A thing that the SEC sometimes does now is
- notice when an anonymous foreigner buys a ton of otherwise thinly traded short-dated out-of-the-money call options just before a company announces big merger news that pushes the stock way up and makes those options suddenly hugely valuable, and
- go to court to take away the anonymous foreigner's possibly ill gotten gains.
What do you think of that? Like, on the one hand, my aesthetic sensibilities are offended, and my sense of fair play: really they ought to have some evidence of insider, as opposed to just lucky, trading. On the other hand it does seem like good police work, and if the anonymous foreigners want their money back they can always show up and dispute the SEC's charges.1
Certainly the latest case, where the SEC froze two trading accounts of shadowy offshore figures who went and bought a lot of call options on Onyx Pharmaceuticals two weeks ago, just before Onyx announced last Sunday that it had received and rejected an acquisition proposal from Amgen, is pretty suspicious. From the SEC's complaint:
Defendants in this action are either foreign traders or traders trading through foreign accounts whose timely purchases of Onyx calls generated profits of over $4.8 million. On information and belief, the Defendants are either located or trading through accounts located in the Canary Islands and Beirut. ...
On June 26, 2013, on the day that Onyx’s board was considering the Amgen offer, one or more of the Defendants purchased 80 Onyx call options with a strike price of $80 (the “July 80 call options”) and 175 call options with a strike price of $85 (the “July 85 call options”), which were out of the money at the time based on Onyx’s closing price of $84.17 that day. These purchases deviated from the historical trading for these series of calls. The July 80 calls began trading on June 20, 2013, and the average daily volume was 16 contracts per day. The 80 July 80 calls purchased on June 26 represented an approximately 400 % increase over the average daily volume. The July 85 calls began trading on began trading on June 11, 2013, and the average daily volume was 6 contracts per day. The 175 July 85 calls purchased on June 26 represented an approximately 2,817% increase over the average daily volume.
So I at least would be intrigued to hear the non-fishy explanation. On the other hand: I'd be intrigued to hear the fishy explanation too! ("Onyx director got off the board call, called his buddy in Beirut ...") The SEC doesn't have that but right now the tie goes to them.
Recently we've discussed evidence that the SEC's well publicized focus on insider trading may or may not have actually reduced insider trading. That's a hard question to answer because you don't have to, like, publicly file a form every time you insider trade,2 so a rough proxy for it is to look at questions like:
- did the target's stock go up just before a merger was announced, and
- was volume in the stock heavier than usual?
If more people are trading more shares at higher prices, it stands to reason that some of them know that something's up. Maybe not! But probably.
That's the academic/pseudo-academic view and it now seems to be the SEC's view as well, part of a general embrace of efficient-markets thinking by the SEC that we've talked about before. There's a certain aesthetic loss in that view: if you outperform the market, whether in one big lucky trade or in a pattern over time, the SEC will think it's suspicious, and will investigate you.3 That's a sort of humorless view of the trading world, which saddens me, but on the other hand it's probably true.
Also I guess it's good for the stats? One model you could imagine is something like:
- Insider trading is illegally trading on insider information.
- Insider trading is measured by existence of abnormal trading before merger announcements.
- Investigations into insider trading are likely to deter insider trading.
- Investigations into abnormal trading before merger announcements are likely to deter abnormal trading before merger announcements.
- If you can have only one, which would you rather?
But by that standard, there's a ways to go. The SEC's complaint lists a bunch of other fishy trades in Onyx by the two frozen acccounts, some fishier than others. For instance, "The 50 July 90 calls purchased on June 28, 2013 represented an approximately 138% increase over the average daily volume." Here, meanwhile, is trading in Onyx's common stock. On Friday, June 28, the last trading day before the merger proposal was announced, the stock traded 1.9mm shares and closed at $86.82, up 1.9%, versus the S&P being down 0.4%. Those 1.9mm shares represented an 84% increase over the average daily volume in June, and a 114% increase over the average volume over the previous 10 trading days. An extra million-ish shares of Onyx traded the day before the merger was announced;4 the people buying those shares - which opened at $132.63 the next trading day - made an instant $40 million and change, ten times what the SEC's shady options-trading targets made. Some people might find that pretty fishy.
1.Also it's a fun test of your probability theories and your belief in the law. Civil insider trading tends to be a preponderance-of-the-evidence type thing, meaning in theory that if it's more likely than not that it was insider trading, the SEC should win. So good questions include:
- (1) Is the bare fact that someone bought a lot of thinly traded call options a few days before a big positive announcement, with no other information, enough to make it more likely than not that he was insider trading?
- (2) Does your answer change if you have two facts, viz. (a) the options and (b) the fact that he shows up in court and says "hi, those were my trades, I promise I was not insider trading, give me my money back"?
- (3) What about (a) the options and (b) not showing up in court?
I go with probably insider trading on (1) and (3), probably not on (2), but I could see other interpretations.
2.Well Form 4 but you know what I mean.
3.This suggests that smart criminals should be fraudulently underperforming the market, Producers-style.
4.These guys bought a total of 1,119 contracts (111,900 shares) over that week, 320 of them on Friday, so dealers hedging their delta was only a very small part of that.