Heinz Insider Trading Highlights Need for Wall Street Transparency

NEW YORK ( TheStreet) -- In Heinz's ( HNZ) $28 billion acquisition by Warren Buffett's Berkshire Hathaway ( BRK.A) and private equity firm 3G Capital, someone may have illegally made a $1.8 million profit using inside information, according to the Securities and Exchange Commission.

The SEC alleges a dormant trading account in Switzerland kicked into action buying up call options for Heinz just ahead of the ketchup maker's purchase by Berkshire and 3G Capital, in what it says is a violation of securities laws.

As it turns out, the SEC's allegation of insider trading and a court order to freeze the unnamed Zurich-based options account comes just as media reports indicate SAC Capital Management saw withdrawals of $1.7 billion, or a quarter of outside investor assets, as the hedge fund tries to battle allegations of insider trading levied against a handful of its former traders.

The separate news events, however, shouldn't be seen independently.

In fact, the SEC's quick ability to catch what it suspects is potentially illegal trading just over 24 hours after Heinz's proposed acquisition and a multi-year investigation to levy insider allegations against SAC Capital traders may prove the rationale for more transparency on Wall Street.

The SEC alleges that on Feb. 13, a day prior to Heinz's acquisition, the Swiss options account bought 2,533 out-of-the money June $65 calls for a total of nearly $90,000. "Between Sept. 1, 2012, and Feb. 13, 2013, the account through which the defendants traded had no prior history of trading in Heinz," the SEC states.

When Heinz's $72.50-a-share acquisition was announced, those trades stood to gain nearly $1.8 million, a 1,700% return from the prior day when the contracts were traded.

At the heart of the issue is whether fraud goes undetected by regulators like the SEC for the simple reason that trading occurs in hard-to-regulate over-the-counter markets, or so-called dark pools of opaque stock trading.

Consider that the alleged illegal Heinz trades occurred on a highly regulated options exchange, the Chicago Board Option Exchange, where individual trades can be seen almost instantaneously. It took only a few moments after Berkshire Hathaway and 3G Capital announced their acquisition of Heinz for reporters, traders and regulators to see the suspicious options trades in the 144-year-old ketchup maker.

By midday Thursday, Bloomberg had reported that regulatory officials were investigating the trades, and the New York Times had an even lengthier report by the end of the business day.

Contrast that with the alleged insider trades that many suspect could cause SAC Capital to face increasing scrutiny with the SEC, after years of speculation that the hedge fund's outsized investment gains resulted, in part, from insider trading and so-called "black edge," as Bloomberg Businessweek reported.

The SEC's allegations, brought in November 2012, indicate that a former SAC Capital trader, Mathew Martoma, was able to make $276 million in profit and avoided far greater losses on the shares of drugmakers Elan ( ELN) and Wyeth by way of trading on illegal knowledge of negative trials in an Alzheimer's drug being developed by both companies in mid-2008.

In Martoma's alleged fraud, algorithmic trading and dark pools appear to have played a key role in obscuring what the U.S. attorney says is the biggest insider trading profit in many years.

The fact that the SEC could look at options trades on exchanges and freeze an account within days, and a four-year inquest that Bloomberg Businessweek reported culminated with tips, informants and wiretapped phone calls might indicate the degree to which opaque trading can be an aid to those with nefarious intent.

Consider the magnitude of SAC Capital's alleged insider trades ahead of a market moving event and the report from Businessweek that the SEC's case wasn't the genesis of simply looking at stock-trading records.

According to the U.S. attorney, after receiving a tip that pharmaceutical companies Elan and Wyeth would soon disclose negative Alzheimer drug trials tests in late July 2008, Martoma of SAC Capital is alleged to have told SAC's owner to liquidate the fund's position in both companies' shares.

SAC did so via its head trader and a massive selling program of over 10.5 million Elan shares over a span of four days. The U.S. attorney says in its charge that SAC Capital's selling represented over 20% of the reported trading volume in Elan's shares and 11% of the volume of Wyeth's shares in the seven trading days prior the disclosure of negative drug trials.

Still, emails floated between a SAC trader who executed the sale, the fund's owner and Martoma show that SAC Capital felt its selling had gone undetected by the wider market. The main reason: the use of trading algorithms and dark pools.

"We executed a sale of over 10.5 million ELN for four internal Hedge Fund account names at an avg price of 34.21. This was executed quietly and effectively over a 4 day period through algos and darkpools," writes the executing trader, according to the U.S. attorney's complaint.

"This process clearly stopped leakage of info from either in or outside the firm and in my viewpoint clearly saved us some slippage," the trader adds.

Dark pools are used by large traders to put out buy and sell orders without revealing their identity, thus avoiding smaller traders attempting to front-run their orders.

Venues like BATS Global Market, Direct Edge and those owned by the New York Stock Exchange, Nasdaq and investment banks like Goldman Sachs ( GS), Credit Suisse ( CS) and UBS ( UBS) are considered to be a breeding ground for high-frequency traders, who have been accused of front-running actual stock buying by ordinary investors and fund managers.

In spite of such large stock selling -- and just days ahead of a market-moving drug-trial announcement -- the SEC doesn't appear to have taken much notice of SAC's trading. Or at least not for many years.

The SEC did notice suspicious trades of a much smaller size in Heinz prior to the company's acquisition Thursday, a commendable sign that enforcement officials are watching over Wall Street for those who seek to make illegal profits.

Still, the amount of time it took for the SEC to bring an action against the former SAC Capital trader and the indication that suspected illegal trades occurred in opaque corners of Wall Street may add evidence of the need for more transparency.

-- Written by Antoine Gara in New York

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