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Insight & Commentary on SEC Enforcement Actions and Related Issues

Texas Court of Appeals Has Put Some FCPA Internal Investigations in an Awkward Spot

Posted in FCPA, Investigations

Given that this case was decided last summer, I can’t quite put the headline in the present tense.  I’m slow to the draw on it, but I think it’s important.  Last July, in Writt v. Shell Oil Co., 409 S.W.3d 59 (Tex. Ct. App. 2013), the Court of Appeals of Texas addressed an interesting issue for internal investigations where the interests of corporations and their employees could come into conflict.

Facts

Briefly, here are the facts:  The Justice Department opened an FCPA investigation into Panalpina, Inc. (surely you remember Panalpina), and on July 7, 2007, wrote a letter asking representatives of Shell Oil Company to discuss that investigation at an upcoming meeting.  The letter asked that Shell prepare a spreadsheet detailing in what countries Shell had used Panalpina’s freight services and the total payments for those services for the last five years.  At the requested meeting on July 17, Shell agreed to conduct an internal investigation into its dealings with Panalpina.  As Shell’s “managing counsel” later testified, “Shell agreed to conduct the internal investigation with the understanding that it would ultimately report its finding to the DOJ . . . .”  A DOJ Fraud Section attorney wrote a follow-up letter noting, “[I]t is our understanding that Shell intends to voluntarily investigate its business dealings with Panalpina Inc. and all other Panalpina subsidiaries and affiliates.”  DOJ also asked for Shell’s proposed investigative plan, the production of 10 categories of documents, and the locations of a number of individuals, including Robert Writt, a Shell employee who had been associated with a project in Nigeria in 2004 and 2005.

As it happens, Shell submitted an investigative report that pointed the finger at Writt.  Specifically, Shell said Writt had been involved in illegal conduct in a Shell Nigerian project by recommending that Shell reimburse contractor payments he knew to be bribes and failing to report illegal contractor conduct he was aware of.

Writt Sues for Libel

Not one to take this lying down, Writt sued Shell for libel.  Shell won its motion for summary judgment in the trial court, claiming that it had an absolute privilege to say what it did in its investigative report to the DOJ.

The Court of Appeals disagreed.  In its view of Texas law, an absolute privilege attaches to communications made in judicial proceedings by judges, jurors, counsel, parties, or witnesses, and attaches to all aspects of the proceedings, including statements in open court, pre-trial hearings, depositions, affidavits, and any pleadings or motion papers.   The privilege has been extended to administrative proceedings before executive officers that exercise quasi-judicial powers.  When the absolute privilege applies, there is no action in damages, even if the words spoken are false and published with express malice.

By contrast, a conditional privilege arises out of the particular occasion on which the statement is published and is based on a public policy recognizing that true information should be given whenever it is reasonably necessary for the protection of the actor’s own interests, the interests of a third person, or certain interests of the public.

The conditional privilege protects the speaker from liability but not civil action.  Put another way, one with an absolute privilege doesn’t have to tolerate litigation over its statements; with only a conditional privilege, the speaker may well win the case, but has to slug it out through discovery, dispositive motions, and trial, and hope things work out in the end.

In the court’s view, DOJ was acting purely in a prosecutorial and non-judicial capacity.  Shell submitted its investigative report on February 5, 2009, and DOJ did not file a criminal complaint against the company until November 2010, 20 months later.  As the court said, “Just because the DOJ ultimately filed a judicial proceeding against Shell does not establish that it was proposing that one be filed when it contacted Shell on July 3, 2007 or received Shell’s report on February 5, 2009.”

The Dissent

Justice Harvey Brown dissented from the court’s opinion, writing, “To deny absolute privilege here would be to chill the free flow of information and impair the DOJ’s ability to conduct its investigations and enforce the FCPA. Without incentives to cooperate, enforcement of the FCPA would be curtailed.  Writt, 409 S.W.3d at 80 (Brown, J., dissenting) (citing Robert W. Tarun, The Foreign Corrupt Practices Act Handbook: A Practical Guide for Multinational General Counsel, Transactional Lawyers and White Collar Criminal Practitioners, 190 (2d ed. 2012) (stating that “DOJ and SEC do need companies to voluntarily disclose because their resources are limited.”)).

The dissent basically would hold that the Justice Department’s investigative process for FCPA violations is a quasi-judicial proceeding that merits an absolute privilege for statements made within its confines.  I think that’s right.  When the Fraud Section is “asking” that you conduct an internal investigation, wants to know exactly how you’re going to conduct that investigation, and wants to know the location of your individual employees, it’s not exactly a voluntary process.

