SEC terminates Cyber-Fraud ring that netted $100 million in CFD trading

Published: 17 September 2015
By: Tom Cleveland

The SEC does not approve of insider trading of any kind, no matter where it takes place across the globe. Its long arm of the law recently reached across national borders to the Ukraine to shut down a highly lucrative cyber-hacking ring that had netted some $100 million in illegal profits. The ring obtained vital press release information, before it had been made public, and then used that information to secure profitable trades in the Contracts for Difference (CFD) market from 2010 through 2014.

The first announcement about these crimes originated in August, but the news today is that $30 million of these ill-gotten gains have already been retrieved from Jaspen Capital Partners Limited, another Ukrainian investment company. This partial settlement is the result of civil actions taken against some 34 individuals, many of who are still at large, awaiting arrest and prosecution.

Back in August, Mary Jo White, the Chair of the Securities and Exchange Commission (SEC), had revealed that, “This international scheme is unprecedented in terms of the scope of the hacking, the number of traders, the number of securities traded and profits generated. These hackers and traders are charged with reaping more than $100 million in illicit profits by stealing nonpublic information and trading based on that information. That deception ends today as we have exposed their fraudulent scheme and frozen their assets.”

Andrew Ceresney, Director of the SEC’s Division of Enforcement, also expanded upon Ms. White’s comments by adding, “This cyber hacking scheme is one of the most intricate and sophisticated trading rings that we have ever seen, spanning the globe and involving dozens of individuals and entities. Our use of innovative analytical tools to find suspicious trading patterns and expose misconduct demonstrates that no trading scheme is beyond our ability to unwind.”

What was the nature of this Cyber-Fraud ring’s activities?

As we have written in previous articles, Cyber-related crime is mushrooming across the planet, approaching an annual toll of nearly $1 trillion in lost funds and time and effort to fix the problems created. Law enforcement officials also estimate that this type of crime is growing at an annual rate of 50%, touching anyone that accesses the Internet from any type of device. This particular cyber-crime ring used insider trading to access its riches. Extracting illicit profits from the market in this way leads to higher transaction costs for everyone in the long run, an insidious way of impacting us all.

The ringleaders of this affair, as alleged by the SEC, were Ivan Turchynov and Oleksandr Ieremenko, who used high tech protocols to hack into the private networks of major press release organizations. They gained access to important corporate earnings information, sometimes days or even minutes before their publication, and then funneled the data to traders in the Ukraine, Russia, Malta, Cyprus, France, and three U.S. states, Georgia, New York, and Pennsylvania. These traders would then buy or short the requisite stocks or deal in CFDs to amass their profits.

Turchynov and Ieremenko remain at large, but ongoing investigations and analysis have pinpointed several patterns of abuse and the entities and individuals that perpetrated the fraudulent activities. Current estimates put an upper limit of $100 million on the illicit gains, but this figure could easily grow as more information is gathered.

An ecstatic Andrew J. Ceresney, Director of the SEC's Enforcement Division, was eager to point out that, "Barely a month after we froze tens of millions of dollars in illegal profits from the defendants' trading on illegal inside information obtained from hacked news releases, we obtained a settlement with foreign traders that deprives them of their wrongful gains. Today's settlement demonstrates that even those beyond our borders who trade on stolen nonpublic information and use complex instruments in an attempt to avoid detection will ultimately be caught."

What is it about CFDs that was so appealing to these crooks?

To understand why fraudsters chose the CFD route to convert their insider information into real profits, one need only review the checkered past of these trading instruments, how brokers make money and operate their back-office, and how these particular crooks leveraged the CFD system for gain. The key to remember is that the crooks wanted to avoid detection at all costs. They were not trying to make big bucks on a single trade. They had hacked into a “gold mine”, from their perspective, and wanted to milk this opportunity for all that it was worth, a period that actually extended over five years.

CFDs originated back in the 1990s in London as an effective hedging instrument for stocks bought on the margin. They were similar to spread betting, another UK phenomenon, and soon gained popularity. In the early 2000s, they were popularized even more when their use was extended to currencies, commodities, and to stock indices. They were a cheap way to gain a large position in the market with a small amount of capital, something that small retail investors jumped on in droves.

