Tired of earning 1% or less on your investments? Want to earn 3,500% a month? From your couch? Using mostly your brother’s money? It’s easy. All you need to do is read financial reports, analyst reports and academic literature. Or so claims 26-year-old Californian Toby Scammell in his blog article defending his 3,500% return against SEC charges that he lifted the identity of Disney’s secret 2009 acquisition target (Marvel Comics) from the Blackberry of his girlfriend, an extern working on the acquisition for Disney. Click here for the update on this story.
Or perhaps he learned Marvel’s identity by overhearing one or more of his girlfriend’s business conversations, or by reading electronic or paper documents in her possession, or through conversations with her. The SEC is not entirely sure. But the SEC is sure that Scammell, an amateur online investor, learned that Disney planned an acquisition, that the target was Marvel, and that the announcement date was to be the end of August. In short, everything one would need to know to make a tidy profit buying Marvel shares.
And a tidy profit was made. Scammell bought a slew of call options in Marvel stock just before the acquisition announcement, and he earned 3,500% on his investment after the announcement. This prompted an investigation by the SEC, which culminated in a Complaint charging Scammell with insider trading. Although the SEC does not allege exactly how or when Scammell learned the target was Marvel, the Complaint nevertheless paints a damning picture that Scammell did in fact learn this information from his girlfriend.
The Girlfriend’s Top-Secret Disney Gig
According to the SEC, shortly after Scammell’s girlfriend began an externship in Disney’s corporate strategy department in June 2009, she emailed Scammell to excitedly report that she may be working on a big acquisition, the target of which she could not identify due to “confidentiality,” but she said “it’s very recognizable and nothing I’ve mentioned before.” She worked long hours for five weeks, sometimes from home, and received detailed information about the acquisition, including three key facts: the identity of the target (Marvel), the $50 price, and the announcement date. Scammell and his girlfriend often discussed the acquisition, including a discussion that she should delay her business school applications so she could write about this big project in her application materials.
During this time, says the SEC, Scammell had the password to his girlfriend’s Blackberry, allegedly “so that he could look up an address or directions.” A trader without his own smartphone, really? The SEC never specifically alleges that Scammell swiped the target’s identity from email or documents on her Blackberry. Instead, the SEC alleges more generally that:
By no later than August 13, 2009, Scammell had obtained the identity of the acquisition target from his girlfriend, whether through overhearing one or more of his girlfriend’s Marvel-related conversations, by seeing electronic or paper documents in her possession related to the Marvel acquisition, or through her conversations with him.
Scammell then went shopping for Marvel call options on his Ameritrade account. Over a two-week period, he purchased 659 Marvel call options with strike prices of $50, $45, and $40. All but three of these options had a very short expiration date of September 19th. His options amounted to a risky bet that Marvel’s stock price would rocket up in the next two to four weeks.
It did. The Marvel acquisition was announced August 31, 2009, and between that date and September 9, 2009, Scammell sold all of the options for a total of $197,960 — a profit of $192,496.
The Magnitude of this Mother Lode
We should pause for a brief aside on the magnitude of Scammell’s return. He earned a return of 3,500% in one month ($192,496 in profit, divided by his $5,464 investment, times 100). Let’s do a quick thought experiment with this. He claims he selected the Marvel investments — not because he had inside information from his girlfriend — but rather through his own rigorous research into Marvel. If true, he’s somewhat of a prodigy at using publicly-available information to deduce the identity of acquisition targets, and the announcement dates. So perhaps it would not be too far-fetched to imagine that he could identify a second, similar deal.
Assume he did, and that he invested his gains from the Marvel trades into this second deal through a set of call options that also generated a return of 3,500%. How much would he have after this second deal? That is, how much would his original $5,464 grow to if he found a second deal that paid the same return he earned on Marvel. Answer: $638 million!
Let’s go one more for fun. He invests his total gains from the first two deals into a third deal, also returning 3,500% (note: finding $638 million in options would be problematic to say the least, but bear with me). How much would he have after this third deal? $2.3 trillion! Yep, after just three deals, at his Marvel-deal rate of return, his $5,464 turns into $2.3 trillion. That’s 46 Warren Buffetts, after just three deals. Such is the incredible power of a 3,500% return.
Am I my Brother’s Keeper?
Scammell spent a total of $5,464.16 on the options. But it wasn’t all his money. In fact, most of the money ($2,800) came from an account held by his brother. Scammell’s brother, a soldier, had given Scammell power of attorney over his account when he deployed to Iraq. The brother’s reposing of trust in Scammell was misplaced. After helping himself to his brother’s funds, Scammell never told his brother that he’d bought Marvel options, or that he’d earned $100,000 on his brother’s trades. Instead, Scammell transferred the $100,000 into another account controlled by Scammell.
Where’s the Proof Scammell Got the Target’s Identity from His Girlfriend?
