#SECfail

Day 1

I am Toby Scammell and last week I was sued by the SEC for insider trading. The SEC’s complaint against me is so riddled with omissions, distortions and inaccuracies that it’s hard to know where to begin. To grab headlines the SEC has concocted an imaginative story that’s not supported by the facts.

Here’s a top 10 list of facts they forgot to mention or knowingly distorted:

  1. There’s s no evidence to suggest I received material, non-public info. The SEC reviewed gigabytes of data and conducted hundreds of hours of depositions under oath. With tens of thousands of emails, texts, and instant messages processed the SEC can’t even muster an out-of-context quote (as they’ve done elsewhere) to support their claim that I knew something. On the contrary, my girlfriend made it clear from the outset that she wouldn’t tell me what the target was, and I never asked. The SEC is making an illogical leap and assuming that I knew what my girlfriend knew. Call it the SEC’s transitive theory of insider information: If Person A knows Person B and Person B knows Fact C then Person A knows Fact C. Based on that standard, well-networked investors everywhere should be sued and embarrassed in the press, not for receiving information but merely for their relationships.
  2. I never traded “secretly” in my brother’s account. I began managing my brother’s finances years before any Marvel trades. Ever since I’ve managed every investment, account opening, tax filing, transfer, credit card application and payment with his full blessing. The two trading accounts used to buy Marvel—his taxable brokerage and my IRA—were accessed through a single login, which meant that with one click I could trade for either of us without regard for whose name was on the legal docs. Over the years I’ve only rarely given him an annual update on his investments let alone asked him for his input before or after a trade.
  3. I didn’t have “limited funds” at any time while trading Marvel. I personally had at least $7500 in cash on hand at all times throughout August. At no point in August did I have less than $120k in buying power at my disposal—enough to repeat my Marvel trades 20 times. And based on my compensation at work, I earned $5500 every eight days. If that qualifies as “limited funds” then the SEC must consider Warren Buffet to be middle class.
  4. During the last three weeks of July 2009 I worked full-time on a confidential Disney consulting project. This involved research and analysis of Disney’s competitors including Marvel. I had no access to material, non-public information from either Marvel or Disney during the project, but our data set included analyst reports, industry reports, and academic literature. It was during this project—and based on the SEC’s timeline, prior to my girlfriend being assigned to work on the acquisition—that I heard Disney had been trying to buy Marvel for years. (This was later confirmed to be a known fact inside media circles by multiple news articles.) My search history confirms my memory of this event almost to the minute.
  5. My searches for “insider trading” and “material, non-public information” were blatantly taken out of context in the complaint. The SEC forgot to mention that my web history shows all of these searches and pages directly stemmed from a Wall Street Journal article I was reading about Mark Cuban’s SEC case. These searches had nothing to do with Marvel. There were hours and hundreds of links separating these visits from anything related to Marvel. And, these searches occurred days after my first Marvel trades. All of this was captured minute-by-minute and link-by-link in my web history.
  6. The SEC’s timeline doesn’t make sense. My web history (the same one the SEC quoted in their complaint) shows Marvel-related research months before my girlfriend started working at Disney. I searched for “marvel disney acquisition” before my girlfriend was assigned to work on the project. My Marvel web research continued well after the SEC claims I knew Marvel was the target—totaling at least 47 searches and pages from August 13th onward; all related to topics that would have been irrelevant had I known Marvel was about to be acquired. And in terms of physical proximity, there were only five nights when my girlfriend was assigned to the Marvel project when I stayed in her apartment. During that period I viewed only one Marvel-related webpage.
  7. My Google Web History proves hours of methodical Marvel-related research in July and August. The distribution of this research supports my testimony about Marvel’s earnings report, the ~10% fall it suffered shortly thereafter, and why I went from passively following to actively researching the company. My research included:
    -analyst recommendations

