by T. GormanPosted on Posted in SECActions

The SEC is the agency charged with monitoring cyber-security, internal controls and similar corporate matters. The agency has issued guidance on cyber-security. It is thus more than ironic that the Commission became a victim of hackers who breached EDGAR, the corporate filing system for the agency. At the same time the breach illustrates what the Commission has always said about compliance systems – the best can be breached. Whether the SEC’s was the best, however, is not the question. It was breached, and the information obtained was used to generate over $4 million in insider trading profits. That breach resulted in an action by the Commission and the U.S. Attorney’s Office. SEC v. Ieremenko, Civil Action No. 2:19-cv-00505 (D.N.Y. Filed Jan. 15, 2019); U.S. v Ieremenko (D. N.J. Filed Jan 15, 2019).

The Commission’s action names nine as defendants: Oleksandr Ieremenko of Kiev, Ukrane; Spirit Trade, Ltd., Hong Kong; Sungjin Cho, Los Angeles; David Kwon, Los Angeles; Igor Sabodakha, Kiev, Ukraine; Victoria Vorochek, Luhans’ka Oblast, Ukraine; Ivan Olefir, Luhans’ka Oblast, Ukraine; Capylield Systems, Ltd., Belize City, Belize; and Andrey Sarafanov, Moskva, Russian Federation. The 16 count criminal indictment names as defendants Artem Radchenko and Oleksandr Ieremenko, both of Kiev, Ukraine.

Defendant Ieremenko is an international hacker charged with having breached three newswire services to secure inside information for trading along with a number of others. See SEC v. Dubovoy, Civil Action No 2:150cv006076 (D. N.J.); U.S. v. Turchynov, No. 2:15-cv-00390 (D.N.J.); U.S. v. Korchevsky, No. 1:150-cr-00381 (E.D.N.Y.). The EDGAR hack is just the next phase of those actions, according to the SEC’s complaint.

The scheme was launched by Mr. Ieremenko and others in the spring of 2016. Common hacking techniques were used to search for access to material nonpublic information in EDGAR. The focus was to access test filings – those made by issuers which are not intended to become public. Rather, they are often made prior to the actual filing to ensure that format and other matters are correct. The test filings, accordingly, often contain information which is material and non-public.

To breach EDGAR the hackers sent a series of malicious emails to sec.gov email addresses. The “emails were spoofed to appear as if they were being sent by SEC security personnel . . .[they] contained malware-infected documents . . .” The efforts successfully infected several SEC computer workstations.

To infect the workstations Mr. Ieremenko used a Romanian IP address he had employed during the newswire hacks. He also used the same web browser – a point evidenced by the fact that both intrusions involved an identical user agent string. Stated differently, the hacker left his signature.

Hacker Ieremenko first successfully accessed a test file on EDGAR on May 3, 3016. . He began manually exfiltrating electronic copies of test filings. Obtaining this information was the initial focus of the scheme.

The next day Mr. Ieremenko began using “deceptive hacking techniques” at 1:09 PM ET to access and exfiltrate a test filing for Issuer 1 from EDGAR. The test filing contained negative, material nonpublic information about the NYSE listed firm’s financial results. That information was apparently passed to one or more individuals at Spirit Trade. Between 2:57 PM and 3:59 PM ET that firm, controlled by Individual 1 who is a veteran of the newswire scheme, sold short 5,500 shares of Issuer I stock. Shortly after the trades were placed the market closed. Issuer 1 released the financial information and the stock price declined. The next morning Spirit Trade closed its position, yielding profits of $9,185 in gross profits. The pattern was repeated several times during May 2016, generating $496,740 in gross illegal trading profits tied to the filings of seventeen issuers.

Beginning in mid-May 2016 Mr. Ieremenko, or others, expanded the scheme. Specifically, an “Exfiltration Machine” was deployed – a server with a program. That server was able to automatically exfiltrate test files, a process initially done manually. This permitted Mr. Ieremenko “to obtain hacked test filings on a greater scale . . . more traders began to monetize the information” – that is, trade on inside information. From at least May 2016 through at least October 20, 2016 Mr. Ieremenko worked with traders located in the United States, Ukraine, and Russia to monetize the information. Virtually all of the traders had participated in the newswire phase of the scheme. During this period one group traded about 369 times using test filings exfiltrated from EDGAR.

In October 2016 SEC IT personnel patched the EDGAR software “in response to a detected attack on the system. . .” Ieremenko could no longer access the system. Nevertheless, efforts to further compromise EDGAR continued until early the next year. Later Mr. Ieremenko boasted that he had successfully hacked specific newswire companies and “sec.gov.” The SEC’s complaint alleges violations of Securities Act section 17(a) and Exchange Act section 10(b). The indictment contains counts alleging conspiracy, wire fraud, securities fraud and computer fraud. Both cases are pending.

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by T. GormanPosted on Posted in SECActions

The courts have issued numerous opinions debating the elements an insider trading claim as well as the definitions of each While the elements sometimes vary, and the definitions can be debated, in the end the key question is always the evidence – what happened? In U.S. v Klein, Docket No. 17-3355 (2nd Cir. Jan. 10, 2019) the Court had little trouble concluding that the statement “it would be nice to be king-for-a-day” to a long-time friend and financial adviser by an attorney whose firm represented King Pharmaceutical, Inc. in a merger made was an illegal tip of inside information.

