doesn’t trade on the information, but instead passes it on to someone else, said Tom Gorman, a lawyer with Dorsey & Whitney and former SEC enforcement attorney who publishes a popular securities blog. The congressman allegedly tipped off his son, who then was able to sell about one and a half million shares.
“That’s basically the congressman trading himself,” Gorman said. “He’s doing it for a personal motive. He had private confidential corporate information to use for the benefit of the company and [according to the SEC’s complaint] he was using it for the benefit of his family and friends.”
Insider trading is, at its core, profiting on nonpublic information by trading a company’s stock before the news investors need becomes public. “If you have any reason to think the information you are getting you shouldn’t be getting, don’t trade on it,” said Daniel Hurson, a former SEC lawyer in Annapolis, Md. “The minute you go out there and start trading on that kind of information, that’s risky.”
SEC investigators have become more skilled at flagging suspect trades
The SEC is getting much better at spotting transactions that look like they might be insider trading, with the help of regulatory partners like FINRA and the stock exchanges. Software can track the purchases and sales of stocks, especially if large numbers of shares are traded before major company announcements. The SEC will investigate anyone who may have access to insider information, including board members, lawyers or secretaries, Hurson said.
In 2017, gambler William Walters was sentenced to five years in prison for trading on information obtained from former Dean Food chairman Thomas Davis. That case was relatively easy to prove, lawyers said at the time, because Walters made a series of large, very successful trades, which set off alarm bells at the SEC.
Or, as acting U.S. Attorney Joon H. Kim said at Walters’ sentencing: “Making millions in the stock market with a deck stacked in your favor leads to time in a federal penitentiary.”
But SEC investigators also use seemingly innocuous information to build a case. In some cases, law enforcement have found evidence by using the timestamps on Metrocards used in New York City subway turnstiles, or by linking two people together through a photo from a wedding on
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Gorman said.
It’s notoriously difficult for federal prosecutors to prove securities fraud
It may not be illegal to trade on information you overhear in public, on the train or at the movies.
The standards are high for proving such cases. In 2014, two hedge fund managers, Anthony Chiasson, cofounder of defunct Level Global, and Todd Newman, a manager at Diamondback, had their insider trading convictions overturned.
The United States Court of Appeals for the Second Circuit said the evidence was insufficient to sustain a guilty verdict, because “in order to sustain a conviction for insider trading, the government must prove beyond a reasonable doubt” that the person providing the information, the tippee, knew that an insider, the tipper, disclosed confidential information and that he did so in exchange for a personal benefit.
Prosecutors also need to prove that the person making the trades knew the tip came from illegally obtained information. In Billy Walters’ case, Walters also encouraged World Golf Hall of Famer Phil Mickelson to trade in Dean Foods stock.
Mickelson made $931,000 in profits in 2012, but the government had no proof that he was aware of why Walters suggested he make those trades. He was named as a “relief defendant” and only had to surrender his profits, plus interest. He never testified at Walters’ trial. (Representatives for Mickelson did not respond to request for comment.) Gorman said naming him a relief defendant was simply to get the trading profits back.
Don’t miss: What you think you know about investing can hurt you
Insider trading tips are sometimes given under the most unlikely circumstances
Sometimes, the information falls into your lap, literally. Last December, the SEC charged a licensed therapist with insider trading.
The complaint said he disclosed nonpublic information about a forthcoming merger of two public companies revealed to him by his patient during a therapy session. Licensed therapists are typically bound by state laws and codes of ethics to keep information shared by patients confidential.
One insider-trading scheme involved the passing of tips via napkins or Post-it notes at Grand Central Terminal in New York.
A law clerk at a major law firm, Simpson Thacher, had access to confidential mergers and acquisitions data, the SEC alleged. Stephen Metro allegedly passed the tips to his friend, Frank Tamayo, who then passed it to a broker, Vladimir Eydelman, who had worked in the past at Oppenheimer and Morgan Stanley.
Metro would tell Tamayo about the deals in coffee shops and bars, and Tamayo would then show Eydelman a Post-it note or a napkin on which he wrote the ticker symbol of companies to be acquired. Then Tamayo would destroy the evidence by chewing it up, sometimes actually eating the Post-it note or napkin. Eydelman was sentenced to three years in prison in 2016.
