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Perfect Insider Traders Got Caught

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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Two things that I say a lot around here are:

  1. If you have inside information about an upcoming merger, don't buy short-dated out-of-the-money call options on the target, and
  2. Boy a lot of people enjoy both playing golf and insider trading, don't they?

I feel like ... I hate to flatter myself here, but is it just possible that these guys have been reading Bloomberg View?

Additionally, R. Stewart and Trader1 attempted to conceal their illegal trading and evade detection by: (a) primarily meeting in-person to discuss the scheme; (b) using coded email messages to discuss the scheme; (c) spreading trades over numerous stock options series in an attempt to avoid regulatory scrutiny; (d) buying stock options during periods when these securities were more heavily traded in order to blend into the daily volume; (e) refraining from options trading too close to the expected announcement date of a merger or acquisition; and (f) in most instances, sharing the illicit profits through cash payments.

Good effort! I mean, sure they allegedly bought short-dated out-of-the-money call options on the target. But not that many of them. And they also bought longer-dated out-of-the-money call options. And at-the-money-ish options. But what really puts this civil and criminal insider trading case over the top is that those coded e-mail messages were in golf code: 

On May 27, 2012, at 9:35 p.m., which was the Sunday of Memorial Day weekend, R. Stewart sent Trader1 a coded email stating, in part: "might have an opportunity to play golf- but would need to book the reservation as soon as the office opens Tuesday morning."

Trader1 began purchasing Lincare options on the morning of Tuesday, May 29, 2012.

I guess they had already agreed that "play golf"  meant "buy Lincare options"? I don't know. Anyway "the Linde Group, a German industrial gas company," announced that it was acquiring Lincare, the stock shot up, Trader1 and Stewart made money, and:

Approximately sixteen minutes after Trader1 sold the last of the Lincare call options, he sent an email to R. Stewart saying, "I ment [sic] to tell you and your wife to have a celebration drink on me! I have some good news for you when you get back." A few minutes later, R. Stewart replied using the same golf-related code he had used in his email of May 27, 2012. R. Stewart stated: "Thanks [Trader1]- saw local story about high cost of golf reservations since a foreign company purchased all- even more expensive than imagined."

This is kind of a dumb code, to be honest, but points for getting golf into another insider trading case!

The story that the SEC and prosecutors tell is that Sean Stewart was an investment banker who had access to deal information, which he would give to his father Robert Stewart, who would then pass it on to his friend -- referred to as "Trader1" in the civil complaint and "CW-1" in the criminal one -- who would then trade in his own account in order to avoid getting caught. Which is a pretty clever plan except that, before they hatched it, the Stewarts allegedly used a different plan, in which Sean Stewart would give his father the inside information and then Robert would trade on it in his own account. In order to ... get caught I guess? Anyway it seems to be how they got caught; this is never a good look:

On or about May 20, 2011, Investment Bank #1 received an inquiry from a regulator in connection with the Kendle transaction. On July 19, 2011, the regulator sent Investment Bank #1 a list of individuals and entities it identified as trading Kendle stock in the period leading up to the announcement of the Kendle transaction. The regulator asked Investment Bank #1 to circulate the list among the individuals who worked on the transaction and ask them to identify anyone with whom they had a relationship. This list included the name "Robert Stewart" and identified the town and state in which he lived.

Investment Bank #1 asked S. Stewart to identify anyone on the list with whom he had a relationship. S. Stewart did not identify his father, "Robert Stewart." On August 23, 2011, Investment Bank #1 submitted its response to the regulator, indicating that no one at Investment Bank #1 knew "Robert Stewart."

Oh that Robert Stewart, my mistake:

On August 31, 2011, Investment Bank #1 submitted a supplemental response to the regulator in which it stated that during a second review, S. Stewart had identified his father, R. Stewart. Investment Bank #1's supplemental response stated that:

(a) S. Stewart "overlooked" his father's name during the initial review and that S. Stewart now indicated that he recognized his father's name;

Honest mistake, could happen to anyone, frequently does. If there's one thing that insider traders like almost as much as playing golf, it's failing to recognize their own fathers' names in Finra inquiries.

At this point the story gets a little vague -- the SEC and FBI don't like to give away their investigative methods -- but at some point the investigators found Trader1/CW-1 and got him to cooperate against the Stewarts. Here's the FBI agent:

As part of his efforts to cooperate with the Government and potentially secure a more lenient sentence, CW-1 arranged and recorded in-person meetings with ROBERT STEWART, a/k/a "Bob," the defendant, on or about March 24, 2015 and on or about April 16, 2015, and recorded a telephone call with ROBERT STEWART on or about May 4, 2015. I observed the meetings, the first of which occurred at a restaurant in midtown Manhattan, and the second of which occurred at a diner in Queens.

The Manhattan meeting featured Trader1/CW-1 handing Robert Stewart $2,500 in cash. But my favorite part of this case -- and there's a lot to choose from -- is the Queens meeting:

ROBERT STEWART also asked CW-1 whether "we have statute of limitations" with respect to the trading about which the SEC had inquired. When CW-1 responded that he did not know, ROBERT STEWART noted that "it's passed" because it had been "four years since the trade."

Also at the April 16, 2015 meeting, CW-1 asked ROBERT STEWART whether SEAN STEWART had supplied the information for ROBERT STEWART's and CW-1's trades "out of the goodness and kindness of his heart for you." ROBERT STEWART responded, "No, you know what? I think he gets angry at times. Angry at the industry."

