Want to Commit Insider Trading? Here’s How Not to Do It

Smithfield’s stock jumped nearly 25 percent after Shuanghui International announced that it would acquire the company. Rich-Joseph Facun/ReutersSmithfield’s stock jumped nearly 25 percent after Shuanghui International announced that it would acquire the company.

Traders who act on confidential insider information usually try their best to keep their actions hidden from view. But other times, insider trading just leaps off the page, as if someone decides to directly flout securities law.

A recent case filed by the Securities and Exchange Commission falls into such a category. It is as if the trader in question had a sign on his back that said: “Sue me!”

Civil charges were filed last week against Badin Rungruangnavarat, who was accused of trading ahead of the May 29 announcement of Shuanghui International’s acquisition of Smithfield Foods.

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Smithfield’s stock jumped nearly 25 percent after the news was made public. Mr. Badin conducted a flurry of trading in speculative securities the week before the announcement, producing a paper profit of $3.2 million – a 3,400 percent gain in only eight days.

A Federal District Court in Chicago froze the account at the S.E.C.’s request after Mr. Badin, who lives in Bangkok, tried to withdraw $3 million. So those paper profits are likely to be kept out of his hands for at least a while.

If one were writing a textbook for a class called “Insider Trading 101,” this case might be the best example of activities that are sure to draw the attention of the S.E.C.
Mr. Badin opened his account just days earlier, and the only trades were in Smithfield securities that would lose much of their value unless the stock price jumped in a short period of time.

He bought out-of-the-money call options, which give the owner the right to buy 100 shares at a specific price, spending about $91,000 on them. These options would expire worthless unless Smithfield’s stock price jumped by about 15 percent within the next two months.

He also bought a large number of single-stock futures contracts; a person buying such a contract has to purchase 100 shares by a set date. These contracts only require payment of a small commission, but the owner must also put up 20 percent of their value by buying them on margin. Mr. Badin transferred about $1.3 million into the account to cover these contracts.

This is the first time I recall seeing this type of futures contract used in an insider trading case. The margin requirement makes the futures contracts much more costly than option contracts, but their use also shows just how eager Mr. Badin was to get his hands on as many shares of Smithfield as possible.

If Mr. Badin wanted to make his trading stand out, he could not have done a better job. The options trading accounted for a substantial portion of the market, and the futures contracts were 100 percent of the trading during this time.

The funding of the account was also suspicious, with over $2 million having been transferred in a short period of time to pay for speculative trades.

Although not mentioned in the complaint, the S.E.C. is no doubt interested in whether Mr. Badin, an employee at a plastics company, is fronting the account for others. This has happened before, including a case involving a trader who used his retired Croatian aunt as the purported owner of an account that made over $2 million before the announcement of a deal.

Perhaps the oddest trade was Mr. Badin’s purchase of 100 shares of Smithfield, a transaction that would net about $800 in profit. That hardly seems worth the effort, but not all traders are rational in their purchases.

The hurdle the S.E.C. faces in any case like this is connecting the trader to the confidential information. To establish a violation, it must show that Mr. Badin bought the securities “on the basis of” inside information, which means proving he had a source with access to confidential information about the deal.

The companies usually cooperate by providing a list of everyone who knew about the negotiations, so it becomes a matter of the S.E.C. finding the needle in the haystack. When a trader like Mr. Badin is outside the United States, then it becomes even more difficult because access to telephone records, e-mails and other evidence is not readily available.

In the Smithfield transaction, Shuanghui was not the only potential bidder. Another company interested in Smithfield was Charoen Pokphand Foods, a Thai company.
Like most potential bidders who looked at the company’s financials, it was advised by an investment bank, which was also located in Bangkok. Although Charoen Pokphand Foods was not the part of the final deal, just knowing that Smithfield had put itself up for sale was valuable information – even if Mr. Badin did not know the specifics of Shuanghui’s offer.

In searching for the link to inside information, the S.E.C. obtained access to Mr. Badin’s Facebook account, where it found a possible source. According to the complaint, he “has a Facebook friend who is a former employee of the company where [the defendant] works, and who is an associate director at the Thai investment bank that advised Charoen on its contemplated Smithfield bid.”

A Facebook connection, of course, only proves that two people ostensibly know each other, and even that link can be tenuous if the person has hundreds of friends. The connection to someone at the Thai investment bank is evidence of a plausible source of confidential information, but not much more than that.

The S.E.C.’s case is at an early stage, and courts are usually willing to freeze an account when there are signs of suspicious trading like Mr. Badin’s. This is especially true when the trader is outside the country and tries to withdraw money, because it would then be nearly impossible to get it back.

The evidentiary threshold is quite low at this stage, and the court will require something more than just a Facebook friend if the case is contested. But if Mr. Badin never responds, then the S.E.C. can win by default, which could let it keep the money put into the account as a penalty for insider trading.

Losing over $2 million in principal from Mr. Badin’s account might be enough to entice someone to show up and fight the S.E.C., but a foreign defendant should be careful about coming to the United States. A textbook case like this is likely to have federal prosecutors very interested in who is behind the trading.