The SEC’s complaint charged Justin Costello with violations of the anti-fraud provisions of several federal securities laws as a result of his role in this massive fraudulent scheme. [2]

While the SEC’s complaint alleges a broad web of fraudulent investment schemes, Costello mainly operated through deceit about his background, his qualifications, and the value of the companies he owned and operated. [2] Throughout the span of his fraudulent schemes, Costello was never registered with the SEC as a broker-dealer nor investment adviser. [2]

Costello’s success in bringing in clients largely rested on his fabricated credentials. Costello falsely stated to both the public in a press release and to the SEC in a Form 8-K filing that he graduated from the University of Minnesota and the Harvard Business School. In reality, Costello graduated from neither of these schools, but instead from Winona State University. [2]

Costello also alleged to prospective and existing clients that he was “the youngest hedge fund billionaire ever,” that he was a veteran of the United States Special Forces, and that he was licensed in money and investment management. [2] Each of these assertions was false yet helped to build Costello’s reputation and lure in unsuspecting clients. [2]

Once Costello secured advisory clients, he operated his fraudulent scheme by exercising complete and independent control over their brokerage account investments to invest only in securities of companies he owned.

In one case, Costello instructed a client never to log into their brokerage account while he managed it. While Costello managed all of the trades in the account, he advised the client that should the client’s brokerage firm ever reach out, the client should lie and state that the client had made the trades, not Costello [2]

Eventually, the client’s initial brokerage firm terminated its business with the client. Costello then convinced the client to allow him to manage another $1.27 million in a new brokerage account with a different brokerage firm, maintaining the same level of unfettered control. [2]

Costello’s independent control over the client’s brokerage accounts played directly into his fraudulent scheme. While he told the client that he would invest in a diversified portfolio of securities, Costello instead invested and traded only in microcap companies owned by him or in which he personally invested, presenting serious insider trading implications.

Costello began managing these brokerage accounts in 2019, and by 2022, the millions of dollars he was originally trusted to manage had dwindled downward by approximately 97% as a result of his fraudulent insider trading scheme. [1]

This is but one of several simultaneous fraudulent schemes Costello ran between 2019 and 2020. The SEC is seeking injunctions, disgorgement, civil penalties, and a prohibition against Costello ever serving as a broker dealer in the future. [2]

Protecting yourself from a fraudulent stockbroker may seem daunting, but the SEC’s Office of Investor Education and Advocacy publishes free resources on Investor.gov to help conduct reviews of a broker-dealer’s background before engaging in business.

Furthermore, if you think your stockbroker may have misrepresented their qualifications, license, or has engaged in fraudulent investment practices, the attorneys at Savage Villoch law can assist you – reach out for your consultation today.

Sources:

[1] https://www.sec.gov/news/press-release/2022-178

[2] https://www.sec.gov/litigation/complaints/2022/comp-pr2022-178.pdf

The win comes as a newly formulated legal theory offered by the SEC survived a motion to dismiss in SEC v. Panuwat, a case proceeding in the U.S. District Court for the Northern District of California.[1] The SEC’s legal theory states that the practice of “shadow trading” constitutes a violation of federal securities law, namely Section 10(b) of the Exchange Act and Rule 10b-5.[1]

“Shadow trading” occurs when a person with a connection to one publicly held company uses material, nonpublic information (MNPI) they have gained from their connection with that company to inform their trading decisions in a separate publicly held company. Typically, this separate company is economically connected in some way to the company for which the person possesses MNPI. [2]

In SEC v. Panuwat, the SEC alleged that the defendant, Panuwat, engaged in an instance of shadow trading which constituted illegal insider trading under 10b-5. At the time of the alleged shadow trading, Panuwat was Senior Director of Business Development at Medivation, Inc., where he reported directly to the company’s Chief Financial Officer. Medivation Inc. was a “publicly-traded, mid-cap, oncology-focused” corporation in the biopharmaceutical industry. [3]

On August 18^th, 2016, Panuwat received a confidential email from Medivation’s CEO stating that plans were being finalized for Meidvation’s acquisition by Pfizer, Inc. [3] Within minutes of receiving this confidential news, and on his work computer, Panuwat purchased shares in Incyte, one of Meidvation’s peers in the biopharmaceutical sector. [3]