If you wish to trade these instruments, then you must find a CFD provider. Trading is over the counter with the provider and rarely performed through an exchange, although Australia has tried to formalize the exchange process with little success. Today, CFDs are available in Australia, Austria, Canada, Cyprus, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, The Netherlands, Luxembourg, Norway, Poland, Portugal, Romania, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom and New Zealand.

The United States and a few other major markets, like Hong Kong for example, have not embraced the CFD concept. A CFD does not have an ownership interest in the underlying security it represents. It is merely a contract between the buyer and the CFD provider. CFD providers have avoided the U.S. market because a CFD technically falls within the definition of a security-based swap (SBS) under the Dodd-Frank Act, and, as such, the act requires all SBS instruments to be traded on an official exchange and fall within the regulatory purview of the SEC, the CFTC, and the NFA. Global CFD brokers have refused to meet these compliance requirements. As a result, CFDs are forbidden in the U.S. for the time being.

Crooks, however, gravitate to environments where anonymity reigns supreme, and this situation currently exists in the back-office operations of CFD providers. A CFD provider can be a market maker in these instruments or be what is called a Direct Market Access (DMA) shop. The latter type of provider actually goes to an exchange and matches one-for-one each CFD transaction that it enables, a very costly process that is not the preferred route. CFD providers prefer to make book on their own CFDs, calculate spreads and margins based on their own needs, and buy and sell only with their customer base without the involvement of any exchange.

By avoiding an exchange, these CFD transactions literally become under the radar, so to speak. Brokers do not publish any trading data. Ownership transfer in an actual stock, commodity, currency pair, or index never takes place in the market, such that regulators are blind to the goings on behind the CFD provider’s storefront. Providers are free to consolidate their combined risk in the back-office, and, when necessary, they will hedge their book and bets by actually buying the real securities or related derivatives from a regulated exchange.

Turchynov and Ieremenko, the crooks behind this fraudulent scheme, demanded, however, full transparency from their trading partners. They stipulated that separate trading accounts must be maintained and shared in order to determine their take in the process. U.S. partners traded in stocks, since CFDs were forbidden, and their non-U.S. partners chose to use CFDs as their method of choice. All went swimmingly well for five years until law enforcement officials caught them red handed.

How did the SEC detect insider trading and charge these defendants?

As experienced crime fighters will tell you, the criminal element in our society is very organized, well funded, and fully capable of using leading-edge technology to further its schemes. In this case, sophisticated hacking software was utilized to gain access to insider information that supposedly had been encrypted for security purposes. As it turned out, the SEC also was using “innovative analytical tools to find suspicious trading patterns and expose misconduct.”

The process in the United States would have been easier since the trading partners had to deal in stocks on regulated exchanges, but the same patterns would have shown up on detection systems when CFD providers went to market to hedge their open risk positions created by the trading partners within their own shops. The SEC also relied on other domestic and foreign agencies, such as Department of Homeland Security and the U.S. Secret Service, the Financial Industry Regulatory Authority, the United Kingdom Financial Conduct Authority, and the Danish Financial Supervisory Authority.

According to its filings, “The SEC’s complaint charges each of the 32 defendants with violating federal antifraud laws and related SEC antifraud rules and seeks a final judgment ordering the defendants to pay penalties, return their allegedly ill-gotten gains with prejudgment interest, and be subject to permanent injunctions from future violations of the antifraud laws.”

Concluding Remarks

The good news today is that, “The Securities and Exchange Commission has announced it has reached a $30-million US settlement with international traders who benefited from insider information hacked from business newswires. The $30 million settles SEC allegations against Ukrainian-based Jaspen Capital Partners Ltd. and its CEO Andriy Supranonok, who were among 34 defendants facing civil charges from the U.S. regulator. Nine people still face criminal charges and another 32 face civil action.”

The bad news is that Turchynov and Ieremenko are still at large, as well as another 30 defendants and an estimated $75 million in illicit trading profits. CFD providers will have to absorb these costs in the best ways that they can – by charging higher fees, ignoring stop-loss orders, forcing re-quotes, or widening Bid/Ask spreads.

We can also rest assured that officials have the tools necessary to police this OTC and shady market. According to Michael J. Osnato, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit, “This case should serve as a shot across the bow of any trader who thinks that CFDs traded outside the United States can be used to mask their unlawful conduct. The SEC’s use of sophisticated analytical tools to identify abusive CFD trading like this demonstrates our ability to police this opaque market.”

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