Friday, January 28, 2011
OK, I'll let the allegations in the a couple of early paragraphs of this recent SEC complaint speak for themselves:
Beginning in at least August 2010, defendant Zizhong Fan, a manager at Seattle Genetics, learned confidential information about positive clinical trial results for a cancer drug under development by the company. Zizhong Fan tipped this information to a relative in southern Califoniia, defendant Zishen Fan, who purchased several hundred thousand dollars of Seattle Genetics stock and options in the U.S. brokerage account of another family member living in China, relief defendant Junhua Fan. When Seattle Genetics reported to the public in late September 2010 that its flagship drug had proven effective in fighting Hodgkin's lymphoma, the company's stock price jumped nearly 18%. By trading on inside information learned by Zizhong, the Fans netted over $803,000 in illicit profits.
Upon being contacted by the staff of the Securities and Exchange Commission ("Commission"), Zizhong Fan denied being related to or even knowing Zishen Fan, despite the fact that they have shared multiple addresses over the years. Zishen Fan similarly denied to the Commission staff that he knew anyone who worked at Seattle Genetics. Almost immediately after being contacted by the Commission staff, Zishen Fan contacted his broker and attempted to transfer several hundred thousand dollars from Junhua Fan's brokerage account to a bank account in China. While two of these attempts were unsuccessful, as of the date of this Complaint, one such request is still pending with the brokerage. ...
Between August 24 and September 24,2010, Zishen Fan purchased over 2,750 Seattle Genetics option contracts - options which provided the right to purchase Seattle Genetics common stock at a designated price - at a total cost in excess of $360,000. On many of the days during which the trades were made, Zishen's purchases represented the vast majority of the option trading volume for the entire market. He purchased these securities in a brokerage account held in the name of Junhua Fan, a relative in Beijing.
The call options purchased by Zishen Fan had an exercise price of$12.50 and an expiration date ofOctober 16,2010. At the time, Seattle Genetics' stock was trading at around $12 per share. This meant that the options were "out-of-the-money" and would have value only if some event caused the company's stock price to jump to $12.50 by October 16; if the stock did not rise by that date, the options would expire worthless,and Zishen and Junhua Fan stood to lose the entire $360,000 investment.
This looks like a run-of-the-mill insider trading case, but there are a couple of important lessons to take from this. First, trading ahead of major corporate events is always a bad idea. Regulators -- actually their computers -- regularly comb through trades and try to correlate them with unusual trading patterns. If you have piling into a stock a week or two before a major announcement, they'll see that. I guarantee it.
Second, if you're buying call options ahead of a major corporate event, you might as well turn yourself in right away. In this case, the SEC alleges that Fan was on many days the largest single purchaser of options in the market. The option market is really thin and definitely not a place for an insider.
Third, when the feds come knocking, don't lie to them. Certainly, you have the right not to incriminate yourself, but you don't have the right to lie. If you do, you just help them make a Martha Stewart-like case against you. If they can't get you insider trading, they'll get you for obstruction of justice. The knocked on Zizhong Fan's door because they knew he was related to Zishen Fan. Why lie about that? Anyway, better to say nothing than to lie.
Fourth, ...so many lessons...placing trades through a relative's account in another country doesn't make the trades any less visible. For some reason people that if they place a trade through a brokerage in China or Serbia or wherever that suddenly no one will notice. Guess what? They'll notice. Placing a trade through a brokerage overseas is like playing hide-and-seek by hiding behind a folding chair.
Fifth, immediately trying to move money out of accounts that you tell the SEC you don't know anything about does help your case. By the time they are standing on your doorstep, believe me, they already know where most of the money is. It isn't that hard to track. Also, don't think your broker is going to protect you. They'll be happy to put a freeze on your ill-gotten gains.
Sixth, though it's not here in the allegations above, prior to the complaint being filed, one of the defendants told his supervisor that he would have to be out of the office for four weeks to go back to China. Let me just offer up that it's a pretty good bet that skipping the jurisdiction is not a good idea. Here's the SEC litigation release and there are some write ups in the Seattle Post-Intelligencer (a great paper, by the way).