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
Few can ignite a legal firestorm like U.S. District Judge Jed Rakoff of the Southern District of New York. Last week, in a mortgage fraud suit against Bank of America and Countrywide, Judge Rakoff refused to dismiss a novel claim for civil penalties under the obscure Financial Institutions Reform Recovery Enforcement Act (“FIRREA”). The ruling will surely encourage civil prosecutors to make wider use of FIRREA, which provides a generous ten-year statute of limitations and low burden of proof, in pursuing financial fraud cases.
FIRREA was enacted in response to the Savings and Loan debacle of the 1980s, as well as the fraud scandals that emerged during that era. The statute includes a clause imposing a civil penalty for mail and wire fraud and other violations “affecting a federally insured financial institution.” Until recently the civil penalty provision has been ignored by prosecutors, leaving courts without occasion to decide what exactly the statute means by “affecting” a financial institution. READ MORE
Almost two years after the Supreme Court issued its momentous decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296 (2011), lower courts continue to reach significantly different conclusions concerning its scope. The Supreme Court held that, for purposes of SEC Rule 10b-5, “the maker of a statement is the person or entity with ultimate authority over the statement, including its content and whether and how to communicate it.” Id. at 2302. Specifically, in Janus, the Supreme Court held that an investment advisor could not be liable for statements in prospectuses filed by a related, but legally separate entity. Because the investment advisor did not “make” the statements—that is, did not have “ultimate authority” over them—it could not be liable as a primary violator of Rule 10b-5 for any misstatements or omissions contained therein.
Janus established a bright-line rule. But the Southern District of New York, in particular, has split over whether Janus applies beyond the context of private actions brought under Rule 10b-5(b). In the most recent decision from that district to address the issue, SEC v. Garber, No. 12 Civ. 9339, 2013 WL 1732571 (S.D.N.Y. Apr. 22, 2013), Judge Shira A. Scheindlin deepened this divide. READ MORE
On April 16, 2013, Judge Victor Marrero conditionally approved a $600 million consent judgment between the SEC and CR Intrinsic Investors LLC (“CR”) where CR “neither admitted nor denied” the allegations brought against it. The settlement was on the heels of a highly publicized investigation and lawsuit regarding CR’s purported insider trading scheme involving S.A.C. Capital Advisors and former S.A.C. trader Mathew Martoma. Despite finding the proposed injunctive and monetary relief “fair, adequate, and reasonable, and in the public interest,” Judge Marrero questioned the appropriateness of the “neither admit nor deny” provisions because of the extraordinary public and private harm caused by CR’s alleged wrongful conduct.
Approval of the CR settlement was conditioned upon the outcome of the pending Second Circuit appeal in S.E.C. v. Citigroup Global Markets, Inc., 11-cv-5227 (2d Cir.). In Citigroup, Judge Rakoff (of the Southern District of New York) denied approval of the SEC’s proposed settlement of fraud charges against Citigroup. Rakoff’s opinion harshly critiqued the agency’s use of “no admission” settlements as imposing “substantial relief on the basis of mere allegations.” He questioned whether “no admission” settlements could be properly judged when the Court did not know the relevant facts and therefore “lack[ed] a framework for determining adequacy.” Both Citigroup and the SEC appealed Rakoff’s decision to the Second Circuit, where the decision remains pending. READ MORE
On April 8, 2013, Judge Shira A. Scheindlin of the Southern District of New York granted auditor Deloitte Touche Tohmatsu CPA’s (“DTTC”) motion to dismiss a shareholder class action, finding that plaintiffs failed to sufficiently allege scienter or any misstatements by DTTC pursuant Section 10(b) and Rule 10b-5 of the Securities Exchange Act. Plaintiffs alleged that DTTC issued unqualified audit opinions on behalf of its client Longtop from 2009 to 2011. During that period, Longtop reported very strong financial results, which were later revealed to be fraudulently inflated.
In May 2011, DTTC released a public letter of resignation as Longtop’s auditor, disclosing that its second round of bank confirmations were cut short by Longtop’s deliberate interference, that Longtop’s CEO admitted the company’s books were fraudulent, and that DTTC had resigned due to that admission and Longtop’s deliberate interference with its audit. As a result, the NYSE stopped trading on Longtop’s securities and delisted the company.
In dismissing shareholder claims against DTTC, the court applied the stringent test for plaintiffs to meet when alleging scienter against an auditor. Because “an outside auditor will typically not have an apparent motive to commit fraud, and its duty to monitor an audited company for fraud is less demanding than the company’s duty not to commit fraud,” an auditor’s mere failure to identify problems with a company’s internal controls and accounting practices will not constitute recklessness. READ MORE
Four derivative lawsuits against Facebook’s directors relating to alleged disclosure issues surrounding the company’s initial public offering have a new status: Dismissed. Last month, Judge Robert Sweet of the Southern District of New York dismissed the suits on standing and ripeness grounds, finding that IPO purchasers have no standing to pursue claims related to alleged misconduct that took place before the IPO. The dismissed derivative suits were “tag-along” actions that largely parroted allegations made by investors in a parallel securities class action also pending before Judge Sweet, and had sought to hold Facebook’s directors liable for damages the company might incur as a result of the securities class action.
In dismissing the suits, Judge Sweet held that plaintiffs who buy stock in an IPO lack standing to pursue derivative claims based on alleged misstatements in an IPO registration statement. As Judge Sweet explained, in order to have standing to sue derivatively on behalf of a company, a plaintiff must have owned stock in the company at the time of the alleged misconduct. The registration statement that the plaintiffs allege to have been misleading, however, was finalized and filed with the SEC two days before the IPO. Judge Sweet rejected plaintiffs’ attempts to create standing by arguing that the wrong continued through the date of the IPO because the directors did not correct the allegedly misleading statements by that date. READ MORE
In what Judge Shira A. Scheindlin of the Southern District of New York called an “extraordinary case,” French multimedia company Vivendi, S.A. has scored an unusual victory based on a successful rebuttal of the fraud-on-the-market presumption of reliance, which the Supreme Court established 15 years ago in the seminal decisions of Basic v. Levinson, 485 U.S. 224 (1998). Though the stakes were relatively small—the Vivendi investor alleged only $3.5 million in damages—the decision is significant. It is one of the few in which a defendant successfully rebutted the almost impenetrable fraud-on-the-market presumption.
The court’s opinion in Gamco Investors, Inc. v. Vivendi, S.A. came after a two day bench trial on the limited issue of whether Vivendi could rebut the fraud-on-the-market presumption. Vivendi was collaterally estopped from challenging any elements of the plaintiff’s 10b-5 claims, other than reliance, following an earlier class action jury verdict concerning similar claims regarding Vivendi’s liquidity status. READ MORE