So I bought some short-dated out-of-the-money call options, so sue me.

Photographer: Chris Goodney/Bloomberg

Hedge-Fund Son Thought Hedge-Fund Dad's Trades Were Pretty Fishy

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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It turns out that having Leon Cooperman for a grandpa is pretty much exactly like you'd expect:

On July 28, 2010, at approximately 6:59 a.m. EDT, APL publicly announced for the first time that it was selling Elk City for $682 million. As a result, on that day, APL' s stock price increased approximately 31% and other APL-related securities greatly increased in value.

After this announcement, Cooperman emailed a family member stating that: "[minor family member] will be pleased to know that the bond I bought [for minor family member] the other day has risen 7% in price as the company just sold some assets that resulted in an improvement of their credit standing."

Some little boys and girls like ice cream, and some like pony rides, but all little boys and girls love it when bonds that they own rise 7 percent due to asset sales that improve the issuer's credit standing. Making a quick event-driven profit in the bond market is like Christmas and a trip to Disneyland combined, for a child.

That passage is from the deeply amazing Securities and Exchange Commission complaint against Cooperman, the hedge fund manager who runs Omega Advisers, accusing him of insider trading on Atlas Pipeline Partners, L.P.  Omega was one of Atlas's biggest shareholders in 2010, but the company wasn't doing great, and Cooperman was getting bearish.  But then Atlas started negotiating to sell its Elk City facility, which would -- as any child could tell -- improve its situation. The SEC says that an Atlas executive (and board member) told Cooperman about the sale while it was still being negotiated, weeks before it was announced. And then, says the SEC, Cooperman turned around and bought a bunch of Atlas stock, bonds and options, which "generated profits of approximately $4.09 million" when the Elk City deal was announced.

No doubt all of this delighted Cooperman's minor family member.  But not everyone in the Cooperman clan was so pleased. Another, more major, family member also runs a hedge fund that sometimes traded Atlas stock. (This seems to have been Cooperman's son Wayne, who runs Cobalt Capital Management. ) He noticed some suspicious trading in Atlas options before the deal was announced, and was outraged at this apparent leak of non-public information. So outraged that, after the announcement, he e-mailed the company to demand a thorough investigation:

Indeed, on July 28, 2010, after APL announced the Elk City sale, Cooperman' s hedge fund manager family member emailed APL Executive 3 twice, complaining about APL options activity prior to the public announcement of the Elk City sale, stating:

"Can you please call me[?] Been trying to get you last few days[.] [T]here had been some fishy options trades in apl [sic] before this that somebody should investigate.

***

I also would like to make sure that the sec [sic] looks into the shady option trades and volume in apl [sic] last 2 weeks or so in front of this deal[.] How do I become a whistle blower[?]"

Guess whose suspicious options trading that was! Actually it's a little strange that Cooperman's son didn't guess, since Cooperman allegedly told him about the Elk City sale before it was announced.  It's a touching display of filial respect: He ran a hedge fund, his dad ran a hedge fund, his dad allegedly told him about the deal before it was announced, he noticed some suspicious options trades before the announcement, he was furious about those trades ... and it apparently never even occurred to him that his dad might have been the one doing them. The SEC doesn't say whether Cooperman's son actually ended up becoming a paid whistle-blower against him, but I'm going to assume not, just because the line to rat out Cooperman for these trades seems to have been pretty long:

APL Executive 1 was shocked and angered when he learned that Cooperman and/or accounts that Cooperman managed traded in APL securities in advance of the public announcement of the Elk City sale.

In late 2011 or early 2012, Cooperman spoke on the telephone with APL Executive 1. During this call, Cooperman informed APL Executive 1 that the Commission had sent Omega a subpoena relating to trading in APL securities in advance of the announcement of the Elk City sale. Cooperman improperly sought APL Executive 1's assurance that APL Executive 1 had not shared confidential information with him in advance of the announcement of the Elk City sale, despite knowing this was not true. APL Executive 1 believed that Cooperman was attempting to fabricate a story in case the two were questioned about their conversations regarding Elk City.