    -analyst report summaries
    -articles discussing Marvel’s earnings report
    -Marvel financial statistics
    -Marvel insider trades
    -Marvel‘s ownership mix
    -Yahoo! Finance discussion boards on Marvel
    -Biographies of members of Marvel‘s management
    -technical analysis of Marvel‘s stock price
    -articles discussing Marvel technical analysis
  8. My trading before and after Marvel shows a clear, consistent pattern: one of aggressive, short-term, event-driven and technically-driven trades. I have years of history trading penny stocks and speculating on FDA approvals, acquisitions, earnings calls, and political events. In 2004 I spent four months researching and writing a book on scenario-based trading. In 2009 I had ~$1.1 million worth of trades, $861k of which was non-Marvel options trading—all naked call options. After Marvel I more than doubled the value of my IRA in less than three months—purely through short-term options trades (46 trades across seven companies over a roughly 90 day period). Compared to my Marvel purchases, my prior options trades were quantitatively higher risk and more than five times further “out of the money” than Marvel. I lost every penny on those options, but only because I screwed up the timing of my exit. I would have more than tripled my money if I’d sold within 60 hours of my purchase.
  9. The SEC doesn’t understand the difference between public and employee options. In general employee options are worthless unless the share price hits the strike price. Not so with publicly traded options, which are commonly bought and sold while they’re very far out of the money. Yet the SEC continues to think of a strike price as a necessary threshold below which one can’t make money. They think a strike price is a price target, which it’s not unless one is planning to hold an option to expiration—a rare and (in my case) unaffordable strategy. The SEC lawyers have been confused about this from day one. Now they’ve made their confusion public by ignorantly misstating that my trades were “highly-remarkable” and “unusual” simply because the strike prices were above Marvel’s recent $41.74 high. The SEC would do well to examine the hundreds of millions of dollars in out of the money options transactions every day that fit their definition. This is truly one of the most basic and easily understood options concepts around, and yet the SEC doesn’t get it and uses this as the basis for their claim against me.
  10. I dumped thousands of dollars worth of Goldman Sachs call options hours before the SEC sued the company in April 2010. I had a relationship with the SEC. Shouldn’t I be sued for insider trading in this case too…? 

And there’s more…

  1. SEC believes Disney and Marvel management lied in their S-4 filing
  2. SEC doesn’t realize you can experience higher percentage gains on a call option than you can on the underlying stock
  3. SEC doesn’t realize that companies can report negative earnings and still beat expectations
  4. SEC believes options always trade at the their theoretical value
  5. SEC can’t figure out where I live so they guess randomly

Like any other claimant, the SEC can say whatever they want in their lawsuit, even if it’s knowingly false, taken out of context and only intended to grab headlines. If the SEC understood how to read a bank statement or how call options worked then I wouldn’t be writing this. But this is the SEC—an incompetent government agency filled with bumbling lawyers who don’t understand the first thing about the markets they’re charged with regulating. They’re the financial regulatory equivalent of the DMV, except their lawyers lack domain expertise. I have 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.

Unfortunately, I will never be in a position to prove I had no material, non-public information about the Marvel deal. I can’t prove a negative. But the SEC has had nearly two years to examine every document imaginable including;

  • Every email, text message, and instant message I sent or received for months before and after my trades
  • Every bank statement, pay stub, trade confirmation, and tax document going back as many years as possible
  • Every phone record from months before and after my trades
  • Every piece of communication between me and my girlfriend for a period of a year or more
  • Every website I visited and every search term I entered over an approximately two year period (as captured by my Google Web History)
  • Thousands of other documents from other people and companies who received subpoenas

and after looking through hundreds of thousands of pages the SEC hasn’t found a sliver of information that suggests I possessed material, non-public info that related to my trades in Marvel.

Contrast that absence of evidence with an overwhelming amount of time and date stamped web research, a trading pattern that is consistent with my Marvel trades, and a logical, well-supported thesis that was independent of a Marvel acquisition.

For four days I answered hundreds of SEC questions under oath, even the ones that demonstrated my interrogators had a stunning lack of knowledge about investing, acquisitions, or how to read basic financial documents. They have ignored all the evidence and sued me based on nothing more than a hunch and a flawed understanding of how people invest in the real world.