Fake insider tradingLet's say that you are on the dark web looking for material nonpublic information about public companies, as one does on the dark web. You encounter a guy. He tells you that his name is "MillionaireMike" and he has a hot tip about a company. "This is from my buddy on the inside," he tells you. You are intrigued. You arrange a small test trade. It works; things look promising. "Okay," you say, "I will trade on your inside information, and we'll split the profits." MillionaireMike comes to you with a can't-miss tip. "This is totally 100% illegal inside information," he assures you. You make the trade. It pays off handsomely. You are rich. You send him his share of the profits (in Bitcoin, because this is the dark web and you are doing crimes). You are a satisfied customer. Later, the Federal Bureau of Investigation contacts you. "Uh-oh," you think, because you are sure you have been doing big crimes on the dark web. But what the FBI says surprises you. "We believe you have been the victim of a crime," they say. "You see," they explain, "when you thought you were getting illegal material nonpublic information on the dark web, you weren't. The guy who gave you that information didn't have a secret illegal source inside the company, and his name wasn't really MillionaireMike. Instead he was an engineer at SpaceX, and he was doing good fundamental research based on public information, becoming informed enough about companies that he was able to predict their stock-price moves without illegal tips. When he shared his predictions with you, sure, you were getting correct stock predictions that made you rich, but you were nonetheless defrauded, because you were hoping to get illegally rich, and you only got legally rich. You had a right not just to correct stock tips based on good research, but also to real, illegal, material nonpublic information. So we've arrested him." I don't know, man. I don't know. Here is a truly hilarious Securities and Exchange Commission and Department of Justice case against James Roland Jones. From the SEC: The Securities and Exchange Commission [Thursday] charged James Roland Jones of Redondo Beach, California, with perpetrating a fraudulent scheme to sell what he called "insider tips" on the dark web. The dark web allows users to access the internet anonymously and, as such, has often been used to host websites and marketplaces that support or promote illegal activity. This is the SEC's first enforcement action involving alleged securities violations on the dark web. The SEC's complaint alleges that, in late 2016 and 2017, Jones accessed various dark web marketplaces, including a website claiming to be an insider trading forum, in search of material, nonpublic information to use for his own securities trading. According to the complaint, in order to gain access to the insider trading forum, Jones lied about possessing material, nonpublic information. By doing so, Jones allegedly gained access to the insider trading forum for a short period, but was unsuccessful in obtaining valuable material, nonpublic information. The complaint further alleges that Jones subsequently devised a scheme to sell purported insider tips to others on the dark web. The SEC alleges that, in the spring of 2017, Jones offered and sold on one of the dark web marketplaces various purported "insider tips" that he falsely described as material, nonpublic information from the insider trading forum or corporate insiders. According to the complaint, several users paying in bitcoin purchased these tips and ultimately traded based on the information Jones provided.
The Justice Department press release says "Spacex Engineer Pleads Guilty To Insider Trading." Did he? He "pleaded guilty to conspiracy to commit securities fraud," which is in fact the crime you would plead guilty to if you were pleading guilty to insider trading. But that's because "insider trading" is not its own crime; it is analyzed as a species of securities fraud. This is also a species of securities fraud. But it surely is not insider trading? He … had no … inside information? Like, that is the whole point? It's a weird species of securities fraud. Here is how the SEC complaint explains it: Jones's false claims were material. The dark web marketplace users found Jones's misrepresentations significant enough to pay a fixed amount for the tips or to share their trading profits with Jones. A reasonable investor would also consider the fact that the Jones was not actually providing them with MNPI [material nonpublic information] important in deciding whether to invest in the securities that were the subject of Jones's purported tips.
Yes! A reasonable insider trader would consider it important, in planning his crime, to know whether he was in fact getting material nonpublic information! The SEC sticks up for reasonable insider traders! It is important for the integrity of the market that people who buy inside information on the dark web actually receive their inside information! I don't know! I sort of assume that what happened here is that the FBI was trawling the dark web for insider traders, and they found this guy, and they saw him bragging about all his insider trading, and they were like "aha, an insider trader, let's arrest him," and they did, and he was like "actually I was making it up, I had no inside information, I'm innocent." They were momentarily stymied, but they had already filled out all the paperwork; what were they going to do, not arrest him? Then they realized that fake insider trading is just as illegal — is in fact the exact same crime — as real insider trading. It is (so the theory goes) a "scheme to defraud" innocent traders to trade on inside information, and it is certainly a scheme to defraud insider traders to give them fake inside information. The FBI's work was not wasted. They didn't even need to change the paperwork. I am perhaps being too generous to Jones. Sometimes he did what I said at the beginning: He made good stock recommendations based on public research and just pretended that they were based on illegal tips: For example, in early 2017, Jones made contact with an individual on the dark web marketplace who had expressed interest in Jones's purported insider information. After an initial feeling-out process, and a small "test" trade, Jones offered the individual a "tip" that paid off handsomely for both Jones and the individual. Jones had researched a publicly-traded clothing company, and believed that the stock would not follow the overall dip in retail sales in early 2017, because of the overwhelming popularity of the company's products. In March 2017, Jones then lied to the individual about having MNPI related to the company, accessed the individual's brokerage account (with the individual's permission), and purchased shares of the company. Jones's gamble paid off, and he received approximately $20,000 in Bitcoin from the individual for his purported MNPI.
