Fraud Stoppers: FINRA’s Market Investigations Team

Detecting and deterring fraud and insider trading is at the core of FINRA's mission of investor protection and market integrity. On this episode, Sam Draddy, the head of FINRA's Market Investigations Team, joins us once again to talk about the latest trends and patterns in FINRA's fraud and insider trading investigations, including some stories about some of the craziest and most interesting cases of the past few years.

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Episode 23: Insider Trading: Finding the Needle in the Haystack

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FULL TRANSCRIPT 

00:00 – 00:23

Kaitlyn Kiernan: Detecting and deterring fraud and insider trading is at the core of FINRA's mission of investor protection and market integrity. On this episode, the head of FINRA's Market Investigations team joins us once again to talk about the latest trends and patterns in FINRA's fraud and insider trading investigations, including some stories about some of the craziest and most interesting cases of the past few years.

00:23 – 00:33

Intro Music

00:33 – 00:47

Kaitlyn Kiernan: Welcome to FINRA Unscripted. I'm your host, Kaitlyn Kiernan. I'm excited to welcome back to the show Sam Draddy, Senior Vice President within Member Supervision's National Cause and Financial Crimes Detection Programs. Sam, welcome back to the show.

00:47 – 00:48

Sam Draddy: Thank you for having me, Kaitlyn.

00:48 – 00:59

Kaitlyn Kiernan: So, Sam, your role has evolved a bit since we last spoke in 2018. So just to kick us off, can you quickly reintroduce yourself to our listeners?

00:59 - 01:24

Sam Draddy: I'd be happy to. So I'm currently the senior vice president and head of FINRA's Market Investigations team, and that team consists of insider trading investigations, market fraud investigations, offerings investigations, and our bluesheets group. And these teams collectively are charged with responsibility of surveilling for and investigating potential insider trading, manipulation and fraud across the U.S. Marketplace.

01:25 - 01:50

Kaitlyn Kiernan: And of course, your responsibilities in this group aren't the only thing that's broadened and changed. Member Supervision itself underwent a transformation. So, for anyone who goes back and listens to our last episode together, there's a lot of talk of OFDMI or the Office of Fraud Detection and Market Integrity, but that is now the National Cause and Financial Crimes Detection Programs. Are there any other changes worth flagging?

01:50 - 02:28

Sam Draddy: Yeah, for me personally, there's been a slight change since 2018. I now oversee the market fraud investigations team, in addition to the other teams I just referenced. But there also have been significant changes in the transition from the Office of Fraud Detection and Market Intelligence to National Cause and Financial Crimes. And that includes adding a Financial Intelligence Unit, merging our national cause group and specialist teams, such as our cyber team, our anti-money laundering team, our vulnerable adults team, and our high-risk registered rep team, with the existing surveillance and investigative teams from the Office of Fraud Detection and Market Intelligence.

02:29 - 02:50

Kaitlyn Kiernan: For our first episode together, we focused a lot on insider trading, and it remains one of our most popular episodes, which makes sense, it's a very intriguing topic for many. It's why Hollywood loves to focus on it as well. But what is new in the insider trading space since we last talked?

02:51 - 03:25

Sam Draddy: Probably the main thing that is new from a surveillance and investigative perspective is the sophistication of our surveillance and investigative tools that we leverage every day to uncover insider trading. So, we have developed tools that draw upon artificial intelligence, machine learning and deep learning, as well as graphing and geo-mapping technology that all assist us in identifying and isolating suspicious trading in the very large amounts of data we conduct analytics on every day. And we continue to develop these technologies with our dedicated technology support teams and with the support of the organization as a whole.

03:26 - 03:37

Kaitlyn Kiernan: So, I think last time we talked, we talked about how it was like finding a needle in the haystack with all of the data out there. So, is this basically you have a stronger and better metal detector now?

03:37 - 03:40

Sam Draddy: That's right. Exactly. That's a good analogy.

03:40 - 03:44

Kaitlyn Kiernan: Are there any notable trends that your team is seeing?

