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Possibly Fake Merger Filing Includes Possibly Real Profits

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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Last year, the Securities and Exchange Commission brought a securities fraud case against a Bulgarian man named Nedko Nedev. The SEC accused Nedev of a pattern of behavior in which he would buy shares of a company's stock, then put out a fake press release or securities filing announcing a takeover of the company. The stock would rally, and Nedev would sell the stock and book a healthy profit of ... well, here is where it gets weird. The SEC said that Nedev did this three times, but by my math he seems to have lost money each time. He bought too early, or sold too late, or both; his alleged manipulations never actually made him a profit.

Of course it is possible that the SEC was wrong, or didn't have the full picture, or just wanted to embarrass Nedev by accusing him, not just of illegally manipulating stocks, but of losing money doing it.

What I most appreciate about yesterday's ... controversial ... acquisition offer for semiconductor company Integrated Device Technology Inc. is that its author took an almost-immediate victory lap on the SEC's own Edgar filing system. At 12:08 p.m., a Schedule 13D was filed on that system, announcing that a group of investors owned 4.4 percent of the shares of IDT. Of those, 185,000 shares were purportedly owned by a member of the group named Nauman Aly in the form of call options with a strike price of $20 per share. Those options had been purchased that morning, for $19,966, and expire on Friday. The rest were purportedly owned by six individual investors in Shenzhen, China.

The 13D also announced a proposal, by Nauman Aly and his partners, to buy the remaining shares of IDT for $32 a share in cash, and came with a letter to IDT's board (dated yesterday) and a proposed draft merger agreement.

The stock spiked on the merger news. Then, at 12:44 p.m., an amended Schedule 13D/A was filed, announcing that in the intervening 36 minutes Aly had sold those 185,000 shares worth of call options, for a total of $447,740 (about $2.42 per share, a profit of $427,774). Here's a chart of yesterday's trading in those $20-strike April call options:

A total of 198,600 shares worth of those options traded before the first filing at 12:08 yesterday -- most of them at around 11:50 a.m. -- at an average price of about 10 cents a share. Nauman Aly bought 185,000 of those. A total of 223,300 shares worth of options traded at $2 and above, for a total of 14 minutes (from 12:15 to 12:29); Aly sold 185,000 of those.  (Usually fewer than 3,000 shares' worth of those options trade in a day.) Aly bought almost all the options available at the lows of the day, and sold almost all the options available at the highs of the day. Whatever you think of the group's merger proposal, you cannot fault Aly's efficiency. Here I am casting a meaningful look at Nedko Nedev.

What is real? Who knows. Poor IDT couldn't come out and say "this offer is fake," because IDT doesn't know that any more than you or I do. It declined to comment for a while, and ultimately put out a press release last night saying that ... well, saying that the offer is fake, but not in quite so many words:

President & CEO Greg Waters stated, “These SEC filings represent the first and only information IDT has received from this group, and we have not had any communication whatsoever with any of these parties. At this time we are unaware of any other information that would support a determination that the group’s proposal represents a credible bona fide offer to purchase the company. IDT will evaluate any further information that may be received from the group to determine whether a genuine and credible offer exists.”

There are, let us say, certain reasons to believe that the offer might not be entirely genuine and credible.  "We’ve seen a lot of different offers being put out there, but nothing as odd and suspicious as this," says an analyst. The bidders have said nothing publicly since their filings. The stock, which opened at $19.39 yesterday, spiked as high as $23.99 after the first 13D filing but fell back after the second, closing at $20.22; it closed at $20.74 today.

If the acquisition offer isn't real, what about the rest of the contents of yesterday's filings? It would be a bit odd to accumulate a 4.4 percent stake in a public company, at a cost of more than $166 million,  only to make a fake merger proposal. Especially if you wait two months to do it: Other than Aly's $19,966 worth of options, those shares were purportedly acquired more than 60 days before the filing, at prices above yesterday's highs, and they don't seem to have been sold yesterday, either. If the acquisition proposal in the 13D isn't real, it's at least possible that the filer or filers of the 13D don't actually own all those shares either.