Sometimes he did more obvious fraud though: In the spring of 2017, Jones listed "insider tips" for sale on one of the dark web marketplaces. Given that Jones did not have access to MNPI, his tips were merely guesses based upon Jones's own research and speculation. Jones recognized that people would not pay him for his own stock tips, so he falsely described them as MNPI obtained from the ITF and/or corporate insiders. Jones's "tips" were typically general predictions that a stock would go up or down, and Jones would sometimes sell tips for the same stock in both directions. In the event his false tips did not pan out, Jones offered to give the next tip for free if the disappointed purchaser would leave a good review for Jones on the dark web site.
He definitely swindled people, but they definitely deserved to be swindled. Or here is this: In late 2016, Jones came across a wiki-page in one of the dark web marketplaces that listed various website addresses on the dark web, including a website for an insider trading forum ("ITF"). The listing described the ITF as an anonymous forum where participants exchanged MNPI about various publicly-traded companies. The ITF's subtitle was: "The community for exchanging Insider Information about the (sic) Publicly Traded Companies." The ITF rules state that its main goal is to create "a long-term and well-selected community of gentlemen who confidently exchange insider information about publicly-traded companies." The ITF rules further state that in the U.S. and many other countries insider trading is illegal, and that the security and the anonymity of its members is the highest priority. To gain access to the ITF, users were required to demonstrate that they possessed MNPI. The ITF's moderators would determine if the insider information was genuine and, if so, grant access to the forum. Jones attempted to gain access to the ITF by lying to ITF moderators and members by guessing certain earnings metrics on various issuers before earnings releases. The first few times he guessed, Jones's predictions were incorrect. After each incorrect guess, Jones created a new email account and tried again. On his third attempt, Jones correctly guessed the upcoming earnings per share for a home building company. Jones misrepresented to ITF's moderators that his information came from a friend who worked at the company, and the moderators granted Jones access to the ITF.
He pleaded guilty, but if I were him I would have vigorously protested my innocence.[1] "No no no, you've got it all wrong," I'd say. "I am a hero. I infiltrated the dark web insider trading forum to reform it, to turn it into a law-abiding stock picks website. My dream was for the ITF to become a long-term and well-selected community of gentlemen who confidently exchange ideas and due diligence about publicly traded companies to hone their research skills and make money without ever violating the law. I knew that I'd face resistance if I just came in saying that, so I started with a little white lie. But I made the insider trading forum better, in the sense that it did a bit less insider trading after I came along. Where's the harm in that?" Fake gut testImagine two public companies, Company A and Company B. They both sell widgets. Their widgets are bad. Nobody should buy them; terrible widgets, over there at Company A and Company B. Company A addresses this problem by lying to its customers. "Our widgets are great," it says, falsely. "They meet all the latest safety standards," it says, again falsely. "They're the widget of choice for the U.S. Department of Defense and the Queen of England. Nine out of ten doctors recommend Company A widgets." Etc. This campaign of lying works, and people buy a lot of Company A's widgets. It — accurately — reports high and growing revenue and net income quarter after quarter; it tells analysts and investors "we are doing great, we sold a million widgets this quarter because our widgets are so good." Executives get big bonuses and sell a lot of stock. This lasts for a year or two. Eventually customers notice that the widgets are bad, they stop buying, the company goes bankrupt and the investors lose everything. Company B addresses the problem by lying to its shareholders. "Buy some widgets," it says to customers, and the customers look at the widgets and say "these widgets are bad," and Company B shrugs and walks away. No widgets are sold. When the quarter ends without any widgets being sold, Company B puts out an earnings report saying "we are doing great, we sold a million widgets this quarter because our widgets are so good." It just pretends. It publishes securities filings with financial statements reflecting millions of widgets that it never sold.