Until recently, it was extremely rare for the SEC to bring enforcement actions against unregulated entities or persons in its administrative court rather than in federal court. However, as a result of the Dodd-Frank Act (and perhaps the SEC’s lackluster record in federal court trials over the past few years), the SEC is committed to bringing, and has in fact brought, more administrative proceedings against individuals that previously would be filed in federal court. Many have questioned the constitutionality of these administrative proceedings. As U.S. District Judge Jed Rakoff remarked in August 2014: “[o]ne might wonder: From where does the constitutional warrant for such unchecked and unbalanced administrative power derive?” Several recent SEC targets agree with Judge Rakoff, and have filed federal court suits challenging the constitutionality of the SEC’s administrative proceedings. (Notably, in a 2011 order regarding the SEC’s first attempt to use its expanded Dodd-Frank powers to bring more administrative cases, Judge Rakoff denied a motion to dismiss a constitutional challenge to the SEC’s decision to bring an administrative proceeding in an insider trading case against an unregulated person, following which the SEC terminated that proceeding and litigated in federal court.)
On June 18, 2014, Judge Victor Marrero of the U.S. District Court for the Southern District of New York approved the SEC’s no-admit, no-deny consent decrees in its insider trading case against CR Intrinsic Investors, LLC and affiliated entities. In approving the decrees, however, the court called on the SEC to take a “wait and see” approach in cases involving parallel criminal actions arising out of the same transactions alleged in its complaint.
The decision follows the much-anticipated opinion in SEC v. Citigroup Global Markets (“Citigroup IV”), in which the Second Circuit vacated Judge Rakoff’s order refusing to approve a no-admit, no-deny consent decree between the SEC and Citigroup. The Second Circuit found that district courts are required to enter proposed SEC consent decrees if the decrees are “fair and reasonable,” and if the public interest is not disserved. A court must focus on whether the consent decree is procedurally proper, and cannot find that a proposed decree disserves the public based on its disagreement with the SEC’s use of discretionary no-admit, no-deny settlements.
A California federal jury sided against the U.S. Securities and Exchange Commission on Friday, June 6, finding the founder of storage device maker STEC Inc. not guilty on insider trading charges. This is the second insider trading loss in a week for the SEC, following a May 30 defeat in which a New York federal jury rejected insider trading allegations against three defendants, including hedge fund manager Nelson Obus.
In STEC, the SEC alleged that founder Manouchehr Moshayedi made a secret deal with a customer to conceal a drop in demand in advance of a secondary offering. According to the complaint, Moshayedi knew that one of STEC’s key customers, EMC Inc., would demand fewer of STEC’s most profitable products than analysts expected. The SEC alleged that he then made a secret deal that allowed EMC to take a larger share of inventory in exchange for a steep, undisclosed discount.
On March 31, 2014, the Securities and Exchange Commission brought insider trading charges against Ching Hwa Chen, the husband of a corporate insider, alleging that he misappropriated financial information from his wife and then shorted her employer’s stock, netting $138,000 in ill gotten gains. SEC v. Chen, No. 5:14-cv-01467 (N.D. Cal). The SEC’s allegations (taken from its complaint) are as follows: Chen’s wife was the Senior Tax Director of Informatica, a data integration company. In late June 2012, Informatica learned it would miss its revenue guidance for the first time in 31 consecutive quarters. That miss caused the defendant’s wife to work more than usual as the company scrambled to close its books and prepare for a potential pre-release of its quarterly revenues. Over the next several days, the defendant overheard his wife’s phone calls addressing the revenue miss, including on a four-hour drive to Reno, Nevada where his wife fielded calls from the passenger seat as he drove. Early the next week, convinced that Informatica’s stock would lose value, Chen bet heavily against the company, shorting its stock, buying put options, and selling call options. In early July, after announcing the miss, Informatica’s stock price fell 27% from $43 to $31. Chen closed out all of his positions that same day. Read More
In a story right out of the movies, complete with “poison pills” and “white squires,” the SEC announced on March 13, 2014 that motion picture company Lions Gate Entertainment Corporation settled charges that it failed to disclose to investors a set of “extraordinary” corporate transactions designed to thwart takeover efforts by investor Carl Icahn.
The tale of intrigue and midnight board meetings can be traced to Icahn’s efforts, beginning in 2008, to acquire control of Lions Gate. Despite his eventually gaining beneficial ownership of nearly 40 percent of Lions Gate’s outstanding shares, the company rejected various demands from Icahn over the years, including a demand to appoint five of the twelve seats on the Board of Directors. In March, 2010, Icahn made a tender offer with a premium over the market price to entice shareholders to sell. To thwart Icahn’s tender offer, Lions Gate adopted a poison pill and began to look for ways to keep the company out of Icahn’s hands. Read More
A trader who uses material nonpublic information to execute trades but does not personally benefit from the resulting gains may nonetheless face disgorgement of all profits, according to a recent Second Circuit opinion. In Securities Exchange Commission v. Contorinis, No. 12-1723, the Second Circuit affirmed a judgment from the Southern District of New York requiring defendant Joseph Contorinis, a former hedge fund manager at Jeffries & Co., to disgorge nearly $7.3 million in profits realized through an investment fund he had managed. The court rejected the argument a person can only disgorge profits that are personally enjoyed and instead found that disgorgement may also apply unlawful gains that flow to third parties. Relying on a principle that the limit for disgorgement is the total amount of gain flowing from illegal action, the Second Circuit concluded that district courts may impose disgorgement liability for gains that flow to third parties. Read More
The leaders of the Securities and Exchange Commission addressed the public on February 21-22 at the annual SEC Speaks conference in Washington, D.C. The presentations covered an array of topics, but common themes included the Commission’s ongoing effort to carry out the rulemaking agenda set forth in the Dodd-Frank Wall Street Reform and Consumer Protection Act, its role as an enforcement body post-financial crisis, its increasing utilization of technology, and its renewed focus on the conduct of gatekeepers. In a surprise appearance, Dallas Mavericks owner and former insider trading defendant Mark Cuban attended the first day of the conference. During his time at the conference, Mr. Cuban shared his thoughts on a number of the presentations via his Twitter account.
