by T. GormanPosted on Posted in SECActions

Congress is locked in battles over what to cut from the federal budget to pay yesterday’s bills. Federal agencies are facing hiring freezes and increasing regulatory burdens while vying for for fewer budget dollars to meet the challenges of tomorrow. SEC Chairman Walter, however, offered a vision for how the agency is moving today to meet the needs of investors tomorrow despite all these limitations in remarks delivered at American University School of Law on February 19, 2013.

The Chairman discussed a mixture of existing programs and initiatives under development which largely focus on using new technology and ideas. The goal is to provide a safer and more secure investment environment for all investors. These initiatives include:

The markets: Greatly enhanced data access providing depth and insight into the markets to improve regulation and investor protection. The Commission has two key projects underway. One is called the Market Information Data Analytics System or MIDAS. Describing this project as the “world’s greatest data sandbox” for researchers, the Chairman stated that it would give the Commission an unprecedented view into the markets by aggregating all trading information data. MIDAS will assist the agency in monitoring and unraveling things like mini-flash crashes or other troublesome and perhaps illegal behavior. It will also give the staff and the public, with whom the Chairman wants to share the data, added insight into things like high speed trading, liquidity and intraday volatility. This will permit the Commission and other researchers to examine the fundamental mechanics of the markets in an unprecedented manner.

A corollary to MIDAS is the consolidated audit trail. This project expands the data available from MIDAS to include nonpublic information such as the identity of the traders. This will significantly expand the ability of the Commission to analyze things like “suspicious trading.”

Market structure: To ensure a more stable market structure the Commission has under development what the Chairman called Reg SCI. Rooted in “Black Monday” which occurred 25 years ago and related policy initiatives of that time, this proposal is expected to have a number of provisions including: 1) A requirement that core technologies of exchanges, significant alternative trading systems and clearing agencies meet certain standards; 2) That these entities conduct business continuity testing; and 3) That they provide certain notifications regarding system disruptions and other events.

Examinations: In an effort to marshal its resources and create a better examination program for firms overseen by the agency, the Commission created the National Examination Program. This is a risk based program that analyzes information from filings and other sources to identify firms most likely to put investors at risk. Those firms are then targeted for further examination.

The Commission is also utilizing tactical risk scoping models which center on the use of performance data to identify firms that require further review. The Aberrational Performance Inquiry or API is one part of this effort. It has been used to review the performance of hedge fund advisers and identify those who consistently outperform others in the area. The approach has been used to identify Ponzi schemers who tend to claim outsized results.

Review of filings: The Division of Risk, Strategy and Financial Innovation – what the Chairman describes as the SEC’s in-house think tank – has designed a model to help the agency identify “earnings management” and fraudulent accounting practices. The model looks at risk indicators and risk inducers. The former are items that might be associated with wrongful conduct even though in and of themselves they are legitimate. The latter are performance difficulties that might give management an incentive to inflate earnings. Under development is a tool designed to enhance detection of irregularities in the written discloses made by companies.

Enforcement: The Chairman identified three new tools being utilized by the Division to enhance its capabilities. The first is the automated Tips, Complaints and Referrals system or TCR. This is the SEC’s first nationwide system for analyzing tips. The second is the Automated Bluesheet Analysis Platform or ABAP. This tool links records of significant company news with trading data to help identify suspicious trading patterns.

A third tool being used by the Enforcement division translates thousands of phone records or lines of trading data into a visual representation. It maps “previously undiscovered relationships between participants in complex sets of transactions, perhaps conspiracies – something simply beyond the capacity of an individual investigator or even a team of investigators.”

Collectively, these new tools are giving the SEC the opportunity vastly improve its investor protection role, more effectively police the markets today and write the regulations which will ensure more stable, fair markets for tomorrow. While these initiatives are not a substitute for the budget increases the agency requires, they are a good example of doing more with less in this age of budget cuts.

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by T. GormanPosted on Posted in SECActions

One day after H.J. Heinz Company announced it was being acquired by Berkshire Hathaway and 3G Capital Partners, the SEC filed an insider trading action seeking a freeze order over about $1.8 million in trading profits. SEC v. Certain Unknown Traders in the Securities of H.J. Heinz Co., (S.D.N.Y. Filed Feb. 15, 2013). As in earlier cases of this type, the Commission moved quickly based almost exclusively on what it calls “suspicious trading” that is so out-sized and dramatic that it virtually demands regulatory scrutiny. The court granted the SEC’s request for a freeze order.

The complaint here differs little from a series of earlier “suspicious trading” cases. On February 14, 2013 Heinz announced that it would be acquired by Berkshire and 3G Capital for $72.50 per share. That price represented a premium of about 20% over the closing price for the previous day. Predictably, the volume of trading spiked dramatically following the announcement to about 64 million shares for an increase of about 1,700% when the announcement was made. The share price rose to approximate that of the deal.

The day before the deal announcement, unknown traders purchased 2,533 out of the money June $65 call options for Heinz. Since each option gave the purchaser the right to buy 100 shares, the options potentially represents a significant block of stock. The purchase was made through an account at what the complaint identifies as the Zurich, Switzerland office of “GS.” The press notes that this is Goldman Sachs.

The complaint alleges insider trading based on “information and belief’ built largely on trading that is “suspicious” because of:

The purchase: The timing and size of the option purchase made one day before the deal announcement;

The account history: In the weeks and months immediately proceeding the purchase, the account did not make any purchase of Heinz options or shares;

The stock price history: The options had an exercise price of $65 which means that to profit the price of Heinz securities had to exceed that amount despite the fact that over the last four months the securities had consistently traded at about $60 per shares;

The amount invested: About $90,000 was spent in one day to purchase out of the money, hight risk options;

The option market: On February 12 only 14 of the same options were purchased while on February 11 none were bought; and

The profits: In one day the value of the account increased by about 2,000% over the amount of the initial investment.

The complaint alleges violations of Exchange Act Section 10(b).

This is not the first “suspicious trading” case brought by the Commission, although since it was filed one day after the announcement it may be the quickest. In a series of cases the Commission has given notice to the market place that out-sized securities purchases made just prior to a deal announcement will draw scrutiny if not an enforcement action even if the identity of the traders may not be known. See, e.g., SEC v. Well Advantage Limited (S.D.N.Y. Filed July 27, 2012)(filed four days after announcement based on large stock purchase two days before deal announcement); SEC v. Yang, Case No. 12-cv-02473 (N.D. Ill. Filed April 4, 2012)(filed eight days after deal announcement against seven defendants who purchased largely options); SEC v. All Know Holdings Ltd., Case No. 11 cv 8605 (N.D. Ill. Filed Dec. 5, 2011)(action filed days after deal announcement based largely on trades placed by four defendants); SEC v. Compania International Financier S.A., Civil Action No. 11 CV 4904 (S.D.N.Y. Filed July 15, 2011)(filed four days after announcement based on large purchases of equity securities).

In view of the Commission’s ability to monitor the markets for large, well timed purchases of options or securities made shortly prior to a deal announcement, it is clear that making such purchases is so high risk it may be viewed as reckless — or as boarding on a wish to get caught. At the same time the potential profits are enormous, meaning that the greed factor his is huge.

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