The U.S. Securities and Exchange Commission sued unknown traders over “suspicious trading” in H.J. Heinz Co. just a day before Warren Buffett and 3G Capital Inc. announced a $23 billion takeover of the ketchup maker.
The SEC alleged in a complaint filed Friday in Manhattan federal court that the traders earned $1.7 million by purchasing Heinz stock just before the announcement was made. The trading in the deal, which Heinz and 3G said is the largest ever in the food industry, was carried out through a Zurich, Switzerland- based account and involved call-option contracts, the SEC said.
Trading in the options gives the right to buy the underlying shares and profit when the stock rises. The timing and size of the trades were deemed highly suspicious by the SEC because the accounts through which the traders purchased the options had no history of trading Heinz securities in the last six months.
“Irregular and highly suspicious options trading immediately in front of a merger or acquisition announcement is a serious red flag that traders may be improperly acting on confidential nonpublic information,” Daniel Hawke, of the SEC enforcement division's market-abuse unit, said in a statement.
The SEC said yesterday it obtained an emergency court order to freeze assets in the Zurich-based account. The account used by the defendants was identified in the SEC complaint as “Switzerland GS Bank IC Buy Open List Options GS & CO c/o Zurich Office.”
Tiffany Galvin, a spokeswoman for Goldman Sachs Group Inc., said the bank is “cooperating with the SEC's investigation.”
The order prohibits the traders from destroying any evidence and the SEC seeks a final judgment ordering them to disgorge their ill-gotten gains with interest, financial penalties and a permanent ban from future violations.
“Despite the obvious logistical challenges of investigating traders involving offshore accounts, we moved swiftly to locate and freeze the assets of these suspicious traders, who now have to make an appearance in court to explain their trading if they want assets unfrozen,” said Sanjay Wadhwa, senior associate director of the SEC's New York Office.
The SEC alleges the defendants invested almost $90,000 in option positions the day before the deal was announced. As a result, their position increased to more than $1.8 million, a rise of almost 2,000 percent in one day.
The SEC said that the traders had material nonpublic information about the impending deal when they used an omnibus account in Zurich to buy 2,533 out-of-the-money call options, which had a strike price of $65 on Feb. 13. Shares closed that day at $60.48.
The purchase of these so-called “June $65 call options,” which expire on June 22, 2013, was highly unusual, the SEC said. On Feb. 12, only 14 were purchased, regulators said, while on Feb. 11, no such options were bought. Since Nov. 14, no more than 61 such contracts had been purchased on any other single day, the commission said.
Heinz shares jumped 20 percent to $72.50 on Feb. 14 following the announcement that Buffett's Berkshire Hathaway Inc. and Jorge Paulo Lemann's 3G Capital agreed to buy the Pittsburgh-based company.
As a result of the takeover announcement, the price of the June call options jumped to a close of $7.33 on Feb. 14 from 40 cents the day before, an increase of more than 1,700 percent.
Trading volume skyrocketed on Feb. 14 on news of the acquisition, the SEC alleged, reaching more than 64 million shares, an increase of more than 1,700 percent, the SEC said. The increase was the highest level since Jan. 31, according to data compiled by Bloomberg.
“The timing, size and profitability of the defendants' trades, as well as the lack of prior history of significant trading in Heinz,” made the transactions “highly suspicious,” the commission said in its complaint, which accuses the unnamed defendants of violating the Exchange Act.
Neither 3G nor any of its employees have been accused of wrongdoing.
Michael Mullen, a spokesman for Heinz, declined to comment on the suit. Buffett didn't immediately return an e-mail left yesterday with an assistant seeking comment on the complaint.
The agency has been increasing its focus on insider trading by overseas buyers of U.S.-traded securities. As of December, the SEC had filed three times as many emergency asset-freeze requests in such cases since 2010 as in the prior two years. The regulator cited suspect trading patterns, typically before mergers or other market-moving news.
One recent SEC case involved another deal connected to 3G Capital. In November, a Brazilian ex-banker and his firm agreed to pay $5.1 million to settle SEC claims that he made illegal trades ahead of 3G's 2010 acquisition of Burger King Holdings Inc.
According to the SEC, Igor Cornelsen learned about the impending merger from a Wells Fargo & Co. broker, whose client had invested with 3G and knew about the acquisition.