[2] Executives get big bonuses and sell a lot of stock. This lasts for a year or two. Eventually someone — auditors? the SEC? a short seller? — notices that Company B never has any actual money despite supposedly selling millions of widgets, the scam is exposed, the company goes bankrupt and the investors lose everything. Classically, Company B is committing "securities fraud." Faking your accounts, saying you sold products you didn't sell and earned money you didn't earn, these things are the core of securities fraud. You are lying to your shareholders about your business so that they will buy your stock. Very much securities fraud. Company A … I would say that Company A is committing what I like to call "everything is securities fraud." Company A is primarily conducting a fraud on its customers. This is, in some rough sense, good for its shareholders; at least in the short term, Company A really is getting more money from this strategy (lying to customers) than it would from a non-fraud strategy (admitting that its widgets are bad and not selling any). Company A's securities filings and financial disclosures are more or less accurate: All the financials reflect real money that really came in. Still there are some arguable inaccuracies. Company A probably uses some loose verbiage, "we sold a million widgets this quarter" (true) "because our widgets are so good" (subjective, but basically false). In any case, Company A's disclosures probably "omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading": If you say "we sold a million widgets" but neglect to say "by doing lots of fraud," you are giving your shareholders an incomplete understanding of your business. (For instance, a lot of that money will probably go out again, once the customers discover the fraud.) It's a little fraudy. For your shareholders. For your customers, it's a lot fraudy; for your shareholders, a little. We talk about this a lot around here. In recent years, securities plaintiffs' lawyers have discovered that any fraud any company does to anyone is also a fraud on its shareholders; in fact, any bad thing that a company does is a fraud on its shareholders, at least if the stock goes down after the bad thing is discovered. The fraud on the actual victims can be complicated to prove; it might be hard to get a lot of victims together for a class action; the damages caused by the fraud might be small or uncertain. But the shareholder fraud is easy: Lying to shareholders (even by omission!) is sort of an obvious fraud, it's easy to define a class of victims (everyone who bought stock during the lies, etc.), and the damages are easy to prove (if the stock dropped) and potentially enormous (if it dropped a lot). If you are a product-liability lawyer or a sexual-harassment lawyer or a defective-widget lawyer, you will be fairly specialized and do a narrow range of complicated lawsuits. If you are a securities class action lawyer, you can sue anyone for anything; every fraud is, also, securities fraud. The U.S. Securities and Exchange Commission also sometimes gets into this business, for related reasons. The SEC can be a meta-regulator; it can regulate companies' environmental and product-market and social behavior. Other regulators regulate one aspect of business, but the SEC can regulate whatever it wants through the lens of securities law. Anyway here are federal criminal and SEC charges against the founders of uBiome Inc., Jessica Richman and Zachary Apte. Here is how the Justice Department describes uBiome: Initially, uBiome offered a direct-to-consumer service, called "Gut Explorer," which allowed an individual to submit a fecal sample that uBiome would analyze in its laboratory and produce a report comparing the customer's microbiome to the microbiomes of others who had submitted fecal samples to uBiome, all for less than $100.
I am not sure what I would do with a comparison of my fecal sample to the fecal samples of other people who submitted fecal samples to the fecal-sampling company, but I guess for some people that's worth a hundred bucks. For the really big money, though, you need insurance: The indictment describes how the defendants eventually expanded uBiome's business model to include development and marketing of "clinical" tests regarding the gut and vaginal microbiomes, which tests would ostensibly be used by medical professionals to make medical decisions and as to which uBiome would seek reimbursement from health insurance providers in amounts up to nearly $3,000. ... "The innovation that emerges from our Bay Area companies is unparalleled," said Acting U.S. Attorney Hinds, "but all innovation must exist within the boundaries of the law. Today's indictment alleges that in their efforts to move fast to drive business and investment capital to their microbiome start up, defendants turned a blind eye to compliance and pursued at all costs a path designed to bring the greatest investment in their company. The indictment alleges defendants bilked insurance providers with fraudulent reimbursement requests, a practice that inevitably would result in higher premiums for us all. Further, defendants cashed out on the investment that flowed into the company to benefit themselves. Today's indictment is a cautionary tale about the importance of robust compliance programs rather than lip service, and the importance of honesty with investors."