Okay, but that's not exactly what CW-1 was asking. Do you get what he was asking? I'll give you a hint: CW-1 has read the Second Circuit's Newman opinion. Or, I mean, he's read Bloomberg View. He knows insider trading law better than the average person caught insider trading and now wearing a wire at the FBI's behest. Robert Stewart missed his point, so CW-1 asked it again:

A few minutes later, when CW-1 once again asked, "out of curiosity," to "understand[] the relationship," whether SEAN STEWART had offered tips on deals "out of the goodness and kindness of his heart," or if ROBERT STEWART had instead "throw[n] [SEAN STEWART] money," ROBERT STEWART denied the provision of cash to SEAN STEWART. He also claimed that he never told SEAN STEWART "I've done anything." Then, referencing CW-1's claim that his questions along these lines were "out of curiosity," ROBERT STEWART asked CW-1, in substance, why he was asking these questions. CW-1 indicated it was just general curiosity. A few minutes later, the meeting ended.

General curiosity! Nope! CW-1 knew that the Second Circuit had found, in the Newman case, that it's only a crime to trade on inside information if the original source of the tips received a "personal benefit" for providing the tip. If a CEO just gives his golf buddy some inside information "out of the goodness and kindness of his heart," then, under a literal reading of Newman, the buddy can trade to his heart's content. In fact, even if the CEO does get a personal benefit from the buddy, if the buddy passes it on to a third party, and the third party doesn't know about the personal benefit, then the third party can trade. So CW-1 was asking the question:

  1. Hoping to hear that Sean Stewart got no personal benefit for tipping Robert Stewart, and
  2. Hoping in any case to create a record that, before asking the question, he hadn't known about any such benefit.

Great, great work CW-1! And great work doing it on a wire!  CW-1/Trader1, whoever you are, you are my new favorite insider trader! And maybe reader! 

One other thing that I like to say around here is: This is not legal advice! I am not optimistic about CW-1's defense. Trading on uncompensated insider tips from your golf buddy may not be illegal, but trading on uncompensated tips from your son probably is. There is some odd language in the Newman opinion suggesting that "a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature" could substitute for a monetary quid pro quo in making insider trading illegal, and anyway the SEC and FBI complaints point out that Robert Stewart did provide personal benefits to his son, "including helping S. Stewart pay for his June 2011 wedding." Awkwardly the wedding was about a month after Robert Stewart allegedly made money trading on one of Sean Stewart's tips. Maybe take some time off from insider trading just before your wedding.

Still, Trader1 really is the greatest of all insider traders. He spread out his trades to avoid attention, he communicated in code, the code was golf code, and when he got caught he cooperated to minimize his sentence while also trying to undermine the prosecutors' legal theory on an FBI recording. He's learned all of the lessons I have to teach about insider trading, except the big one: Don't insider trade! You'll always get caught, and it's never worth it.

  1. Sometimes from deals he was working on, but other times not. I found this sort of poignant:

    Although S. Stewart did not personally begin to work on the Kinetic transaction until June 10, 2011, he learned material non-public information about this proposed transaction by at least late March 2011. At or around this time, S. Stewart helped coordinate assignments for some junior employees at Investment Bank #1. This position allowed S. Stewart to learn about potential acquisitions in which he was not directly involved. For example, on March 30, 2011, an Investment Bank #1 colleague who was working on the Kinetic transaction sent an email to S. Stewart stating: "[Investment Bank #1 analyst] will work on the Kinetic project."

    On April 3, 2011, S. Stewart emailed a different colleague, who was working on the Kinetic transaction and asked, "Kci alright?" The colleague replied, in part: "KCI is going ok. Working away."

    On April 23, 2011, S. Stewart emailed that same colleague saying: "Also fyi: I mentioned to [an individual] that [a managing director and a vice president working on the Kinetic transaction] were very pleased thus far for all of your work on KCI (I had spoken w/ both of them last week) and that you were doing a really good job."

    Prior to April 25, 2011, S. Stewart tipped his father, R. Stewart, that Kinetic was likely to be acquired.

    He was being such a good staffer, even while he was also insider trading! I wonder if that analyst now feels like that praise was cheapened by the insider trading charges.

  2. Stewart figured it out, too late:

    On or about May 4, 2011, CW-1 placed a telephone call to ROBERT STEWART. During that call, ROBERT STEWART explained to CW-1 that he had become concerned about the questions CW-1 had been asking him at the April 16, 2015 meeting: "After we met ... you'll probably laugh about this, but ... couple of the questions you asked me, uh, when we were at lunch ... I tried to give you a call back and I couldn't get you, I'm like, 'oh my god,' I wonder if, uh, there was something going on there, now I can't get [CW-1] because they got [CW-1] somewhere, where I can't talk to him and . . for about two weeks, I didn't sleep at night ... I'm like, 'oh my god,' uh, you know, something's going on, something bad's going on, and all this stuff ...."

  3. The alternative, lamer reading here is that CW-1 was doing this at the FBI's demand, to establish that Sean did get a quid pro quo from Robert. I hope that's wrong -- there doesn't seem to have been a quid pro quo, and if that's what the FBI was fishing for why put it in the complaint? -- but I don't really know. I just want CW-1 to be freelancing, while wearing an FBI wire in a Queens diner.

  4. Also there is some dispute about whether "misappropriation" insider trading cases, like this one, are fully covered by the Newman standard.

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:
Matt Levine at mlevine51@bloomberg.net

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