Anyway, however it happened, the SEC investigated, Cooperman declined to answer questions, and now the SEC has sued him for insider trading.

As a family drama sweeping up three generations of Coopermans, this is the most riveting insider trading case since the last insider trading case we discussed. But it is also pretty interesting as an insider trading case! First of all, Cooperman appears to have quite a robust factual defense, judging by the five-page letter he sent to Omega clients today denying the charges. I often mention that the Second Law of Insider Trading is: "If you have inside information about an upcoming merger, don't buy short-dated out-of-the-money call options on the target," and the regulators -- and Wayne Cooperman, for that matter -- make much of Omega's suspicious purchases of short-dated out-of-the-money call options just before the Elk City sale was announced. But Cooperman says that Omega was actually short Atlas call options in early July 2010, and had made a nice profit on that short position as the stock and options bottomed out. So it coincidentally bought options to close out its short position as the price of those options approached zero,  and "was never long any Atlas Pipeline calls prior to the Elk City announcement." As a defense to a Second Law violation, that is pretty convincing.

The investor letter has responses to the SEC's other allegations, noting that the purchases were mostly for managed accounts that were underweight Atlas, and that Omega didn't sell any Atlas stock for more than a year after the Elk City announcement. So the basic facts of what went on and why are hotly disputed, and if there's a trial it will no doubt be fun.

But even beyond the factual dispute, there is a more basic puzzle in the SEC's case. Here's what the SEC says happened:

  1. An Atlas executive told Cooperman some material nonpublic information about the Elk City sale.
  2. Cooperman traded on it before it was public.

When you say it like that, it sounds bad, but it is not necessarily illegal.  I know, it's wild, but here we are. There is no allegation that the Atlas executive violated any fiduciary duties to Atlas when he told Cooperman -- one of Atlas's largest shareholders, who regularly talked with management -- about the upcoming deal. For all we know, the executive had a good corporate purpose in telling Cooperman -- to get his advice, say, or to encourage him to support the company. There is certainly no allegation that the executive got any personal benefit for tipping Cooperman. So this isn't a classic insider trading case in which an insider illicitly tips a friend, who then trades on it and gives the insider a bag of cash as a thank-you gift. 

Instead, the SEC says that Cooperman's trading was illegal because he told the executive that he wouldn't trade on it, and then broke his word. From the complaint:

Despite knowing that information about the Elk City sale was material nonpublic information, APL Executive 1 told Cooperman about the Elk City sale because he believed Cooperman had an obligation not to use this information to trade APL securities. Indeed, during one of these conversations in which APL Executive 1 told Cooperman confidential information about the Elk City sale, Cooperman explicitly agreed that he could not and would not use the confidential information APL Executive 1 told him to trade APL securities. Cooperman, however, did not abide by his agreement to maintain in confidence, and not trade on the basis of, the Elk City sale information.

This is a very odd passage. The critical question here is whether Cooperman had a duty to the Atlas executive to keep the information confidential; the SEC alleges that he did. ("Cooperman and Omega owed a duty of trust or confidence to APL Executive 1, which required them to maintain in confidence the information about the Elk City sale and to not trade on the basis of it.") That sort of duty can be created by a history of sharing personal and business confidences, but it doesn't sound like that was the kind of relationship they had. Cooperman's essential relationship to the Atlas executive seems to have been a shareholder/manager relationship, which is sort of the opposite of a relationship of trust and confidence. If a manager tells a shareholder something about his company, he should expect the shareholder to trade on it. Nor can the duty of trust and confidence be created by the fact that the executive "believed Cooperman had an obligation not to use this information." Sometimes managers are just wrong.

