Viatris Insider Trading Scheme Busted
If you have ever wondered why stocks seem to inexplicably rise hours and even days before big positive news and begin to weaken before big negative news, an insider mole and his minions may be at work.
Details of the scheme
This phenomenon has recently been seen with drug manufacturer Viatris Inc. (NASDAQ:VTRS), whose chief information officer was recently charged by the Justice Department with insider trading.
While the FBI and Securities and Exchange Commission are pursuing the case, court documents show insider Ramkumar Rayapureddy, who is the CIO of Viatris, conspired with his former colleague, Dayakar Mallu, to trade in Mylan and Viatris securities based inside information the latter obtained via his position at Mylan and in advance of market-moving corporate announcements for their own financial gain. Mallu, the former chief of global IT operations of Mylan (the predecessor company of Viatris), left the company in 2017 and was a close personal friend of Rayapureddy.
A relatively new company, Viatris was formed by the merger of Mylan and the Upjohn division of Pfizer Inc. (NYSE:PFE) in November of 2020.
From 2017 through 2019, Rayapureddy allegedly tipped Mallu off on multiple occasions with nonpublic inside information about Mylan concerning, among other things, Food and Drug Administration drug approvals, financial earnings and a merger with the UpJohn division of Pfizer. Mallu then used the inside information to execute stock and option trades in the companys securities. According to the FBI, Mallu cleared about $7.2 million with these trades. In return for the tips, Rayapureddy then received cash payments in Indian rupees from Mallu via intermediaries in India.
Rayapureddy is charged with conspiracy to commit securities fraud and three counts of securities fraud. If convicted, he faces a maximum penalty of 20 years in prison.
Previously, in September 2021, Mallu pleaded guilty to conspiracy to commit securities fraud and aiding in the preparation of a false tax return and is awaiting sentencing in February. He also pled guilty to tax fraud by filing false tax returns and recycling money through a LLC controlled by him using fake expenses to launder profits.
Once they nabbed Mallu, the FBI evidently used information obtained from him to charge Rayapureddy. It remains to be seen if Mallu will testify against his friend to reduce his sentence, but it seems likely.
Viatris released the following statement following its former CIO's indictment:
"Since the charges against Dayakar Mallu were made public over a year ago, the company has thoroughly and independently assessed all relevant information available to it. We take the governments allegations made today against Ramkumar Rayapureddy very seriously and will continue to review the matter in the same fashion. The company is committed to the highest standards of integrity and compliance with the law. Ramkumar Rayapureddy is on a leave of absence from the company. We have and will continue to fully cooperate with the authorities, and we expect to have no further comment on this matter."
What is insider trading?
The SEC, the government agency responsible for enforcing the law against market manipulation, has adopted rules regarding insider trading that define it as any securities transaction made when a person involved in the trade has nonpublic, material information and uses this information to violate his or her duty to maintain the confidentiality of such knowledge by using it for financial gain.
Insider information is material if its release would affect a company's stock price. For example, the announcement of a tender offer, a pending merger, a positive or negative earnings report, the pending approval or rejection of a new drug by the FDA, accounting restatements and so on.
A person is defined as an insider if they have a relationship with a business that makes them privy to information that has yet to be released to the public. Insiders, especially those in senior management or board positions, have a fiduciary relationship with their companies and shareholders, so trying to profit from insider information puts the insider's interests above those of the entities to whom they owe this duty. This is similar to a lawyer or a doctor using a client or patient's vulnerability to extract an advantage for himself.
Not all insider trading is illegal, however. It is perfectly legal for insiders to trade as long as all material information is public and the trades are disclosed and public. In fact, insider trades are avidly followed by investors and analysts to try to determine the positive and negative convictions of insiders.
The illegal variety of insider trading occurs when a securities transaction (i.e., purchase or sale of stocks, bonds or derivatives) is influenced by knowledge that only a small group of people inside of the company (the insiders) whose stocks are being traded would know about. This obviously gives the insider an unfair advantage that allows them to profit from information about a potential fluctuation in a company's trading value before others are aware of it. This allows the insider to "front run" the market.
As in the case with Viatris, sometimes insiders use someone outside the company to do the trades. In these situations, there is a tipper and a tippee. The tipper is the person who has broken his or her fiduciary duty by intentionally revealing confidential information to outsiders. The tippee is the person who knowingly uses that confidential information to make a trade for purposes of turning a profit or avoiding a financial loss.
Obviously, the reason insider trading is illegal is because it gives the insider an unfair advantage in the market, puts the interests of the insider above those of shareholders and allows an insider to artificially influence the value of a company's stock. In also undermines the confidence of the investing public in the smooth functioning of the markets.
Valuation and financials
While Viatris is an unfortunate victim of this breach of faith by its senior-level employee, overall I think the stock is very undervalued. The insider trading does not seem to be material enough to have affected its value.
About half of its revenue is generated from off-patent branded drugs (i.e., Lipitor, Xanax and Viagra), with the rest from generics and non-precription products. The company is using its significant cash flow to develop its pipeline as well as pay a good dividend (currently yielding 4.06%).
GuruFocus' proprietary FCF Value is $25.61, more than twice the current stock price. GuruFocus developed the projected free cash flow value to deal with situations where earnings are erratic or obscured by non-cash charges such as in this case. Essentially, the metric takes 80% of the book value and adds it to the present value of free cash flow averaged over six years.
In terms of valuation, it is one of the cheapest stocks on the market as it trades at a forward price-earnings ratio of only 3.5. Recent results have been encouraging and the stock is bouncing off its low. At the current price, investors should be very well rewarded in the coming years.
Conclusion
Insider trading is common and lucrative, yet notoriously hard to prove and prevent. A 2020 study estimated that only about 15% of insider trading in the U.S. is detected and prosecuted. Insider trading is even more prevalent outside the U.S., where markets and regulators are not as advanced.
Investors should be aware that insider trading is a possible factor in stock volatility, which may be more common that they think. This is one more reason they should demand a margin of safety in buying stocks, so even if there are sheneganians like this going on (and we never know), they will still be OK.
This article first appeared on GuruFocus.