Sounds like (alleged) insurance fraud! And in fact the Justice Department charged Apte and Richman with conspiracy to commit health-care fraud. But the SEC does not regulate health-care fraud, and both it and the Justice Department also charged them with securities fraud. The SEC says: According to the complaint, Richman and Apte portrayed the company as having a strong track record of receiving health insurance reimbursement for its clinical tests, which purportedly could detect microorganisms and assist in diagnosing disease. The complaint alleges that these claims were false and misleading because uBiome's purported success in generating revenue depended on duping doctors into ordering unnecessary tests and other improper practices that Richman and Apte directed, which, if discovered, would have led to insurers refusing to reimburse uBiome. According to the complaint, Richman and Apte acted to conceal the improper practices from investors and insurers, including directing uBiome employees to provide insurers with backdated and misleading medical records to substantiate the company's prior claims for reimbursement. Ultimately, the complaint alleges, Richman and Apte's efforts to conceal the practices unraveled, which led to uBiome suspending its medical test business and entering bankruptcy. According to the complaint, Richman and Apte were each enriched by millions through selling their own uBiome shares during the fraudulent fundraising round. "We allege that Richman and Apte touted uBiome as a successful and fast-growing biotech pioneer while hiding the fact that the company's purported success depended on deceit," said Erin Schneider, Director of the SEC's San Francisco Regional Office. "Investors are entitled to know the material risks of the companies they are investing in, no matter how transformative those companies claim to be."
Its a weird description: They "portrayed the company as having a strong track record of receiving health insurance reimbursement for its clinical tests," which was true, but it was also "false and misleading because uBiome's purported success in generating revenue depended on duping doctors into ordering unnecessary tests and other improper practices." It got insurance reimbursement, and told investors that, but it shouldn't have gotten that reimbursement, so it was somehow lying when it told investors that it did. Or, from the SEC complaint: Defendants repeatedly described uBiome's clinical tests to investors as "ordered by doctors, reimbursed by insurance." That description of uBiome's clinical test business was made in various pitch decks provided by Defendants to prospective investors between May and September 2018, during the company's Series C offering. Defendants' representation of uBiome's clinical tests as "ordered by doctors, reimbursed by insurance" gave the false and misleading impression that the tests fit squarely within the well-established and lucrative healthcare insurance reimbursement model.
I guess? But it gave the correct impression that the tests were ordered by doctors (though "those doctors, by Defendants' own design, often did not know what they were ordering") and reimbursed by insurance (though "uBiome was engaged in numerous improper billing practices … that would lead insurers to deny reimbursement for tests uBiome billed, once insurers caught on to the practices"), which is what it actually said. The alleged fraud was all on the insurers (and doctors and patients); the alleged fraud on shareholders amounts to just not telling them "oh we're doing a fraud." To be clear, that does seem bad! For the shareholders! In fact uBiome's financial results and projections were misleading, and when insurers caught on they did stop paying, and "in September 2019, uBiome ceased operations and filed for bankruptcy protection because it did not have a sustainable model for generating revenue." It's perfectly reasonable to call it securities fraud. It's just not mainly securities fraud. Except in one sense. The Justice Department claims that uBiome collected some $35 million from insurers; it is not clear whether some of that was justifiable or if it was all allegedly fraud. The SEC says that uBiome's Series C offering, done while it was allegedly doing all this fraud, "valued uBiome at nearly $600 million" and "succeeded in raising approximately $59 million." If you do a fraud on customers for a while, you will earn some (fraudulent) revenue, though it will take time and constant effort. If you then sell stock, you can sell it at a multiple of your revenue; you may be able to raise more money from the stock sale than from the original fraud. Doing securities fraud on top of your original fraud is a good way to leverage it into more money, faster. So it kind of makes sense that the SEC would pay attention. One other odd thing about this case is that uBiome was a private company during all of this; it never went public. My usual phrasing of "everything is securities fraud" is that every bad thing a public company does is also securities fraud, but it's not really limited to public companies. The thing about public companies is that everything they say in public can be read by potential shareholders who can then go out and buy or sell their stock, so everything they do or say can affect (and be fraud on) the stock. In private companies that is less true: If you read a good tweet from a private-company CEO, you can't necessarily go out and buy her stock. But if a private company is actively raising a funding round while also doing bad stuff, sure, why not, that's securities fraud too. How's Citi's $500 million doing?We have talked before about how Citigroup Inc. accidentally sent about $900 million to some hedge funds, asked for it back, only got about $400 million back, sued for the other $500 million, and lost. The problem is that Citi was the administrative agent on a term loan for Revlon Inc., responsible for making payments on the loan, and accidentally wired $900 million of its own money to pay off the loan in full when Revlon only wanted to make an interest payment. Some of the lenders were in a dispute with Revlon anyway, so they gleefully kept the money; Citi sued, but a court found that the weird New York legal doctrine of "discharge for value" entitled the hedge funds to keep it. Because they really were owed the money (by Revlon), and because at first they had no reason to think the payment was in error (because Revlon might have wanted to pay off the loan, and if it had then the money would have gone through Citi), Citi can't get it back. This is a weird result, and Citi is appealing. (Also lenders are rewriting loan contracts so it won't happen again, and Citi is mad at the hedge funds that kept the money and won't sell them new loans.) But meanwhile there is some question about … what actually happened? Here are some possibilities: - Citi paid off Revlon's loan. (Thus, "discharge for value.") Revlon doesn't owe anyone any money anymore.[3]
- Citi paid off $500 million of Revlon's loan: There was "discharge for value" with respect to the lenders that kept the money, but not with respect to the ones who returned it. Revlon owes $400 million to the lenders who returned the money. Citi has effectively given Revlon $500 million of free money to pay off its debt.
