Not mad, just disappointed.

Accused Herbalife Insider Trader Tried to Take Back His Trades

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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The Pershing Square/Herbalife insider-trading case raises some pretty interesting issues but first things first, it is adorable. Here's what happened, according to the Securities and Exchange Commission:

  • A Pershing Square analyst was working on Bill Ackman's big Herbalife-is-a-pyramid-scheme presentation.
  • The analyst told his roommate, Filip Szymik, about the upcoming presentation.
  • Szymik told his friend, Jordan Peixoto, an analyst at Deloitte.
  • Between 12:00 and 1:23 p.m. on Wednesday, Dec. 19, 2012, Peixoto bought "eight out-of-the-money Herbalife put options" expiring on Friday the 21st.
  • Thirty-five minutes later this happened:
At 1:58 pm EST on December 19, 2012, after Peixoto had purchased the Herbalife Options, CNBC reported that Pershing had acquired a significant short position in Herbalife stock and that Pershing would present its thesis -- that Herbalife was operating an illegal pyramid scheme -- at a conference the next day (the “CNBC Report”). At 2:04 p.m. on December 19, the New York Stock Exchange temporarily halted Herbalife stock trading due to its high volatility in the wake of the CNBC Report.
  • By Friday, Peixoto's options were worth $339,421 more than he'd paid for them.
  • It's nice to make $339,421 in two days.
  • But not that nice.
  • Insofar as you are just so obviously going to get caught for this, come on.
  • So Peixoto did the modern financial industry equivalent of putting all that money in a trash can and walking away whistling innocently:
  • Peixoto requested that his brokerage firms permit a number of his profitable Herbalife Options to expire without exercising them. However, one of Peixoto’s securities brokers refused his request, resulting in the exercise of certain of the Herbalife Options and his obtaining $47,100 in illicit trading profits.

Can you imagine those conversations?

Broker: Hey, you made $47,100 on a $1,200 investment, nice trade, where should we send the check?

Peixoto: No never mind I was kidding.

Broker: What?

Peixoto: I just ... I just don't want the money. For reasons.

Broker: So you want me to keep it?

Peixoto: Sure, whatever, I just don't want to talk about it any more, okay?

Broker: Yeah I don't think I'm going to do that.

I mean, that's how one of them went. All the other brokers were like, "Oh you don't want the money? Yeah we get that all the time, it's cool."

The poor kid! Buying short-dated out-of-the-money options just before major news is announced is a great way to make money, but also a great way to get caught insider trading. Peixoto managed to get caught for insider trading even after turning down the money.

Legally, DealBook finds this case interesting because this is not traditional inside information:

In another apparent first for the S.E.C., the agency built its case on the premise that a hedge fund’s private investment playbook amounted to inside information, setting a sharp tone not only for the broader Herbalife investigation, but also in how the S.E.C. pursues insider trading on Wall Street and beyond. That decision, legal experts said, puts a twist on the prototypical investigation into leaks of earnings information or other corporate announcements.

This does not seem like a huge stretch to me, honestly. Insider trading is about trading on material nonpublic information. The courts and the SEC realized a long while back that not all MNPI comes from inside the company. In particular, if Company X is planning to take over Company Y, and you find out about it and trade Company Y stock, that can be insider trading. Pershing Square's plans to tank Herbalife stock are sort of in the same category. The question is: Is this information likely to be material to investors? And the straightforward factual answer is yes. Herbalife's stock fell some 36 percent in the first three days of Ackman's campaign.

But obviously some people can trade based on Pershing Square's "private investment playbook." Pershing Square, for instance. Pershing Square knows what Pershing Square plans to do, but can still do it. That one's obvious, but there are a lot of harder questions. For instance: Can a Pershing Square/Valeant vehicle trade Allergan stock while knowing that Pershing Square and Valeant are going to offer to buy Allergan?

The basic rule is that you can't trade on material nonpublic information if the person who gave it to you:

  • had a duty to keep it confidential,
  • breached that duty, and
  • did so for some personal benefit.