03:44 - 04:19

Sam Draddy: Yeah, I'd say the most notable trend in the insider trading world has been the proliferation of hacking, phishing and cyber intrusions in attempts to access material non-public information and to leverage that information to profit from trading. So, we're seeing hackers that are generally highly sophisticated and targeting systems where they know material non-public information exists, such as media outlets, law firms, rating agencies, and just about any organization that has systems that contain information that the hackers can profit from. So that's probably the biggest trend we've seen in the last few years.

04:19 - 04:36

Kaitlyn Kiernan: We have all these podcasts on cybersecurity as well and how it has overlapping risks that have repercussions elsewhere. So, it seems like another example of that. But in the past few years, since we last spoke, what would you say is one of the most interesting cases you've seen?

04:36 - 06:42

Sam Draddy: Well, I don't have to go back very far to highlight interesting cases because we have a constant flow of them. But while I'm on the topic of hacking, this past December, the SEC charged five Russian nationals for engaging in a years-long scheme that profited from stolen news announcements by hacking into the systems of two U.S.-based filing agent companies. And so, these companies actually assisted companies filing reports like 8-Ks and 10-Ks with the SEC. So, you can imagine these companies possess a ton of material non-public information.

And in this case, the lead Russian hacker used a variety of techniques to hack into the company's servers, including using compromised credentials of the company's employees as well as malware. Once he gained access to the material non-public information, the hacker then provided the not yet published earnings announcements to his four Russian co-defendants, who then placed trades through 20 different brokerage accounts located in the U.S., Denmark, the UK, Cyprus and Portugal. And they generated profits of over $82 million in the case. Now, the ring used the stolen information to trade before over 500 earnings announcements that they have stolen. And then they funneled the profits through a Russian information technology company owned by one of the Russian nationals. Criminal authorities were involved in this case, too. And the U.S. Attorney's Office for Massachusetts also issued criminal insider trading charges against the five defendants.

But the criminal complaint also noted that the owner of the Russian information technology company that was used to launder the money that was made through the stolen material non-public information was also an ex-Russian military intelligence officer and was recently extradited from Switzerland to the U.S. Because he was also involved in the hacking of the Democratic Party computer networks before the 2020 U.S. Election. And so, he was wanted by the U.S. Government on those charges as well. So, when you're talking about roads and paths crossing, in terms of the work we do with other civil and criminal regulators and law enforcement, you just never know where these insider trading cases may lead.

06:43 - 07:06

Kaitlyn Kiernan: That's a really interesting overlap there. Something else that sticks out to me, as you mentioned, $82 million, which is a lot. But you also said more than 500 earnings announcements. So that's not that much per earnings announcement. So, it seems like one of those things where your team can detect these unusual trades, even if it's not a huge dollar amount per event.

07:06 - 07:27

Sam Draddy: That's correct. And a lot of times, whether it's hackers or insider traders, they may not trade in large dollar amounts in order to basically avoid detection from a regulatory perspective. So, it's likely that that was part of the reason why they did that. We're not certain they traded on all 500, but certainly a decent percentage of them to make $82 million.

07:27 - 07:38

Kaitlyn Kiernan: That is quite a lot. That's definitely an interesting case. Related, but a little different, what would you say the craziest thing you've seen is in more recent years?

07:39 - 09:33

Sam Draddy: Yeah. And again, it's a little tough to pick out because of the craziness of what we see on a daily basis. I don't have to go back a few years to describe cases that came to our attention in the last couple of years and were actually brought his actions by the SEC in the last few months.

So, one of them was in September of last year, the SEC announced insider trading charges against an individual named Jose Luis Casero Sanchez. And Mr. Sanchez was a Spanish national and former senior compliance analyst at a prominent international investment bank. Mr. Sanchez generated more than $471,000 in profits by trading on material non-public information that he stole from his firm that concerned the firm's investment banking clients.

Sanchez's actual compliance job was to ensure that employees kept material non-public information confidential and that they did not engage in insider trading. And in fact, during the course of our investigation, we actually saw that Sanchez's LinkedIn page said his primary responsibility at the investment bank was preserving the integrity of the firm's information barriers, which is exactly the barriers that he broke.

Then between September 2020 and May 2021, he traded on at least 45 different events involving the investment bank's clients using stolen material non-public information. And actually, along the lines of what we just discussed, Kaitlyn, he actually, to avoid detection, traded in multiple US-based brokerage accounts held in the name of his parents. He also refrained from placing large trades and only made modest profits across the 45 transactions in an attempt to avoid detection.