But then there are those call options. Those just have the feel of truth. For one thing, the prices and volumes that Aly supposedly bought and sold at match the trading records, and the volume in those options yesterday was much bigger than it usually is. Someone was doing some very distinctive trading in those options, and someone was filing 13Ds describing that trading accurately just 15 or 20 minutes later.  It's hard to be entirely sure, but it stands to reason that those two someones were the same someone. Meaning that, however much you suspect the rest of the 13D, the disclosures about Aly's options trading do seem to have been scrupulously honest and incredibly prompt.

Does that make the rest of the filing more or less likely? Well, if Aly really was trying to buy IDT, his options trading would be very strange indeed. As of noon yesterday, Aly had the right to buy 185,000 shares of IDT for $20 per share. Then he and his friends put in a bid to buy all of IDT for $32 per share. Which is more than $20. In particular, buying 185,000 shares at $32 would cost $5.9 million. Aly could get those same shares for just $3.7 million by just exercising his options, saving himself $2.2 million. Instead he sold the options for $447,740, throwing away the $2.2 million (if the acquisition proposal was real), for a net loss of about $1.8 million. Perhaps he panicked.

Or perhaps the merger proposal was never meant to be all that seriously, and whatever was going on with the existence and/or share ownership of Aly's Chinese partners, he himself just bought some options, announced the acquisition proposal, sold the options, made 20 times his money in a few hours, and vanished without sticking around to negotiate a merger. It has happened before, it will happen again, it is totally illegal, but, aside from that drawback, it is an entirely rational and potentially very profitable trade.

Except: Why make the second filing? If that explanation is right, after Aly had sold his options, his work was done. All he had to do was collect the proceeds, move them to a secure offshore jurisdiction, and gloat over his success. But instead of gloating quietly to his family and friends in the privacy of a non-extradition jurisdiction, Aly seems to have gloated in the form of a filing with the SEC announcing exactly how much ($427,774, net) he'd made on the trade. 

Nothing in the structure of the trade requires this. If you want to pump up a stock with a fake merger so you can sell some options at a profit, it is very important that you announce the fake merger, but you don't need to announce when you've sold the options. There's no meta-rule of stock-manipulation fair play that demands that you tell everyone when you're done with your manipulation. You can just launch the manipulation and wander off, and most manipulators do; it's rare for them to announce when they're finished. Perhaps Aly is just unusually scrupulous, or unusually tidy-minded. Or perhaps he got short some stock at the top of the rally, and wanted to puncture the fake merger so he could profit on the way down as well. 

But I sure hope he's gloating! The SEC, in its case against Nedko Nedev, threw down a sort of stock-manipulation gauntlet. If you manipulate public U.S. stocks by announcing fake mergers, the SEC implied, not only will we catch you, but you will also probably lose money. The SEC might eventually find Nauman Aly, or whoever was behind yesterday's IDT filing. And it might accuse him (or her, or them) of manipulating the stock. But it won't be able to accuse him (or her, or them) of losing money. Nauman Aly made 20 times his money on this trade. It says it right there in the filings.

  1. In this post I refer to the filer of the 13D as "Nauman Aly," because that's what the filing says. Of course I have no idea if that is actually the name of the person (or of any one of the people) who made the filing.

  2. That's from Bloomberg's VAP function. The amended 13D/A shows the sales in price ranges of $2 to $2.90 (for 148,200 shares at an average price of $2.15 per share) and $3.50 to $3.70 (for 36,800 shares at an average price of $3.52 per share). Note that one call option equals 100 shares.

