Gene J. Puskar/Associated PressAn animated neon Heinz Ketchup bottle sits atop the Senator John Heinz History Center in Pittsburgh.Just a day after the buyout of H.J. Heinz was announced, the Securities and Exchange Commission took aim at an account, claiming it was used to trade on inside information about the deal to reap potential profits of over $1.7 million.
The challenges for the S.E.C. will be to overcome obstacles to figuring out who was actually involved in the trading, then linking that person or group to a source of information about the Heinz deal.
The suspect trading involved more than 2,500 call options, which give the purchaser the right to acquire 250,000 shares of Heinz stock at $65 each until June 22. The buyout offer from Warren E. Buffett’s Berkshire Hathaway and the investment firm 3G Capital Management prompted Heinz’s stock to rise nearly 20 percent, to about $72, on Thursday. The stock rise took the call options from being out of the money to generating a potentially handsome profit.
The S.E.C. described the trading as “highly suspicious” four times in its complaint, filed in Federal District Court in Manhattan, and for good reason. The initial investment was approximately $90,000, the options were very thinly traded, and the purchase was made only a day before the deal became public, resulting in a 1,700 percent return overnight.
As if that were not enough, the location of the account raised another red flag: the trading was executed through an account at Goldman Sachs called “GS Bank IC Buy Open List Options GS & Co. c/o Zurich Office.” Described in the complaint as an “omnibus account,” it operates as a kind of train station for securities trading by other banks and brokerages working through Goldman to access United States markets for their customers.
The omnibus account probably handles trading for a number of foreign banks that allow customers to use a trust or other entity that masks the identity of the true owner. Thus, the omnibus account may be just the first of many layers the S.E.C. will have to peel back before it finds out who actually bought the Heinz call options.
Penetrating financial secrecy may be impossible without the assistance of the Swiss authorities, or whatever other country from which the trades originated. The S.E.C. does not have the authority to issue subpoenas to obtain customer information from foreign banks and brokerage firms like it does in the United States, and it will have to rely on foreign regulators who may be unwilling to push hard to obtain the records. And if the account is maintained in a jurisdiction that protects client confidentiality, then the S.E.C. could quickly hit a dead end.
That also explains why the S.E.C. filed an emergency action so quickly to freeze the account. If the call options or any profits from them move outside the United States, then it would be almost impossible to get them back, depriving the government of its strongest leverage in the case.
Whether the call options are located in the United States or in Switzerland will be an important issue to be resolved. The trading took place in the United States through the Chicago Board Options Exchange, but like most securities, there are no physical assets, only electronic credits to accounts.
The S.E.C.’s release states that it obtained “an emergency court order to freeze assets in a Zurich, Switzerland-based trading account.” That indicates the call options may be held by Goldman’s Swiss subsidiary, which is not necessarily bound by the orders of an American court.
If the securities are frozen in a Goldman account in the United States, then anyone who wants to claim them will need to make an appearance in this country and agree to be subject to the jurisdiction of the federal court. That would give the S.E.C. a very big carrot to try to lure the trader out into the open. But that person will have to act fairly quickly because the options are set to expire in four months, after which they are worthless.
The S.E.C.’s approach is like that of any good investor – if it sounds too good to be true, it most likely is not true. The complaint is bare-bones at best, however, asserting only how “highly suspicious” the trading was without citing evidence to show the means by which the information might have been leaked or any connection between the trader and an insider to the deal.
That was enough for Judge Jed S. Rakoff, who is no stranger to insider trading cases, to grant the temporary freeze order. But the S.E.C. will have to come up with more evidence if it wants to convince the judge, or perhaps the Swiss authorities if their assistance is required, that the trading was based on confidential information about the Heinz deal.
Insider trading cases are not always the slam-dunks they can appear to be. A case I wrote about last year involving a foreign trader was dismissed when the S.E.C. could not show anything more than suspicious trading. Much like the Heinz trading, the defendant bought out-of-the-money call options right before a deal, generating a 1,000 percent profit in a short period. But the defendant appeared in the United States and fought the case, and the S.E.C. was never able to show any connection to a source of inside information.
The S.E.C. is only at the start of its case, and will look for any possible connections between participants in the deal and the actual account used for the trading. It has been successful in other cases at cracking open a wider ring of insider trading.
In 2005, suspicious options trades related to the acquisition of Reebok, ostensibly made by a retired seamstress in Croatia, led to the discovery of schemes involving many defendants trading on inside information from an investment bank and advance access to BusinessWeek magazine.
Whether the S.E.C. can penetrate layers of secrecy to ferret out insider trading in Heinz call options remains to be seen. Its first battle is to make sure it can keep the account in reach of the federal court, otherwise it may never be able to figure out who was responsible for some awfully well-timed trades.