In addition to charging Mr. Casero Sanchez with insider trading, the SEC also charged his parents as relief defendants. So, in addition to throwing away his career at a large investment bank, Mr. Sanchez also got his parents in huge hot water as a result as well.

09:34 - 09:40

Kaitlyn Kiernan: I am sure that was an interesting conversation with his parents, to say the least.

09:41 - 09:42

Sam Draddy: Yeah, not a happy day.

09:43 - 09:43

Kaitlyn Kiernan: No.

09:44 - 12:24

Sam Draddy: And I had one other case that I thought I'd bring up as well. So, the other case I want to discuss involves the former CFO of a pharmaceutical company called Immunomedics, a very large pharmaceutical company. The CFO's name was Usama Malik, and the SEC charge Malik, along with his former romantic partner with insider trading in the company's stock. And this is just in the fall.

While serving as the CFO of Immunomedics, Mr. Malik learned that the FDA had permitted the company to halt the clinical trial for a breast cancer drug because the existing trial data would provide compelling evidence that the drug was effective. Malik was the subject of a trading blackout that applied to him and everyone in the household. But despite that, he immediately tipped his live-in girlfriend, Lauren Wood, as well as three of her family members. And so, Ms. Wood and two of her family members and one of their spouses then immediately went out and bought Immunomedics stock before Immunomedics made this announcement. Then after Immunomedics announced the FDA's decision, its stock price nearly doubled, generating a gain of nearly $200,000 in the girlfriend's and her family members' accounts. And in fact, after she made the profits, Ms. Wood wrote a $65,000 check to Mr. Malik for money Malik had loaned her a few months before, and she actually wrote "home" on the check memo line.

This turned out to be somewhat ironic because as a part of the FINRA investigation, we sent a list of names to Mr. Malik and others that contained the names of people we had deemed training timely, profitably and suspiciously. And we asked Malik to review those names. Mr. Malik then failed to identify Ms. Wood as his girlfriend, and he also falsely claimed that he'd not even communicated with her during the relevant period in question, even though he was living with her at the time at what I would deem, and what she called, home.

So, in a parallel action, the U.S. Attorney's Office for the District of New Jersey announced criminal charges against Malik and Ms. Wood and by the time the SEC and criminal charges were filed Malik had left Immunomedics after the company was bought out by Gilead Sciences for $26 billion. And Malik then became CEO of a large biotech startup called Fore Therapeutics. And on the day the SEC and criminal charges were filed, Mr. Malik and Ms. Wood were arrested, and Malik was fired as the CEO of Fore Therapeutics.

So, my ultimate takeaway is that it never ceases to surprise me about the greed and really the arrogance of folks like Mr. Malik and Mr. Sanchez, that they throw away their careers. They obviously alienate their parents in some cases. And then in Mr. Malik's case, they threw away their freedom because they simply think they won't get caught.

12:25 - 12:50

Kaitlyn Kiernan: Yeah. It's noteworthy you often mentioned in these stories that individuals are doing stuff to avoid getting caught, but clearly there is not much you can do to avoid it when the systems that FINRA uses are so sophisticated to notice the patterns and the trends of the data. Also seems like there's probably better and safer ways to win over your potential in-laws than breaking federal securities laws.

12:50 - 12:51

Sam Draddy: There's no question about that.

12:52 - 13:08

Kaitlyn Kiernan: Well, that is all very interesting. And I could listen to the insider trading stories all day, but I did want to flip over to the fraud program that you also oversee and hear the latest you're seeing from that perspective as well.

13:09 - 13:50

Sam Draddy: The market fraud team has been incredibly busy over the last couple of years with extreme market volatility and record volumes across the markets, but particularly in the OTC markets where a lot of our market fraud team focuses. In fact, COVID really started the volumes with people at home, some say, with little to do and an inability to go out to casinos. So, they started actually trading in the markets and people at home are getting stimulus checks. And then a lot of the member firms were switching over to zero trade commissions, as well in terms of purchasing securities, and these were all contributing factors to the increased trading in the market. So, I'd say the biggest change that I've seen is just the amount of volume and the volatility within the markets.

