How to beat insider trading rap at IB

Discussion in 'Retail Brokers' started by just21, Jul 28, 2008.

  1. just21


    How to Beat an Insider Trading Rap
    How does someone turn $42,000, their entire yearly income, into $286,457 in a day? They cheat and game the market is how! This story covers a loophole in SEC regulations where it's essentially legal to trade on inside information that was obtained by an outsider. The EU has clarified their regulations to make any gaining of inside information by criminal activity a violation of insider trading laws. The following comes from NY Times, Wired, and the SEC complaint file:

    Who Did It
    The case involves a Ukrainian national living in Uzhgorod, Ukraine named Oleksandr Dorozhko. He is a self-employed engineering consultant and alleged to have hacked into Thomson Financial’s network to obtain the earnings information for IMS Health, Inc. (Public, NYSE:RX), a company that provides market research to the pharmaceutical and health care industries.

    Dorozhko's Timeline
    September 2007
    Dorozhko began the process of opening an account at Interactive Brokers.

    Thurs October 4
    Attempted to fund an online trading account at by wiring $42,500 (USD) from Central European International Bank Limited, even though no trading account had yet been opened.

    Tue October 09
    IMS Health had publicly disclosed that it would announce its third quarter earnings on October 17, 2007 at around 5:00 p.m. (EST)

    Wed October 10
    IB approved the opening of a trading account through their affiliate located in the United Kingdom. The account was authorized to trade in stocks and options.
    RX closed at $30.39 w/ 480k vol.

    Wed October 17
    Dorozhko allegedly hacked into the computer network of Thomson Financial at 2:15:28 p.m. (EST) 35 minutes after the hack occurred, and hours before the information was to be released to the public he:

    Purchased 300 Oct 25 OTM puts at $0.10 = $3,214.90.
    Purchased 330 Oct 30 ATM puts at $1.17 = $38,456.00
    The total cost $41,670.90 approximately 99% of the cash value of his account
    RX closed at $29.56 w/ 832k vol.

    After the market closed IMS Health reported third quarter earnings of $0.29 per share 28% below consensus of $0.40 and 15% below earnings of $0.34 for the same quarter the previous year.

    Thurs October 18
    Market open RX fell to a historic low of $21.20 per share, 28% lower than the previous day's close. This was the steepest decline in the stock's trading history.
    9:35 a.m. began selling his put options
    9:41 a.m. sold all options = $328,571.00 overnight profit of 697% nearly six times his annual income!

    RX closed at $23.12, a decline of approximately 22% from the previous day's close. The trading volume was more than 23 million shares, representing a more than 2,735% increase from the previous day.

    Fri October 19 Options Expiration
    Upon discovering the suspicious trading in Dorozhko's account IB began an internal investigation and placed certain temporary restrictions on the account.

    Dorozhko's put option purchases represented almost 90% of all customer purchases in the October 25 and Oct 30 option series between September 4, 2007, and October 17, 2007.

    On October 19,2007, and on October 22,2007, Defendant Dorozhko, attempted to access funds held in his account at Interactive Brokers. Interactive Brokers informed Dorozhko that his account was being reviewed by compliance and that access to his account was restricted.

    Daily Chart of RX

    How To Double Your Net Worth In A Day (Ukraine Style)
    On the date of the release, October 17, 2007, at 8:06 a.m. (EST), a computer hacker began probing the IMS Health website at Thomson Financial. Since Thomson Financial had not yet received the earnings report from IMS Health, the hacker's attempt to retrieve information was unsuccessful. Three times thereafter, at 12:10 p.m, 12:51 p.m, and 1:52 p.m. respectively, the same IP Address attempted to access the information, to no avail.

    The IP address is registered in the Netherlands, but the actual user could be anywhere due to a location-hiding technique called “spoofing.”

    At 2:01 p.m., IMS Health sent Thomson Financial PowerPoint slides containing its earnings report. Upon receiving the slides, Thomson Financial transformed the slides into a certain proprietary format, and, using a custom tool, uploaded the slides to an internal secure server where they were staged and waiting to be uploaded for public viewing at 5:00 p.m. Thomson completed this process quickly, and had the slides uploaded on to its own internal server by around 2:08 p.m.

    At 2:15.01 p.m., the hacker from the same IP Address again probed the Thomson Financial network, and this time discovered that Thomson Financial had received the slides and uploaded them to the secure site. Within 27 seconds, starting at 2:15:28 p.m., the hacker managed to breach Thomson Financial's security system and began viewing the slides. By 2:18:43, the hacker had downloaded or viewed all the slides containing IMS Health earnings report.

    While the hacker's IP address has not been traced at this stage, the circumstantial evidence pointing to Dorozhko as the hacker is powerful. At 2:52 p.m., less than thirty minutes after the hacker breached security at Thomson Financial, Dorozhko, who had yet to trade in the account he had opened at Interactive Brokers, began using his account to buy all available put options in IMS Health. Within 14 minutes, by 3:06 p.m., Dorozhko had bought $41,670.90 worth of IMS Health put options.

    What Makes An Insider Trade
    The broker, Interactive Brokers, suspected something was wrong and temporarily froze the money to investigate before Dorozhko could withdraw it. Now the Securities and Exchange Commission wants to seize the funds, but a federal judge has ruled that the freezing of the money was unlawful because Dorozhko didn't violate the securities law governing insider trading.

    Dorozhko's alleged "stealing and trading" or "hacking and trading" does not amount to a violation of securities laws, a U.S. District Court judge, Naomi Reice Buchwald, ruled last month.

    Although he may have broken laws by stealing the information, the judge concluded, "Dorozhko did not breach any fiduciary or similar duty in connection with the purchase or sale of a security." She ordered the SEC to let him have his profits.

    She refused to dismiss the case, saying the SEC could try to prove that he had gotten a tip from an insider, but there does not appear to be any evidence of that.

    Similarly, a couple of recent law review articles suggest that hackers should be, but are currently not liable under § 10(b) for ‘hacking and trading.’ For example, Kathleen Coles writes in The Dilemma of the Remote Tippee, 41 Gonz. L.Rev. 181, 221 (2005-2006):

    “[A] computer hacker who breaches the computer security walls of a large publicly held corporation and extracts nonpublic information may also trade and tip without running afoul of the insider trading rules. The burglar and computer hacker may be liable for the conversion of nonpublic information under other laws, but the insider trading laws themselves appear not to prohibit the burglar or hacker from trading or tipping on the basis of the stolen information. This is because there was no breach of a duty of loyalty to traders under the classic theory or to the source of the information under the misappropriation theory.”

    Did He Get His Money?
    The SEC filed for a stay of the district court’s decision to lift an asset freeze which was granted by the US Court of Appeals on Feb. 27, 2008. So he hasn't gotten his money yet. The nuances of the crime will be hashed out for a while apparently. You can read the details here. It appears Congress will have to change SEC regulation to circumvent another event like this. There is no indication Dorozhko will be prosecuted for the hack and theft.

    S.E.C. v. Dorozhko S.D.N.Y.,2008
    Make Big Profits Illegally (and Maybe Keep Them, Too)
    By Floyd Norris February 15, 2008
    Ukrainian Hacker Makes a Killing in Stock Market Fraud
  2. Regardless of whether the thief gets the money, it will likely be a law-changing case.
  3. Pekelo


    Let's say just not to be so obvious, had he also bought 300 OTM calls, would that have rised a red flag?

    He could have claimed just playing a simple option strategy on earnings and the price of those calls (let's say around 3K) would have been small compared to the pay off...

    Oh, greed.....