From a litigation and enforcement perspective, key takeaways from the conference include the following: Read More
On January 7, 2014 the SEC lost an insider trading bench trial before Judge William Duffey of the U.S. District Court for the Northern District of Georgia. In a thorough opinion, Judge Duffey found the SEC’s case to be entirely circumstantial, founded on no more than a pattern of trades that were made in close proximity to communications between the purported tipper and tippee. This case shows how difficult insider trading claims are to prove, especially without wire taps, and may give the Commission pause in bringing cases to trial that rest on such circumstantial evidence.
On trial was Larry Schvacho, a retiree who spent much of his free time investing. The SEC alleged Schvacho had misappropriated material, nonpublic information from Larry Enterline, a long time friend, who was then CEO and director of Comsys IT. Although Schvacho had traded in Comsys stock for many years, the SEC’s case focused on trades Schvacho made during the run-up to an acquisition of Comsys by Manpower in early 2010. As the SEC established at trial, Schvacho and Enterline had repeatedly communicated and socialized together during the period, and there were numerous phone calls, text messages, car rides, sailing trips, and dinners where Enterline could have given Schvacho information about the acquisition. When news of the acquisition was eventually made public to the market, Schvacho made over $500,000 on his trades. Read More
Following a defense verdict in the insider trading case brought against him by the SEC, Dallas Mavericks owner Mark Cuban has not been sitting on the bench—but rather using his blog to stay on the offensive. Since the October 16, 2013 verdict, Cuban continues to post about the case on his blog—including, just a few days ago, blogging about when his own blog became the focus of the trial. According to his October 26 post, an SEC attorney asked him during trial if everything he posted on his blog was true information, to which he replied that it was meant more “to communicate a point” and stimulate discussion. Following up, the SEC attorney asked: “If you post on your blog that you think the Lakers are going to stink in 2013 . . . you’re not telling this jury that that’s an opinion you don’t honestly hold, right?” Cuban posted that the courtroom “cracked up” when he replied “This year?”, before going on to answer: “Well, no. In 2004, I wouldn’t say it. They had Shaq, they had Kobe, they actually went to the finals . . . To answer your question, if I said in 2004 that they stink, I didn’t believe it.” In an earlier blog entry, Cuban also poked fun at the former Head of Enforcement—posting about internal emails, disclosed earlier in the case, in which SEC attorneys commented on photos of Cuban. Read More
In 2008, Rajat Gupta made a handful of short phone calls to his friend Raj Rajaratnam. The information that Gupta conveyed to Rajaratnam in those phone calls is now likely to cost Gupta millions of dollars, two years in prison, and the loss of his livelihood. These are the fateful consequences of the government’s use of wiretapping to uncover evidence of insider trading on Wall Street.
In June 2012, after a weeks-long trial and relying heavily on recorded conversations between Gupta and Rajaratnam, a jury convicted Gupta of three counts of federal securities fraud and one count of criminal conspiracy. The jury found that Gupta, a former director of Goldman Sachs, had provided Rajaratnam with material non-public information regarding Goldman’s then-unreported financial results and an imminent investment by Berkshire Hathaway at the height of the financial crisis. Though the court found that Gupta did not receive “one penny” in return for providing the information, he was convicted and ultimately sentenced by Judge Jed Rakoff to two years in prison and assessed a $5 million fine, a heavy penalty for his gratuitous generosity to his friend, Rajaratnam. To prove insider trading, the government is not required to prove that the “tippee” receive any direct financial benefit in recompense for transmitting material nonpublic information in violation of a duty of nondisclosure.
It is important to note that Gupta’s brief phone calls, which later became the key evidence used against Gupta in the criminal trial, were recorded by federal criminal prosecutors without Gupta’s knowledge or consent. (The SEC can seek to obtain wiretap evidence from criminal proceedings through civil discovery.) While the nation debates NSA snooping, this is a reminder that the Department of Justice could be listening to and recording your most sensitive domestic telephone conversations with court authorization. Gupta’s criminal prosecution was only possible because federal law enforcement officials had obtained warrants to record telephone communications of Gupta’s friend, Rajaratnam – telephone conversations that happened to include Gupta – based on evidence of possible insider trading. Gupta’s criminal conviction was then used to underpin his civil liability. The use of federal wire taps, previously the weapon of choice in organized crime prosecution, to generate the evidence needed to pursue both criminal and civil insider trading cases is a watershed moment in securities enforcement. Read More