13:51 - 13:57

Kaitlyn Kiernan: Are there any trends in the types of fraud you're seeing as a result of this influx of volatility and new investors?

13:58 - 16:01

Sam Draddy: Yes. In fact, in the beginning of COVID and through probably 2020, the COVID term became quite a lightning rod for us in the fraud space, and particularly the surveillance and investigative space, because we saw a lot of fraud tied directly to the pandemic with companies, actually a lot in the OTC markets, falsely claiming to have vaccines or test kits that assisted in preventing COVID, especially, again, in the early stages of the pandemic.

And we had one case that is a perfect example of these false claims when in early 2020, we investigated a company called Bigfoot Investment Projects, which was literally, as the name indicates, engaged in searching for and documenting and collecting evidence of the existence of the creature known as Bigfoot. That was their company model. Then the company completed a reverse merger in February 2020 and called itself Lord Global Corporation and announced that they had switched business lines to a mouthwash that could protect people against COVID-19. Now, the only way we figured that product would work, as far as we can tell, is if they actually found Bigfoot and Bigfoot had bad breath. But neither, I think, ever occurred.

But people actually bought the company stock when they made this claim about the COVID mouthwash. And the company actually had a market cap of $8 million at one point as a result of gathering investors to put their money in that stock. And the SEC ultimately issued a trade suspension of the company's stock stemming from a FINRA referral.

Now, along these lines to your question, many companies, and $8 million was probably a minor number compared to some of the companies, particularly in the OTC space, whose valuations went through the roof throughout the course of the pandemic. The most famous one, which made a lot of news, was a company called Hometown Deli, which was a standalone deli in southern New Jersey that is publicly traded, and it had a $100 million market cap. Now, I did hear through word of mouth that the pastrami was really good at the hometown deli, but not $100 million good.

16:01 - 16:03

Kaitlyn Kiernan: That's a lot of pastrami.

16:03 - 16:32

Sam Draddy: It's a lot of pastrami. I mean, it had to be very good to get to $100 million. But to close the loop on your question, in 2020 alone, we sent nearly 100 referrals to the SEC with respect to over 100 different publicly traded companies specifically making false COVID claims and the SEC in a fantastic job throughout the course of 2020 and early 2021, issuing over 30 trade suspensions in less than a year on public companies as a result of the FINRA referrals.

16:33 - 16:47

Kaitlyn Kiernan: Another notable change over the past few years, and you mentioned this with the influx of new market participants, is the introduction of the idea of a meme stock. First, can you define a meme stock?

16:47 - 17:49

Sam Draddy: Yeah, it's a good question because meme stock can have a number of different meanings. But the best definition I heard was that it refers to the shares of a company that has gained a cult-like status and following online and through social media platforms. But it actually involves a lot more in practice because in terms of the meme stock phenomenon of 2020 and early 2021, what happened was a significant number of investors banded together to invest in single stocks, and again, a lot of them were in the OTC market space. At that point, investors may have had different motivations. Some believed in the stocks like GameStop or Bed, Bath and Beyond or AMC. Some people wanted to ride the momentum of other investors as the price of the stock moved up. And others, for example, in the case of GameStop, wanted to actually squeeze the institutional short sellers in the stock by causing them to have to buy out of their short positions at a loss as they move the price of the stock up. So, there were a lot of different motivations, but at the same time, it was a true phenomenon in the marketplace.

17:49 - 18:04

Kaitlyn Kiernan: What kind of issues is your team seeing when you have these cult-like followers investing and talking about these individual companies?

18:25 - 19:09

Sam Draddy: Well, we're obviously looking for potential manipulation, and that entails not only the price of a stock moving up, but a group of investors who are banding together to cause a situation where the stock moves up. But also, we're looking for any misrepresentations that may be out there about the stock on social media platforms or coming obviously from the companies themselves. And that those misrepresentations or falsehoods potentially causing people to invest in the stock.

And quite frankly, Kaitlyn, we didn't see that by and large in the meme stock phenomenon or meme stock market event. What we saw is an influx of new investors in the marketplace, many for the reasons I told you about in terms of remote working and stimulus payments and having the time and money to invest in stocks, but also people who believed in the companies and actually were out there touting in a legal way on social media platforms, these particular stocks and having people join in and purchase the stocks. And so, I view it in many ways as not a manipulative scenario, but more of a scenario where you have new investors in the marketplace, they're engaged in the marketplace, and it really has changed what I consider the U.S. marketplace forever.