- Citi bought $500 million of Revlon's loan: "Discharge for value" is just an antiquated term that doesn't mean discharge; the lenders who got the money get to keep it, but Revlon's debt doesn't go away. It just owes the money to Citi now, since Citi paid off the lenders on its behalf.[4]
- Citi didn't pay off anything, and Revlon still owes the whole $900 million to the original lenders. But when it sends payments to the lenders who kept Citi's money, Citi can demand it back from them (and perhaps stop it on the way, as administrative agent), because it's not fair for them to get paid twice. Citi has a claim to, let's say, " equitable subrogation"; Revlon still owes the money to the lenders but Citi can get it back out of fairness.
- Citi didn't pay off anything, Revlon still owes the whole $900 million to the original lenders, they can keep it and Citi is out of luck. Citi has just given $500 million of free money to lenders, who might now end up making 200 cents on the dollar on their loans.
I think that the answer has to be No. 3 or 4, but that is not legal advice or anything; I just think the other answers are self-evidently insane and no court would allow them. You can't get a permanent $500 million windfall because someone in Citi's back office pressed the wrong button. I gather that not everyone agrees with me. In any case, there is no official answer yet; last month's 105-page opinion doesn't actually address this issue, and presumably Citi doesn't want to press it too hard while it appeals the main decision. In any case here's Revlon's 10-K, which mentions the controversy and also has no answers: Citi has appealed the Citi Decision. Citi has also asserted subrogation rights, but, as yet, there has been no determination of those rights (if any) under the 2016 Facility and Revlon has not taken a position on this issue. In these circumstances, it is the current intention of the Company to continue to make the scheduled payments under the 2016 Facility as if the full amount of the 2016 Facility remains outstanding.
"Revlon has not taken a position on this issue." Citi is Revlon's banker, and they still do business together, and Revlon can't really press too hard on this. On the other hand, sure, if a court were to decide that Revlon doesn't have to pay back that $500 million, that it's just totally Citi's problem now … Revlon would probably be happy to keep the money? It's just going to wait and see how this develops. Things happenAs Blackstone Barrels Toward Trillion-Dollar Asset Goal, Growth Is In, Value Out. Turkish Markets Nosedive as Agbal's Dismissal Stokes Lira Crisis. The New Stock Influencers Have Huge—and Devoted—Followings. The finance inventor whose vision blurred at Greensill Capital. Credit Suisse CEO Signals Potential Asset Management Spinoff. Marsh & McLennan scrutinised over role in Greensill collapse. $29 Billion Railroad Merger to Connect U.S., Mexico and Canada. High-Income Tax Avoidance Far Larger Than Thought, New Paper Estimates. Tax Evasion at the Top of the Income Distribution: Theory and Evidence. Goldman Sells $53 Million of Bankrupt Texas Utility Claims. Tony Hawk Skates His Last Ollie 540, Puts the NFT of It Up for Auction. NYC man sells fart for $85, cashing in on NFT craze. Prices in a 'Bubble,' Beeple Says After His $69 Million NFT Sale. Famed LA giraffe that starred in 'The Hangover' seized as evidence. Map of the Names of Donald Duck's Nephews in Different Countries. Zoom Escaper. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] It goes without saying that this is not legal advice! In general it is not a defense to criminal charges to say "well sure I did a crime, but I only did it to criminals, so that doesn't count." [2] This is hard to do if you have auditors reviewing your financial statements, but perhaps you can find a way. Set up a secretly affiliated shell company, sell widgets to yourself, that sort of thing. Or maybe bribe your auditor, I don't know, this is not a newsletter of practical advice about how to commit fraud. [3] This one would be super weird — what would happen to the lenders who returned the money? — but I list it for completeness. It seems absurd because I think those lenders *can't* assert a "discharge-for-value" defense, since they returned the money, which arguably means they knew it was erroneous. So their loans can't have been discharged. But I dunno. [4] There's no reason to think that the loan would be *accelerated*, that Revlon would have to pay Citi *now*; it would just pay in accordance with the original terms, but to Citi. I think? | 
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