Last week, Howard Wetston, chair of the Ontario Securities Commission, said that the regulator was asking the government for the power to use wiretaps in insider trading and tipping investigations.
The only surprising thing about the announcement was that it took them so long to ask. Wiretaps have become a mainstay of American enforcement, starting with the case against Raj Rajanatram’s Galleon Group in 2009. Since then, U.S. Attorney Preet Bharara has strung together 79 insider trading convictions in a row since 2009—a perfect record. In that same time period, the OSC found 9 people guilty, only one of whom received a jail sentence. Unlike the U.S., where the SEC has been going after institutional investors, especially hedge funds like Galleon and SAC Capital, the OSC’s convictions are mostly of small-time traders.
This is the latest step by the OSC to increase enforcement. Last year, the commission announced the creation of the Joint Serious Offences Team, a collaboration between the OSC, the OPP and the RCMP, which has been targeting ponzi schemes and securities fraud. They’ve also added “no-contest” settlements, where an individual or company could agree to pay a fine without entering a guilty plea, a tool that’s been used to great effect in the U.S.
Inside trading, however, is a notoriously difficult crime to enforce. Prosecutors have to prove that a person was trading on illicitly obtained information and not because of other reasons, like independent research or a hunch. To get a a truly “inside” perspective on exactly how difficult the OSC’s task is, I spoke to Stan Grmovsek, a former inside trader and the only person to ever serve jail time in Canada for the crime. For 15 years, Grmovsek traded on tips he got from his friend Gil Cornblum, a prominent corporate lawyer.
Canadian Business: Could you tell us how you were caught?
Stan Grmovsek: We were identified near the end after almost fifteen years of [insider trading]. I was purchasing a U.S. stock that was relatively illiquid and one day I asked a broker to put an order to buy 10,000 of those shares. The broker’s assistant was not there, so I instructed the replacement assistant to work the buying of shares slowly, but instead of doing that—buying slowly 100 shares or whatever at a time when they came up throughout the day—she put a market order in to buy the whole 10,000. And I think on that particular day, I was 80-90% of all the volume. So I believe that is what jumped out to regulators. If it wasn’t that trade that did it, it certainly confirmed it for anyone looking at our activities before then.
How easy or difficult is it to get away with insider trading?
Unless you engage in it frequently or make your trading obvious by loading up on out of the money options, you can always explain your actions as innocent to anyone who inquires, particularly if it’s a one-off and if you are careful enough to buy other stocks in the same sector at the same time.
For example, I knew that I had a steady source of information that in theory could have gone on forever, so I never did things, until the end, that would draw attention to myself. So I never traded options in the last ten years of doing it, I would never buy too much of a stock at once if I could help it (I’d always want to do a small percentage of the day’s float and certainly not be the last trade if a deal could be announced the next day).
I was careful, but most people get their information and that’s their one and only chance. And because of that they want to leverage that informational edge the most that they can and that usually involves buying call or put options. That’s how they identify themselves; by never buying options before and one day buying a tremendous amount of options. Or never trading in stocks before and then all of a sudden having the first stock that they margin up to buy being taken over a day later. Sometimes they also pump the stock they just bought because they are panicking that they are so heavily invested and need it to go up by any means possible. On two occasions I had people I had never met before that I was speaking with at a social setting give me tips about companies they knew would be taken over as encouragement for me to invest in them. In both cases the takeovers happened exactly as these complete strangers to me stated they would. I guess not everyone is as careful as we were for a time.
It seems like a wiretap wouldn’t be very useful to regulators in those cases.
You’re right, in those cases [the OSC] wouldn’t identify a person until after the fact. Whereas a wiretap for someone like myself who did it with a great deal of frequency, but also did a lot of innocent trades around it, that would make it much easier for them to prove their case.
I would always have an innocent explanation as to why I bought a stock if a broker asked. So I’d have research reports with me, maybe some chat room posts I read about or options activity regarding the stock that I identified. So if a broker ever asked “Why did you buy that thing that was taken over?” I’d have all the information on hand. I’d be able to recite it very quickly to them so they think, “Wow, he obviously was ready for that question so that must be an innocent explanation.”
Of the over 100 trades I ever did, only one broker ever asked—an American one. He was on the phone with his manager and me, and apparently my explanation was good enough that nothing ever came of it as that was five or six years before I was ever charged.
I’m actually very surprised that [the OSC] hasn’t been tapping phones until now. You’d think that’s a tool they would have accessed a long time ago, particularly as the SEC has used it to great effect the last few years.
When you and Gil were figuring out which stocks to trade on, did you ever talk on the phone?
The actual exchange of the information would always be in-person, and after that we might talk about the status of the deal. I would meet him and he would say “Company A is buying Company B at $20 in the next two weeks.” So then I would buy Company B and we would talk on the phone, and we’d have some code word. “How’s John, did you see our friend John last week?” And he’s say, “Yeah, I saw him passing in the hallway, he looks really good.”
“So in our phone conversations, unless we slipped up, we would never actually discuss the transaction on the phone.”
Do you think there are hedge funds in Canada that are trading on insider information, similar to what happened at Galleon and SAC Capital?
At one time I knew of a mutual fund manager that would front-run their funds as Americans have been accused of doing, so I don’t think I’m saying anything that people don’t realize—there are likely hedge funds in Canada that are doing the exact same thing the Americans were doing regarding inside trading. SAC Capital is not the only American one and I’m sure there are certain Canadian ones that are similar. The reason is that they are almost the perfect vehicle to engage in the activity as it is easy to blend in trades done with inside information with innocent trades. Also, brokers that want a mutual fund’s or a hedge fund’s business have a financial interest in passing along information in exchange for doing the trades for them, so I suspect it’s often quid-pro-quo that way.
Unless your hedge fund is 100% inside trading, you can always make a rational explanation for a trade. Like I said, of all the times I did, only one broker ever asked, and I had a rational explanation for it that sounded very plausible—or plausible enough to end the inquiry.
But for every one person that’s identified, I think there are 10 that aren’t. As I mentioned, hedge funds are the easiest place to do this activity because you can always cover it with innocent trades. If you’re placing a hundred trades a day, you can always say that was just one of a hundred trades purchased during normal activity or as part of an overall investment philosophy in that sector.
Again, I am not saying anything that people informed on the subject don’t already know. When asked after my conviction about the subject I would simply say it goes on more than the public believes and also more than regulators identify or likely will ever admit.