Background

Defendant Robert Schulman was a D.C. based partner at Hutton and William in the patent group. Tibor Klein was the principal of Klein Financial Services, a registered investment adviser based in Long Island, New York. Mr. Klein had served as the financial adviser to Attorney Schulman since 2000. The adviser had discretionary authority.

Over the years the attorney and adviser developed a routine of meeting about three times per year on a Friday afternoon to review the performance of the portfolio and advisory. Mr. Klein traveled to Washington, met with the attorney and his wife at their home in Virginia, and then stayed over-night following dinner.

The couple was generally pleased with Mr. Klein’s services although they had some concern that he had become to “bearish” in the wake of the great financial crisis. There had also been some concern in 2010 when the adviser purchased shares of Enzo Pharmaceuticals for the Schulman IRA account. Hutton represented Enzo at the time of the purchase.

In July 2010 the Shulmans met with the adviser. At the time Mr. Schulman knew firm client King Pharmaceutical was in merger discussions with Pfizer – the attorney learned about the deal while conducting patent litigation for the client. During the course of the evening Mr. Schulman stated that “boy, it would be nice to be king-for-a-day.” The attorney claimed the statement was a joke and that he never mentioned the merger or any discussions, according to the testimony he provided to the SEC. Essentially the same statement was made to the U.S. Attorney’s Office in a 2015 interview. Mrs. Schulman – the only person to testify at trial who was present at the time of the statement – did not remember anything being said about King.

The following morning – a Sunday – adviser Klein called long time friend and Ameriprise Financial adviser Shechtman but failed to reach him until Monday. During the Monday conversation Mr. Klein asked his friend what he would do if he had inside information – noting that “Pfizer’s buying King Pharmaceuticals.”

Mr. Shechtman subsequently spent $15,000 to acquire King options. Some were scheduled to expire in mid-September; others would expire in mid-October. He also invested $45,000 in King stock for himself and his wife. Mr. Klein spent $585,217 to acquire King stock in a number of his accounts as well as those of the Schulmans and forty-eight clients which included friends of the Schulmans and his parents.

The Pfizer-King deal was announced on October 12, 2010. Subsequently, all of the shares were sold. Mr. & Mrs. Schulman had profits of about $15,500 – about 50% in two months.

The SEC investigated and charged Mr. Shechtman. The adviser admitted liability, agreed to cooperate, and pleaded guilty in a parallel criminal case. Mr. Klien was also charged. The Schulmans fired him. Following trial, the jury deliberated for about one day. They returned a verdict of guilty on two counts – one based on conspiracy and a second for securities fraud. Following the denial of a Rule 29 motion for acquittal, the Court sentenced Mr. Schulman to serve three years of probation, pay a $50,000 fine, forfeit the trading profits and perform 2,000 hours of community service.

The Opinion

The key question on appeal was the sufficiency of the evidence. Mr. Schulman argued that the only evidence against him – the “king-for-a-day”– was insufficient to support his conviction on two criminal counts. In rejecting this claim the Second Circuit began by noting that an Appellant such as Mr. Schulman has a “heavy burden.” The reviewing court must “credit every inference that could have been drawn in the government’s favor.” If, from the reasonably drawn inferences, the “jury might fairy have concluded guilt beyond a reasonable doubt” the conviction must be affirmed.

In assessing the evidence, it is essential that it be viewed in its totality, not piecemeal or bits in isolation. The lynchpin to the Court’s conclusion is two statements by attorney Schulman, the inferences drawn from them and the trading. Initially, Mr. Schulman admits making the statement about being “a king-for-a-day,” although his wife did not recall it. Indeed, she testified that if she had heard it, the comment would have sounded silly.

Second, Mr. Schulman admitted that the “king-for-a-day” comment referred to King Pharmaceuticals, although there is no reference to the company in the statement. From these facts the Court inferred that “Klein apparently recognized that by ‘king’ Schulman meant ‘King.’” Further, “[c]ommon sense also would lead a rational juror to conclude that Schulman had to have communicated additional information to Klein for Klein to have promptly called Shechtman, cited ‘inside information’ about King and Pfizer . . and begun buying King stock. Indeed, this precise issue was argued to the jury . . .and was resolved by the jury against Schulman.”

Other evidence supports similar inferences – the record is “replete” with such evidence, according to the Court:

· A “reasonable jury could infer that Schulman intended Klein to trade from the evidence” because the trading followed immediately after the discussions of the two men;

· The immediacy of the stock purchases and their size supports the inference that the adviser was acting in accord with the directive of his client; and

· The fact that the adviser had once traded in the shares of a Hutton client – Enzo – supports the inference that he might again; while Mr. Schulman had been upset about the Enzo purchase as the adviser knew, that was because he believed the President of the firm was a “lunatic” but the context here of the “king-for-a-day” statement suggests approval.

When read in its totality, the evidence supports the determination of the jury, the Court concluded.

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