19:10 - 19:17

Kaitlyn Kiernan: So that's interesting to hear about the meme stock phenomenon. But are there any other new or emerging trends worth highlighting today?

19:18 - 20:40

Sam Draddy: Yes. In the fraud space one of the things we're seeing with the explosion in social media and the use of social media and trading, we have seen a proliferation of bad market actors who are buying up significant amounts of shares in low-priced microcap securities. Again, a lot of them in the OTC markets. And then what's happening, and we're focused on this, and the SEC is focused on this, these bad actors are then simultaneously creating their own social media following and promoting and touting those low-priced microcap securities and in many ways making misrepresentations. So that's where it crosses the line from legal trading to illegal trading. And once they have reached a significant following in social media, a lot of the people who buy into the stock and drive it up are following the lead of these people who have these social media followings. But what happens is those touting and promoting the stock will then dump the shares as the stock is moving up, again while still promoting and touting the stock. It's an age-old pump and dump scheme, but with a modern twist using social media and it's actually called scalping is the term we use for what's being done.

And really the lesson to the listeners here on this podcast is do not trust just anyone providing market advice on social media, but make sure to seek out a seasoned investment professional from either a reputable broker-dealer or investment advisor. And that's really my public service announcement for the day.

20:41 - 21:13

Kaitlyn Kiernan: So, it sounds like you've got this general meme stock phenomenon where it's become maybe a little bit more established for people to turn to social media for investing ideas. And on the one side, you've got some of this going on where your team is seen, there's not manipulation. It's just people who believe in a company talking about it. But on the other hand, you also have people taking advantage of this social media frenzy around stocks for their own gain. So, you have both sides going on simultaneously.

21:13 - 21:18

Sam Draddy: That's right. And again, it comes down to the difference between legal trading and manipulation.

21:18 - 21:27

Kaitlyn Kiernan: And the hard thing for investors is to remember social media with anonymous accounts, you just really don't know what you're getting when you're reading different posts on social.

21:28 - 21:30

Sam Draddy: That's the absolute lesson to be taken out of it.

21:31 - 21:43

Kaitlyn Kiernan: So, you've mentioned during this conversation a couple of times referring matters outside of FINRA to the SEC or others. What does it mean to refer the matter either for fraud or insider trading?

21:44 - 22:57

Sam Draddy: Well, actually, the vast majority of our investigations that reach conclusion result in referrals to the SEC. We also send referrals to criminal authorities such as the FBI and U.S. Attorney's Offices, as well as actually the state and foreign regulators. So, on average, we send between 900 to 1,000 referrals a year to the SEC as well as to other regulators and law enforcement.

Now the reason we do this is because while we have jurisdiction to pursue investigations, because we represent the US exchanges through their listing agreements with their issuers, we don't have jurisdiction to prosecute matters against individuals and entities who are not registered with FINRA. We also don't have subpoena power or the ability to obtain wiretaps or informants. And that's why the SEC and criminal authorities are better situated jurisdictionally to prosecute these insider trading and fraud cases. But we also do look very closely at FINRA registered conduct, and we will refer any insider training or fraud we uncover in the registered space to our colleagues in FINRA enforcement. So ultimately, we will pursue any insider trading or fraud that we uncover regardless of jurisdiction. Kaitlyn, the bottom line is that uncovering fraud is at the heart of FINRA's mission, and that mission will never change.

22:58 - 23:29

Kaitlyn Kiernan: Well, that's it for today's episode of FINRA Unscripted. Thank you, Sam, for joining us once again. I always love hearing the stories you have to share, both from the insider trading and fraud programs. Listeners, if you don't already, you can subscribe to FINRA Unscripted wherever you listen to podcast. And if you have ideas for future episodes, you can shoot us an email at [email protected]. Today's episode was produced by me, Kaitlyn Kiernan and Stephanie Van den Berg and engineered by John Williams. Until next time.

23:29 – 23:34

Outro Music

23:34 - 23:58

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23:58 – 24:08

Music Fades Out