  3. Some considerations:

    • The proposal letter and draft merger agreement are a little generic, but not obviously full of typos; the merger agreement even gets little things, like the par value of IDT's stock, right.
    • The 13D has a detailed list of the stock holdings of the various group members, and gives some names and addresses (mostly Chinese citizens in China, though Aly is described as a Pakistani citizen in Portland, Oregon). But it says almost nothing else about who they are, other than "investors."
    • None of the materials name the group's advisers or financing sources, which is a little weird -- you'd expect, you know, bankers and lawyers to be involved -- but not absolutely disqualifying.
    • Aly's address in the filing is listed as an unprepossessing building in Portland.
    • "A call outside business hours to the address of the Chinese group wasn’t answered."

    By the way, the second filing, the 13D/A, doesn't mention the acquisition agreement, but that doesn't mean anything. The original 13D did, and the 13D/A doesn't specifically amend that section, which means that everything the original 13D said about the merger remains true. Or not true, as the case may be.

  4. From the 13D:

    LSUN purchased 2,410,886 shares of Common Stock for aggregate consideration of $58,726,747.

    LSUN purchased American-style call options referencing 3,600,000 shares of Common Stock for aggregate consideration of $93,168,241.

    LXU purchased 260,433 shares of Common Stock for aggregate consideration of $6,401,443.

    HZHOU purchased 130,775 shares of Common Stock for aggregate consideration of $3,176,524

    ZLIN purchased 75,915 shares of Common Stock for aggregate consideration of $1,856,881.

    JCHEN purchased 72,000 shares of Common Stock for aggregate consideration of $1,746,090.

    LYANG purchased 70,877 shares of Common Stock for aggregate consideration of $1,742,156.

    NALY purchased American-style call options referencing 185,000 shares of Common Stock for aggregate consideration of $19,966.

    That first slug of LSUN purchases was at an average price of about $24.36, and the others were in the same ballpark. IDTI was mostly trading above $24 from October through January, though it plunged below $20 in early February.

  5. This is not dispositive, but IDT's ownership is pretty well accounted for. Based on filings mostly as of late February and late December, Bloomberg's "HDS" function for IDT finds disclosed owners of 107.33 percent of IDT's outstanding shares. (That number counts the shares purportedly owned by yesterday's filing group, though not their options.) Some 4.59 percent of the shares outstanding are sold short, which partly explains why the number is over 100 percent, and of course people could have sold since their last filings (but more than 60 days ago), etc. Still it's a bit tight for someone to have accumulated 4.4 percent of the stock more than two months ago.

  6. That is: The options buying happened mostly at around 11:50 a.m.; the first 13D was at 12:08. The selling was finished by around 12:29 p.m.; the 13D/A was filed at 12:44.

  7. By the way, one thing that I like to say, when I am busy not giving out legal or investing advice, is that if you have nonpublic news about an imminent merger announcement, you shouldn't use it to buy short-dated out-of-the-money call options on the target. The SEC checks for stuff like that.

    But if you believe these 13Ds, Nauman Aly did some perfect trading on nonpublic merger news. He bought a bunch of just out-of-the money options, announced his own merger plans, sold those options, and reported all of this to the SEC.

    One thing to say about this particular series of events -- and I say this while wearing my novelty oversized Not Legal Or Investing Advice Hat -- is that it is pretty much legal. If you have illicitly obtained information about someone else's merger plans, trading in short-dated out-of-the-money call options on the target is a no-no. But if you yourself are planning to announce a bid for a company, you can buy that company's stock, or even its short-dated out-of-the-money call options, to your heart's content. There are some technical issues -- if, like Aly, you are part of a bidding group, can you really say that it is your bid? -- and they sometimes trip up even quite well-known investors. But the basic idea is that you can go ahead and trade on nonpublic information, if it's nonpublic information about your own plans. 

    On the other hand, if you don't believe that the acquisition proposal was meant seriously, but was just meant to move IDTI's stock briefly so that Aly could sell his options at a profit, then that is fairly straightforwardly manipulation, and not at all allowed.

  8. Or, at least, Nedev allegedly did it, but allegedly without making any money.

  9. Obviously this isn't legal, or illegal, or investing, or any sort of advice whatsoever. I am still wearing the novelty oversized Not Legal Or Investing Advice Hat.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net