Employees Implement Trading Scheme Defrauding "Big Oil"
Well this is a refreshing change. We normally read about unscrupulous people preying on the general public. In this case, we see a couple of devious individuals (Clay Krhovjak and Paul Cochran)who set out to screw "Big Oil" - Coastal, Inc...Although, I'm sure some people probably don't really care. Coastal engages in petroleum refining, marketing and distribution, natural gas transmission and storage, and oil and gas exploration and production from its world headquarters in Houston, Texas. They have recently merged with El Paso.
The CFTC alleges that over a five-month period in 1996, Krhovjak and Cochran defrauded Coastal in a scheme to allocate profitable trades belonging to Coastal to accounts controlled by other unnamed scheme participants. In 1996, both Krhovjak and Cochran, who were Assistant Vice Presidents at Coastal's commodity futures trading desk in Houston, Texas, were responsible for placing energy futures orders for Coastal with floor personnel at the New York Mercantile Exchange (NYMEX), according to the complaint. The complaint alleges that one of the NYMEX floor operations Coastal used in 1996 was Refined Energy, Inc. (Refined) of Red Bank, New Jersey, and it was through Refined that this scheme was conducted. This allocation scheme ensured Cochran, Krhovjak and other participants risk-free personal profits, according to the complaint.
The complaint alleges that Krhovjak and Cochran fraudulently allocated trades or traded ahead on nine different days between June and October 1996. From those misappropriated trades, Krhovjak, Cochran and their co-participants received $89,228 in stolen profits, according to the complaint. The profitable, stolen Coastal trades were directed to an account in the name of Ocean East, Ltd. ("Ocean East"). The Ocean East account was controlled by another member of the scheme.
During the relevant period, Krhovjak and Cochran also traded ahead of Coastal's trades. Using their positions as traders for Coastal to obtain advance knowledge of trades Coastal planned to make on any given day, Krhovjak and Cochran deliberately purchased and sold futures contracts for accounts controlled by their confederates while holding executable Coastal orders, thus taking the same side of the market as Coastal. As a result, Krhovjak and Cochran received better fills than Coastal did. Profits from Krhovjak and Cochran's trading ahead activities were also directed to the Ocean East account.
To put it in similar terms, Krhovjak and Cochran setup up their own trading account named Ocean East, Ltd. They obviously knew the moves that their employer would make in the futures markets, i.e. placing trades, hedging, etc. In reading through the complaints, the CFTC alleges two major activites. First, Krhovjak and Cochran would place trades for Coastal. Then, through Refined Energy, they simply allocated some profitable trades into their Ocean East account. As for the unprofitable trades...they made sure they stayed in Coastal's account. It's a pretty simple process. They basically "cherry-picked" some profitable trades and had them directed to their personal account and left the bad trades alone.
Secondly, we look at another simple process. When Krhovjak and Cochran were to place a large order for Coastal, which they apparantly thought would move the market, they would place their orders prior to Coastal's. After the Coastal orders were placed, they would allegedly take profits on their personal trades. That's normally called "front running", which is a violation. They were just riding on the coattails of a big player.
Krhovjak and Cochran have each already plead guilty to one count of conspiracy to commit commodities fraud in violation of 18 U.S.C. Section 371 before the United States District Court for the Southern District of Texas. Sentencing is expected to occur in early 2002. Then, they still have to deal with the CFTC, which will most likely put some ban on trading futures and a monetary fine if they are found guilty.
So, they came away with less than $90,000. That money and more will most likely be sucked away in legal fees, fines and paybacks. It would be interesting to know how they were caught and if someone blew the whistle. The alleged scheme only lasted for 5 months. The bounty could have been substantially larger if it went on unnoticed for years.