But the application of that rule here does seem like a stretch. Like, you might quite reasonably say, OK, this Pershing Square analyst had a duty to Pershing Square to keep this stuff under his hat, and he didn't, so everyone's guilty of insider trading. But that's not what the SEC said. Instead, it said that Szymik had a duty to the analyst to keep it confidential, and he didn't, so he and Peixoto are guilty of insider trading. (And the analyst is fine. ) Here, I drew you a little chart:

Right? Neither the analyst nor Szymik traded Herbalife. Neither of them seems to have gotten any tangible benefit out of passing on this information; only Peixoto made any money. Each of them tipped off a close friend, in both the metaphorical and physical-proximity senses of "close." The only difference between them is that the analyst violated Pershing Square's written confidentiality policy, while Szymik just violated his duty to his roommate. And Szymik is the one who got in trouble.

To be clear: The SEC has chosen to enforce, not Pershing Square's written confidentiality policies that are designed to protect its proprietary trading strategies, but rather the unwritten duty of roommate confidentiality. There is precedent for this, I suppose, but it's a bit murky. There's the time, for instance, that the SEC took two conflicting views on the unwritten duty of golf-buddy confidentiality this summer, within the same golf club. Securities law is weird.

There is ... a lot going on in Herbalife. For instance: Is it an illegal pyramid scheme, as Pershing Square claims? Or, if you don't like that one: Is Pershing Square illegally manipulating its stock, as Herbalife claims? Or maybe, did George Soros illegally counter-manipulate its stock, as Pershing Square also claims? Those are all critical questions in a multibillion-dollar battle over the very existence of a large public company. And they're all in the SEC's jurisdiction. And the SEC brought this case! And why not? Wouldn't you prefer to avoid the hard questions if you could spend your time on delightful trivia like this?

  1. This clearly doesn't mean eight listed option contracts -- which would be just 800 shares, which were trading at around $42 when he bought the options, so the most he could possibly make on the options would be $32,000 or so -- but rather eight separate trades, each for multiple contracts, and apparently with several (eight?) different brokers.

  2. There were apparently several of them, raising the question of why a 20-something Deloitte analyst needed multiple brokerage accounts, but whatever.

  3. That number is made up, but for context, from Bloomberg I see the $40 strike put closing at $0.30 on Dec. 18, 2012 and $13.20 on Dec. 21, 2012. So Peixoto really could have made a 40-fold return.

  4. Weird question: Did the brokers actually let them expire worthless? Or did they say, "Oh fine yeah we'll take them off your hands for zero" and then exercise them themselves? In either case, should the SEC try to hold Peixoto responsible for the full $339,421 in paper profits that he made, even though he disclaimed most of them?

  5. That is, from a $42.50 close on Dec. 18, 2012 to $27.27 on the 21st. You can argue about how much of that was about the mere fact of Ackman's trading (MNPI) and how much of it was the power of the analysis (maybe not MNPI?), but it's certainly reasonable to think that Ackman's position and plans were material.

  6. The analyst left Pershing in September 2013; unclear if this had anything to do with it.

  7. Sourcing:

    • Paragraph 15 of the Szymik order says that "the Analyst and Szymik were very close friends who had grown up together in Poland" and roomed together in New York. Paragraphs 11-14 describe the analyst's duty of confidentiality to Pershing. Paragraph 18 says that he disclosed information in breach of that duty. The analyst was never charged by the SEC.
    • Paragraph 19 says "Szymik and Peixoto were close friends who lived within a block of each other in New York, New York and spent time socializing together nearly every weekend." Paragraph 21 says "Szymik breached his duty of trust or confidence to the Analyst" by tipping Peixoto.
    • Paragraph 22 says:
    Szymik knew or recklessly disregarded both that he was violating his duty of trust or confidence to the Analyst and that Peixoto intended to trade Herbalife securities based on that information. Szymik received a personal benefit by gifting confidential information to his friend, Peixoto.
  8. And then there is this thing, which I love.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net