When news of Pfizer’s acquisition of Medivation was released to the public just four days later, Incyte’s stock price rose appreciably, as did the stock prices of other industry peers.[3] As a result of Panuwat’s August 18^th trades, Panuwat generated gains in excess of $100,000.[3]

In SEC v. Panuwat, the SEC argues that Panuwat’s profits in this situation constitute “ill-gotten gains” in violation of federal insider trading laws because Panuwat based his purchase of Incyte shares on the material, nonpublic information he had received about Medivation’s impending acquisition by Pfizer. [3]

Panuwat moved to dismiss the SEC’s claims on the grounds that the SEC had not adequately pled that the information he received about the impending acquisition was material and nonpublic, that he breached his duty to Medivation; and that he acted with the requisite scienter. [1]

The court rejected each of these arguments and ultimately stated that the federal securities laws in question are indeed broad enough to permit MNPI from one company to be considered material in relation a separate company’s as well. This broad interpretation of Section 10(b) of the Exchange Act opens the door for the SEC’s argument that such “shadow trading” may indeed constitute actionable insider trading under federal law.

The court’s denial of Panuwat’s motion to dismiss, as well as their decision on the remainder of this case, will be of keen importance for public corporations and employees alike. Corporations may well begin considering revisions to the language of their internal insider trading guidelines to include explicit prohibitions on shadow trading.

Furthermore, individuals may need more carefully evaluate the basis on which they are making trades in the market, ensuring their trades are not motivated by material, nonpublic information that might also apply to a company besides the one they are directly connected to.

As SEC v. Panuwat unfolds, those interested in learning more about its implications may reach out to the attorneys at Savage Villoch with questions.

Sources: [1] https://www.troutman.com/insights/secs-new-insider-shadow-trading-theory-survives-its-first-test.html#_ftn1 [2] https://www.troutman.com/insights/securities-and-exchange-commission-tests-new-insider-trading-theory.html [3] https://www.sec.gov/litigation/complaints/2021/comp-pr2021-155.pdf

Members of Congress are inherently privy to more information about in-process legislation, forthcoming policy shifts, and potential economic impacts than the average market participant. [1] Such “insider” knowledge is a direct result of the duties entailed in a lawmaker’s job, and some argue this insider position presents an unmistakable conflict of interest. [1]

Congress previously sought to address this conflict of interest with its passage of the Stop Trading On Congressional Knowledge (“STOCK”) in April 2012. [2] At its most distilled, the STOCK Act explicitly made congressional insider trading illegal, and put in place disclosure requirements for each individual stock trade made by a member of Congress. [2] Prior to the passage of this law, insider trading – that is, trading by members of Congress based on material, nonpublic information – had been perfectly legal. [2]

Unfortunately, the STOCK Act has not seemed to adequately deter insider trading by members of Congress as planned. [1] Namely, noncompliance by Congress members with STOCK Act trading disclosure requirements is rampant. In 2021 alone, 54 members of Congress violated the STOCK Act by failing to meet the stipulated requirements for disclosing financial information about individual stocks they traded. [3]

This noncompliance may well be driven by the insignificant penalty imposed on offenders – typically a simple $200 fine. However, it is also worth noting that no prosecutor has ever brought charges stemming from the STOCK Act. This likely stems from the difficulty involved in adequately proving that a member of Congress’ trade was in truthy made as a result of particular insider information they possessed. [1]

So, how can the issue of congressional insider trading be remedied? One bipartisan coalition of congress members is actively proposing bills to limit the potential for unlawful insider trading within Congress. [1] One such bill aims to require members of Congress to place their individual stocks in a trust fully operated by another person, while a second bill aims higher by proposing an outright ban on members of Congress trading individual stocks. [1]

While bipartisan support does exist for these potential steps forward, there are also plenty of dissenters on both side of the aisle. Democratic leader Nancy Pelosi has voiced her distaste for new legislation proposing additional limits on stock trades by Congress members, arguing that members of Congress “should be able to participate in” the free market economy of the United State’s just as other citizens may. [1]

To the contrary, critics of the current state of congressional stock trading note that members of Congress are in a vastly more informed, and thus advantageous, position when compared with the average U.S. citizen. Others argue that Congress members are elected to their positions, and run for election by their own free will. Should they wish to freely make trades on the market, they are free to solicit employment within the private sector instead. [1]

Research shows that Congress member’s insider knowledge has resulted in “higher than average returns on their stock investments.” With this information becoming public knowledge, lawmakers are likely considering the importance of public perception and trust amongst their electorate. [1]

While the future of new legislation in this space remains unclear, main street investors can be encouraged that the conversation surrounding this ethically-questionable congressional stock trading is gaining attention once again.

