GUEST BLOG: Weird Apple Pickings by Aegis Frumento Esq

February 28, 2019

Weird Apple Pickings

Lawyer Gene Levoff was, until last September, in charge of policing Apple Computer's compliance with the securities laws. It was his job to make sure that Apple insiders did not trade Apple stock prior to public earnings releases, during so-called "blackout periods." Material non-public information is thought most likely to exist when facts and figures are being compiled to prepare public disclosures. Trading on material non-public information about a company is what we colloquially call "insider trading," and one of Levoff's top jobs was to prevent Apple employees from doing it. 

In one of the weirdest of cases, last week the SEC charged Levoff himself with insider trading. On three occasions in 2015 and 2016, Levoff sold and bought Apple shares during blackout periods. Levoff made or avoided losses totaling $384,000, trading stock worth over $12 million. His illegal trades maybe yielded 4%, which I suppose looked like a pretty good annualized rate of return at the time. Levoff may not think so anymore. On top of the SEC's civil case, he faces up to 20 years of jail time on a related criminal count.

Levoff graduated from Stanford Law School, so he must be smart, but there's little evidence of that here. The conduct described in the SEC's complaint is such that I hesitate to call him stupid -- for fear it would insult the low-IQ crowd the President often talks about. The best explanation I can conjure is that, for some psychological reason that the SEC doesn't get into, Levoff just wanted to get caught. 

Here's the timeline laid out in the SEC complaint for the first and biggest of Levoff's trades. On July 26, 2015, Apple sent its employees an email that a blackout period would begin on June 1, and last until the beginning of trading on the third day after third quarter earnings were released sometime in July. On Friday, July 10, Levoff and other members of the Disclosure Committee got draft earnings data and a draft 10Q. On Monday, July 13, Levoff co-chaired a meeting of the Disclosure Committee to discuss the drafts. On Friday July 17, Apple announced that it would release its third quarter earnings on Tuesday, July 21, and it did so that day after the close.

Between July 17 and July 21, Levoff allegedly sold over 70,000 shares of Apple, just about all his holdings, worth about $10 million. His timing was impeccable -- he allegedly sold several days after he reviewed the draft 10-Q and on the day that Apple announced when the earnings would be released.

But Levoff's weird trading is only half of it. There's a deeper story, and the SEC, which always seems to skim the surface of things, hasn't gotten it. To see what more is going on, you have to look at Apple's stock price during this time-frame.

From May 26, when the blackout period was announced, Apple's price dropped steadily. It started falling before the start of the blackout, and it continued falling through the entire blackout period. There seems to have been a lot of clairvoyance amongst Apple watchers. This is no surprise. Let's face it: many Apple employees -- most not even subject to the blackout (which usually only applies to management) -- knew the general tenor of Apple's earnings well in advance of the actual compilation of results into the formal documents. And then, as if to score the point, Apple's stock price collapsed on July 9, the day before Levoff and the Disclosure Committee got the draft 10-Q. Clearly a lot of people knew what the Disclosure Committee would be getting the day before. Levoff didn't sell anything during that whole rundown, but there were sellers anticipating the news. Where are those insider trading cases?

There are no such cases, because there'd be no way to prosecute them. The problem with insider trading is that it is largely a technical offense. There has to be something concrete enough to be deemed "factual" information before anyone can illegally trade on it. But much of the information we rely on every day is not concretely factual. My "sense" that things aren't going as planned -- gleaned around the water cooler from my friend's worry over sales numbers, or my other friend's frustration over not being able to ship backed-up orders -- is quite enough for me think the stock will take a hit. So long as I have a good sense of the direction, I don't need to know anything about the magnitude. I certainly don't need to see the 10-Q to make a profitable trade. Decades of research have demonstrated that corporate insiders, even when complying with blackout periods, outperform the market by about 10%. I co-wrote an article five years ago arguing that much of the knowledge needed to make profitable trades isn't even "inside information" under the securities laws. See,

But after that consistent run-down, immediately before the earnings release, Apple's price inexplicably spiked. That's when Levoff is alleged to have sold. That's when the weirdness starts.

The first weird thing about all of this is that Apple's 3rd Quarter earnings showed record results, and encouraging prospects. The only thing not to like about them was that they didn't meet analysts' "expectations." Let's go on a riff here, starting with the question, "Who cares?" Failing to meet "analyst expectations" is just another excuse we give for random market movements we don't -- and can't -- really understand. No doubt there are patterns in Apple's stock price that mean something to someone, using names as quaint as a "double-shoulders formation" or as sophisticated as a "regression to a mean." The truth is that we humans are built to see patterns in every random thing we run into. Those who read much into stock price patterns err to think themselves much more enlightened than those who see the face of Jesus in their morning toast.

Regardless, most folks assumed that not meeting "analyst expectations" would lead Apple's price to drop, so they sold Apple, which of course caused Apple's price to drop. Surely the market "knew" that the earnings report would be a downer, by someone's definition. But then, for whatever reason, a determined cadre of investors thought Apple was a BUY. It looked like a tug of war between those who thought record earnings would be good against those who thought not meeting expectations would be bad. Who knows? What we do know is that Levoff didn't cause the increased demand. Those investors who bought Apple on July 17, 20 and 21 would still have bought it whether or not Levoff sold. Therefore, had Levoff not sold, Apple's price would have spiked even higher. Levoff, by supplying some of that sudden demand, actually helped to stabilize the price, and to a degree mitigated the losses later suffered by those buyers. To be clear -- Levoff's sales injured absolutely no one and did not harm the market one bit. 

None of this is to excuse Levoff. What he allegedly did was criminal and stupid, and if he goes to jail for it, he deserves it -- though it's a tough call whether more for the criminality or the stupidity of it. After all, he owned $10 million in Apple stock. Why risk prison just to save a few hundred thousand dollars of it? If he'd done nothing, that stock would today be worth $13.5 million, and he'd be free to spend every penny of it. But even if Levoff felt compelled to sell, had he sold on May 25 instead of July 20, he would have been in the clear and made the same profit. Had he sold on July 24 instead of July 20, he would still have avoided -- legally -- the bulk of the losses that occurred in the subsequent weeks going into August. Had he entered into a Rule 10b5-1 trading plan before the blackout, he would have been fine. There were so many ways for him to peel this apple. He chose the one way that guaranteed he'd be caught. That's weird. And he might go to jail for a completely victimless crime. That's weirder still.


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.

Also READ:  "The Apple Of My Ire" ( Blog, February 18, 2019)