As mentioned, the SEC seems to have no direct evidence that Scammell learned the identity of the target from his girlfriend or her materials. Is this lack of proof a problem? Probably not. There are host of other factual circumstances beyond the return, and his girlfriend’s connection to the acquisition, that tend to prove he did in fact learn the information from his girlfriend. Here are just a few examples mentioned by the SEC:
- He’d never invested in Marvel before;
- During the time he invested in Marvel, he bought no other securities;
- He’d bought options only once before (for Google), but they had expirations of over a year, and he lost 99% on them;
- He knew Marvel had never traded above $41.74, yet bought very short-term options at $45 and $50, betting the stock would rocket up within two to four weeks;
- His Marvel options represented 90-100% of the daily market volume for those options — in other words, he was essentially the only investor making this risky short-term bet on Marvel;
- The first set of options he bought had a $50 strike price – Disney’s acquisition price for Marvel;
- He appeared desperate to buy more options on the last trading day before the acquisition announcement, placing ten separate limit orders for options with a $40 strike price, each time canceling the unfilled prior order and raising his bid until finally, just minutes before trading closed, he was able to purchase them;
- On or around August 16, 2009, before he bought most of the options, he searched the Internet for the terms “insider trading,” “tender offer,” “Williams Act,” “Rule 10b-5,” and “material, non-public information,” and read several articles on Wikipedia regarding those topics;
- He told nobody he was researching or investing in Marvel, not even his brother, despite spending the weekend with him two days after investing his brother’s funds;
- He told nobody about the $192,000 in profits;
- His brother did not learn of his own $100,000 in profits until he was contacted in connection with the SEC investigation in November 2009.
The SEC also notes that Scammell provided no credible explanations for his trades. He claimed he did extensive research on Marvel’s earning the first week of August, but the materials he claims he read, at best, painted a mixed picture (if not negative) regarding Marvel’s future earnings, and none suggested the stock would increase substantially within two to four weeks. These facts, if true, point strongly to one conclusion: Scammell traded on material non-public information his got from his insider girlfriend. But the SEC complaint is just a set of allegations. Scammell has the right to dispute the claims. In fact, he’s already done so in a most self-destructive and asinine manner: in a blog berating the SEC and its case.
An Attorney’s Nightmare — Scammell Berates the SEC in a Blog
In a highly unusual and ill-advised counterstrike, Scammell subsequently created a blog called “#SECfail,” (regrettably now defunct) in which he claims his spectacular trades were based on his research, and rips the SEC as “an incompetent government agency filled with bumbling lawyers who don’t understand the first thing about the markets they’re charged with regulating.” He then adds, for good measure, that he has “no doubt a random selection of TSA screeners and postal workers would do a better job if their only training involved watching an hour of CNBC.”
In an interview with DealBook, Scammell said he launched the blog while his attorney was on vacation, and did not know if his attorney approved of it. Well, we know, don’t we? He doesn’t approve. How could he? The blog is unprofessional, immature, loaded with irrelevancies, and it contains damaging admissions. It’s also calculated to anger the very people he may need to strike a deal with later. There is no upside to his blog. Just downside. And he will see his blog again, when it is waved around and quoted during his cross-examination at trial.
A Final Note on Insider Trading Liability
Insider trading law can be confusing. Understanding one key part really helps. And that’s the concept of “a duty of trust or confidence.” In simple terms, insider trading law prohibits “the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.” SEC Rule 10b5-1 Thus, to be liable, the trader must have material nonpublic information and the trade must be in breach of a duty of trust or confidence. So what is “a duty of trust or confidence?” A simple example involves a corporate officer provided information about his company’s secret plans to acquire another company. Such information was provided to him with the understanding that he keep it confidential and not trade on it. This is an example where the investor (the officer) owes a duty to the company and its stockholders not to misuse corporate information that was given to him in confidence. But the rule goes beyond corporate insiders — as the rule says, the duty can be owed to “any person who is the source of the information.” This is fairly broad. The SEC has a rule to help understand just how broad it is. The rule defines “a duty of trust or confidence.” It provides:
For purposes of this section, a “duty of trust or confidence” exists in the following circumstances, among others:
1. Whenever a person agrees to maintain information in confidence;
2. Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or
3. Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties’ history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.
SEC Rule 10b5-2. Number 1 would cover Scammell’s girlfriend if she herself tried to trade. She agreed with Disney to keep the acquisition details secret. So she can’t trade on it without liability. But the case is against Scammell. And the question is whether he owed a duty of trust or confidence to his girlfriend, who is “the source of the material nonpublic information.” The SEC says yes. The SEC is essentially contending that Scammell and his girlfriend had a “history, pattern or practice” of sharing confidences (number 2 above), and/or, that their boyfriend-girlfriend relationship is essentially the same as the relationships listed in number 3 (e.g, spouse). In short, Scammell owed his girlfriend “a duty of trust or confidence” that was breached when he used her confidential information about the Marvel acquisition to trade.
Here’s one last point to understand the requirement that there be a breach of “a duty of trust or confidence.” Say you are at a bar sitting near two executives who are chatting. You walk by to go to the restroom and overhear one blurt out to the other: “we are announcing Disney’s acquisition of Marvel on August 31th.” Can you trade on this information? Probably yes, because you do not owe a duty of trust or confidence to strangers in a bar. That’s the dividing line between the stranger scenario and Scammell’s. He does not seem to contest, at least not in his blog, that he owed his girlfriend a duty of trust or confidence. We can bet, however, that at trial his lawyer will want to argue that Scammell did not owe such a duty, at least as an alternative theory of defense. This is one example where his blog, which weds him to a specific story, can come back to haunt him.
Published by Jeremy L. Bartell
Financially Regulated is published by Jeremy L. Bartell, a long-time admirer of Wall Street and its interesting cast of regulators. Jeremy is an attorney with Bartell Law in Washington D.C. He represents financial professionals nationwide in Finra inquiries and investigations, Finra arbitration, securities employment disputes and registration and disclosure matters.