Sources:

[1] https://nyti.ms/3KV33oQ

[2] https://www.investopedia.com/terms/s/stop-trading-on-congressional-knowledge-act.asp

[3] https://www.businessinsider.com/congress-stock-act-violations-senate-house-tradin

While the driving factors behind this downturn are many, the impact of the pandemic is undeniable. As an at-home exercise equipment company with the ability to connect users from their homes across the world via real-time classes, it’s no wonder the company and its stock soared through 2020’s COVID-19 lockdowns. Less clear, as of now, is Peloton’s staying power as consumer demand wanes, leading the company to hire consultants at McKinsey & Co. to review finances and to halt production on several of its models. [2]

In light of Peloton’s precipitous fall, some have turned their attention to massive stock sales undertaken by Peloton insiders before the downturn began. SEC filings from late 2020 and into 2021 show that insiders at Peloton sold approximately $500 million in stock before the price began to plummet. [3]

Among these insider sales were that of Peloton’s CEO and co-founder, John Foley, as well as the company’s president, William Lynch. First, in November 2020 Foley sold shares worth $119 million as part of a selling plan for “personal financial management purposes.” [3] Then, Lynch sold over $105 million in stock during 2021, the majority of which was sold in February 2021 at an average price of $144. [3]

While the timing of these Peloton insider trades might appear “lucky” in hindsight, the well-timed insider trades certainly were not unique. In fact, 2021 saw a new record for insider selling, which reached $170 billion, up from $94 billion in 2020. [3] As Daniel Taylor, associate professor at the Wharton School of Business succinctly explained, “[o]ne of the most well-accepted facts from decades of research on insider trading is that corporate insiders buy near bottoms and sell near peaks.” [3]

Given this well-established pattern of insider trading, two questions emerge: first, when does insider trading cross the line from legal to illegal; and second, how might everyday investors use knowledge about insider trades to their own investing advantage?

To start, insider trading crosses the threshold into illegality when company insiders trade securities when they have access to material information that the public does not. [4] Such illegal insider trading can be committed by anyone who has material and nonpublic information about a company – whether it be the CEO, a broker, or even an employee’s family or friend. [4]

Conversely, insiders may lawfully trade securities so long as they adhere to trading restrictions which lay out specific timing and other conditions for when trading is legal. [4] As a result, insider trading like that of Peloton and other executives throughout 2021 is both routine and legal, unless shown otherwise.

But how can these trades help individual investors? As described, insiders often sell stock when the price is high. At a base level, this may serve as a signal to investors with a short-term investment plan to consider selling their positions as well, while the stock is still high.

Furthermore, research has shown that executive’s insider trading activities can be extrapolated out to broader trends in the market. A company’s stock tends to outperform the broader market when executives of the company buy shares, and a company’s stock tends to underperform the broader market when executives sell. [4]

Helpfully for individual investors, the SEC requires that all corporate insiders report their stock sales or purchases within two business days of each transaction. [4] This information can then be accessed by the public either on Yahoo! Finance or on the SEC’s EDGAR Database.[4]

With more attention on insider trading as its volume rises, more individual investors may have their sights set on learning from these trades to inform their own investment decisions. When doing so, it is critical to remember that data on insider trades may not always tell the full story. A corporate insider may indeed have different motivations relating to other financial considerations, such as taxes, than would the average investor. Thus, it is possible to view insider trades as a guidepost, but investors should continue to exercise their own due diligence in making personal investment decisions.

Sources:

[1] https://www.google.com/finance/quote/PTON:NASDAQ?sa=X&ved=2ahUKEwivmo7qi8n1AhUSTd8KHYinAHIQ3ecFegQIERAc

[2] https://www.cnbc.com/2022/01/20/peloton-to-pause-production-of-its-bikes-treadmills-as-demand-wanes.html

[3] https://www.cnbc.com/2022/01/19/peloton-insiders-sold-nearly-500-million-in-stock-before-its-big-drop-.html

[4] https://www.investopedia.com/articles/02/061202.asp