A large, successful trade before important news is a big red flag for investigators
Last March, former Equifax technology executive Jun Ying was charged by federal authorities with securities fraud. Ying allegedly used confidential information about Equifax’s
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massive hack attack last year to sell nearly $1 million in shares before the news was public.
The “paper trail” in this case included his browser history where, according to the SEC complaint, Ying researched a similar — but smaller — Experian
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hack in 2015. His attorneys did not respond to a request for comment.
Raj Rajaratnam, founder of hedge-fund Galleon Group, either was very lucky or, as SEC lawyers suspected, an unbelievable fortune-teller. Like Walters, the SEC noticed Rajaratnam made several large trades just before a series of major corporate events.
In 2007, he took large stock options in Hilton Hotels immediately before it was taken over by the Blackstone Group. The government eventually collected enough evidence of his winning trades to get permission to eavesdrop on his phone calls.
Rajaratnam was convicted of 14 counts of securities fraud and insider trading relating to numerous companies, including Goldman Sachs
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The onetime hedge-fund star is now serving an 11-year prison term (the longest ever for an insider trading case) and was fined $10 million, as well as ordered to forfeit more than $53 million.
Prosecutors must prove that something of material value was expected in return for tips
However, his brother, Rengan Rajaratnam, who was a portfolio manager at his brother’s company, was acquitted on insider trading charges but agreed to pay more than $840,000 to resolve his case in 2014.
The SEC charged several other portfolio managers and directors at numerous companies with insider trading related to this case. (Neither of their attorneys responded to a request for comment.)
Eight employees of the now-defunct hedge fund firm SAC Capital Advisors were convicted on criminal charges related to insider trading in 2013.
The United States Court of Appeals for the Second Circuit tossed out two of those convictions, for Anthony Chiasson and Todd Newman, who had been convicted of improper trading in shares of two technology companies.
The appeals court said the original tips were not illegal because the company corporate executives who gave Chiasson and Newman most of the confidential information did not expect anything in return. The court said prosecutors must show something more than friendship was expected in return for the stock tip.
In October 2015 the United States Supreme Court declined to review the ruling. Two weeks later the 2013 conviction of Michael S. Steinberg — the highest-ranking employee at SAC Capital Advisors to stand trial for insider trading — was dropped, as well as the guilty pleas of six cooperating witnesses.
SAC Capital founder Steve Cohen, who was never charged with criminal wrongdoing, settled a civil case for “failure to supervise” the traders brought by the Securities and Exchange Commission, agreeing to a ban on acting as a supervisor of a fund until 2018.
Last year, Cohen shared plans to come back to the industry with a goal of managing at least $20 billion.
Lying to the FBI is a criminal offense along with insider trading
In 2001, Martha Stewart, founder and former chief executive officer of Martha Stewart Living Omnimedia was indicted on criminal charges of securities fraud as well as obstruction of justice after selling shares of ImClone Systems, a biopharmaceutical company, based on nonpublic information.
Prosecutors alleged Stewart sold the ImClone stock only after her broker told his assistant to tip her off that her friend, ImClone founder Sam Waksal, was trying to sell. Both Stewart and Waksal were clients of the broker, Peter Bacanovic. He and Stewart told investigators they had an arrangement to sell once the stock fell to $60. But Stewart sold the stock the day before the company announced news about an FDA ruling that tanked the price of ImClone shares.
Stewart, like Rep. Collins, was charged with securities fraud and lying to the FBI. She was found guilty of four counts of obstructing justice for lying to the FBI, but the judge threw out the securities-fraud charge which carried a maximum penalty of 10 years in prison and a $1 million fine. She spent five months in prison, five months on house arrest and two years of probation. (Her attorney for the case, Robert Morvillo, passed away in 2011).
Lying to law enforcement, even if not under oath, is a felony, Gorman said, and that’s why Stewart went jail. “If you have done insider trading and you get a subpoena and talk to law enforcement, it is a bad thing,” he said. “You can make it worse by lying.”
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