On the other hand, a duty not to trade absolutely can be created by agreeing not to trade. If Cooperman "explicitly agreed that he could not and would not use the confidential information," and then used it, then yes, he committed illegal insider trading. But this too looks like a disputed factual question, and one very similar to the dispute in the Mark Cuban insider trading case, which the SEC lost at trial.  The executive will presumably say that Cooperman agreed not to trade, and Cooperman will presumably say that he never said that. Both sides will have their own self-interest: If Cooperman agreed not to trade and then did, he probably committed insider trading; if Cooperman never agreed not to trade and the executive told him about Elk City anyway, the executive probably violated Regulation FD, the SEC rule prohibiting selective disclosure.  The way that companies normally deal with this issue, these days, is that if they are going to tell a shareholder about an upcoming deal, they get him to agree in writing not to trade until it's public. The fact that there was no written agreement here makes me wonder if the executive's memory is mistaken and Cooperman was never sworn to silence.

Here is how the SEC describes Cooperman's methods:

By July 2010, Cooperman had been a hedge fund manager for a number of years. One strategy Cooperman employed was to accumulate large positions in publicly-traded companies and develop close relationships with those companies' senior executives.

Cooperman employed this strategy with APL. According to a statement he filed with the Commission, as of December 31, 2009, Cooperman was the beneficial owner of over nine percent of APL's common stock, worth approximately $46 million. By mid-2010, Cooperman had developed close relationships with APL's senior executives.

As a result of his APL ownership and status, Cooperman had a level of access to APL's executives that was not available to APL's smaller shareholders. Through this access, Cooperman had numerous telephone conversations and meetings with APL executives.

The obvious intention of this passage is to make you suspicious of Cooperman. Where does he get off, using his ownership and relationships to gain access to executives that wasn't available to smaller shareholders? The SEC, and the Justice Department, would really like insider trading law to prohibit this sort of thing, to make it illegal for any big hedge fund manager to use his privileged access to gain information that isn't available to mom and pop investors. But it doesn't. Not quite. The basic core unfairness, that big famous powerful hedge-fund managers can talk to executives and get information that isn't available to everyone, isn't exactly illegal under current insider trading law. There's a patchwork of stuff that almost covers it: Regulation FD bars companies from selectively disclosing information (but doesn't bar hedge funds from trading on it if the companies mess up ), and insider trading law bars hedge funds from trading on inside information if they've promised not to or if they've given the insiders a personal benefit for disclosing it.  But in the U.S., the basic information-parity rule of insider trading -- if you get nonpublic information from a corporate insider, you can't trade -- doesn't exist.

I'm not at all sure that it should, though the SEC and the Justice Department and many legislators want it to. And maybe it will, depending on what the Supreme Court does with the Salman case, though I wouldn't hold your breath for that sort of expansion of the law. But for now, insider trading cases will always involve this weird puzzle of figuring out who owed duties to whom and why, and the simple intuition behind them will never match up with the complexity of the law.

  1. Atlas Pipeline was acquired by Targa Resources in 2015.

    Oh also:

    The SEC’s complaint further charges Cooperman with failing to timely report information about holdings and transactions in securities of publicly-traded companies that he beneficially owned, alleging that he violated federal securities laws more than 40 times in this regard.

    These are all cases of alleged failure to file Form 4 or Schedules 13D or 13G when required by Cooperman's trading activities in stocks that he and Omega owned. The SEC complaint discusses them at some length but, come on, we are going to focus on the fun stuff here.

  2. The SEC puts it more bluntly:

    On July 7, 2010, Cooperman expressed to Omega Consultant that APL was a "shitty business."

  3. The SEC doesn't get more specific, but Cooperman's letter to investors today says it was his grandson.

  4. Again, the SEC doesn't name this family member, and just says that he was "at times an APL investor." But Cooperman's investor letter identifies him as Cooperman's son Wayne, who runs Cobalt Capital Management -- and says that Cobalt was short Atlas stock at the time of the announcement. Which would explain why he was so upset. The letter also points out that Leon Cooperman "was at the time the largest investor in Cobalt Capital," so he stood to lose money from Cobalt's short position, though he didn't know that Cobalt was short at the time. 

  5. From the complaint:

    On July 27, 2010, at approximately 8:36 p.m. EDT, Cooperman sent an email to a family member, who also was a hedge fund manager, stating:

    "Good news on APL ... [t]hey sold their ELK City operation for $682mm which will enable them to pay off bank debt, de-risk company because keep whole contracts largely gone and fund their Laurel Mountain obligations. We think stock worth at least $15 in near term---for what that is worth."

    Cooperman's family member forwarded this email to a colleague who replied, in part: "That explains the fishy $17 August calls, etc. I still haven't come across any press release - want to see how it's discussed ...." Cooperman's family member responded: "Somebody should investigate that."

    Cooperman's investor letter denies this, saying that "as my son is prepared to testify if need be, I didn't share with him any information concerning the Elk City transaction."

  6. From the complaint:

    In connection with an investigation concerning Cooperman's and Omega's conduct, including the trading in APL securities referenced above, the Commission issued a subpoena for Cooperman's testimony. Cooperman invoked his Fifth Amendment privilege against self-incrimination in response to Commission questions regarding Cooperman's and Omega's trading in APL securities.

  7. From the letter:

    In July 2010, the $15.00 options that Omega had sold for $1.32 in February and March 2010 were trading for as little as $0.05, generally the lowest possible quoted price for an exchange-traded option.

    On July 7, 2010, the day after Atlas Pipeline's stock fell to its lowest closing price of the year, Omega began purchasing those $15.00 call options at a price of just over $0.05 per option. Between July 7 and July 13, Omega flattened out its position in the August $15.00 options for an average price of $0.07 per option. Thus, Omega was able to flatten out its position while giving up only $0.07 (or 5%) of the $1.32 premium it had received per option.

  8. Not, mind you, because closing out a short position can't be an insider trading violation. It absolutely can be! If Omega was short Atlas stock, and got positive information about Atlas, and bought in its short to avoid losing money, that could be insider trading. What makes this defense so compelling is that Omega had sold the options at a high price and bought them in at a price that was functionally equivalent to zero. Once the options reached the minimum possible price, there's no reason to keep a short position open -- you can only lose money. So of course Omega should have bought in the position, regardless of whether it had good or bad or no news.

  9. Not legal advice! Also, by "legal," I mean "not illegal insider trading." It is perhaps a Regulation FD violation, but that is the company's problem, not Cooperman's.

  10. Including -- why not -- by buying shares.

  11. This is Rule 10b5-2(b)(2).

  12. That is why Regulation FD exists: to prevent managers from disclosing information to some shareholders before they disclose it to everyone else. Because of course the shareholders will trade on it.

  13. That is Rule 10b5-2(b)(1).

  14. Another thing: The SEC says there were three conversations about Elk City, on July 7, 19 and 20, and that the executive only swore Cooperman to secrecy in one of them -- and it doesn't say that it was the first one. (Nor does it give the exact wording of Cooperman's alleged promise.) If the executive blithely told Cooperman about the deal, twice, and Cooperman traded on it, and the executive then called him back and said "hey you're not going to trade on this are you" -- I am not so sure that Cooperman had any obligation not to trade.

  15. Regulation FD says that a company can't disclose material nonpublic information to a shareholder unless it simultaneously discloses that information publicly. But there are exceptions, including for disclosure "to a person who expressly agrees to maintain the disclosed information in confidence." 

  16. Or at least send an e-mail after the call being like "hey just confirming our oral agreement that you wouldn't trade on the material nonpublic information I told you, right?"

  17. Also, I have never noticed especially robust enforcement of Regulation FD. For instance, prosecutors tried to send Anthony Chiasson and Todd Newman to prison for years for insider trading on material nonpublic information they got from a Dell investor relations employee. A federal appeals court reversed their convictions, in part because this was the sort of information that Dell investor relations employees gave to investors as a matter of policy. And the SEC never brought a Regulation FD case against Dell. 

  18. Also Rule 14e-3 pretty much covers the waterfront as far as insider trading on tender offers goes.

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