It seems to me that the majority’s take on DOJ’s intentions as of July 2007 is quite naïve.  They were just asking some questions!  Submitting that investigative report was totally voluntary!  I think the court properly, but woodenly, applied the law as it exists in Texas.  FCPA investigations these days are a different animal, and probably deserving of different treatment by the courts.  As of now, a company conducting an internal FCPA investigation in Texas has to ask, what do we do if one of an investigation reveals one of our employees as a bad actor?  Do we say as much in the report we turn over to the government, as the government surely expects?  If we do, are we signing on for libel litigation by the employee?  Shell has petitioned the Texas Supreme Court for review.

SEC Says the Cyber Police Are Coming

Posted in Broker-Dealers, Compliance, Investment Advisers

Pretty soon we’ll all be data privacy lawyers.  The SEC is certainly doing its part to ensure that comes to pass.  Earlier this year the SEC’s Office of Compliance, Inspections, and Examinations announced that its 2014 Examination Priorities included a focus on technology, including cybersecurity preparedness.  On  March 26, the SEC sponsored a Cybersecurity Roundtable in which Chair Mary Jo White underscored the importance of this area to the integrity of the national market system and customer data protection.  And on Tuesday, OCIE announced an upcoming series of over 50 examinations of registered broker-dealers and investment advisers focusing on areas related to cybersecurity.

More specifically, the exam staff will be looking at each entity’s cybersecurity governance, identification and assessment of cybersecurity risks, protection of networks and information, risks associated with remote customer access and funds transfer requests, risks associated with vendors and other third parties, detection of unauthorized activity, and experiences with certain cybersecurity threats.

It gets even more specific than that.  The alert attaches a sample request for documents and information that should be very useful for regulated entities and their compliance staffs.  If you’re concerned about your firm’s data security – and you probably should be – do yourself a favor and read up.

Give Me That Old-Time Insider Trading

Posted in Insider Trading

Recently I had a question that required me to review Don Langevoort’s comprehensive insider trading treatise.  It got me thinking about the roots of insider trading law.  Specifically, the pre-SEC, pre-10b-5 insider trading courts used to deal with.

Back then, securities were frequently traded in face-to-face transactions, and not on exchanges, certainly not electronic ones.  The key insider trading question in those deals was whether the tort of misrepresentation could reach material nondisclosures in addition to affirmative untruths.  While some courts were unwilling to find any affirmative duty of disclosure of material facts to trading counterparties (on grounds that corporate officers and directors owe duties only to the corporation itself) others began to overturn the principle of caveat emptor in the corporate context.  For instance, in Strong v. Repide, 213 U.S. 419 (1909), a former shareholder of a Philippine sugar company had been induced to sell her shares to a person who (unknown to her) was the company’s general manager.  He knew that the company was about to enter into an extremely profitable contract with the Philippine government.  The U.S. Supreme Court granted rescission of the sale of securities under what has become known as the “special facts” doctrine.  Although recognizing that tort law generally prohibits only affirmative misrepresentations and half-truths, and does not create an affirmative duty to offer all material information to the person on the other side of the transaction, the Court concluded that the special facts of this case – particularly the defendant’s insider position and the significance of the information – were enough to compel disclosure.

This rule was refined and expanded in some later cases to place on all corporate officers and directors a general obligation of affirmative disclosure when dealing with shareholders.  Rather than adopting a case-by-case approach, these courts simply announced a blanket rule of compulsory disclosure, derived from the fiduciary status that exists between management and shareholders.  Building from this line of precedent, in time it became an established principle of federal law under Rule 10b-5 that insiders owe a fiduciary duty of disclosure when engaged in face-to-face purchases or sales with corporate shareholders.

But who cares?  How would this arise today?  Consider any number of transactions where a business is broken up into privately held securities and those securities are bought or sold.  Suppose X learns a material fact just before the deal is closed.  Does X have to disclose the fact to Y?  I think Strong v. Repide says the answer is yes, and it’s old-time insider trading if X doesn’t.

Two Thoughts about Dewey LeBoeuf and Parallel Proceedings

Posted in Parallel Proceedings

You’ve probably read about the Manhattan district attorney’s office’s indictment of executives at former Big Law giant Dewey LeBoeuf.  According to the WSJ  Law Blog, the crux is this:

“[F]ormer Dewey Chairman Steven Davis, former executive director Stephen DiCarmine, and former Chief Financial Officer Joel Sanders misrepresented expenses and falsely claimed revenue to hide a cash flow shortfall stemming from the financial crisis.  The scheme allegedly ran from November 2008 to early March 2012, shortly before Dewey fell into bankruptcy court and dissolved, and was designed to create the illusion that the firm had weathered the financial crisis and was set to grow, according to the indictment.  The three former leaders are charged with a number of crimes including grand larceny, securities fraud, conspiracy, and falsifying business records. A former client-relations manager at the firm, Zachary Warren, was also charged with crimes related to the alleged fraud.”

In a devastating New York Times story over the weekend, James Stewart zeroed in on that last sentence.  Client relations manager?  Who? Apparently it wasn’t obvious to “longtime Dewey insiders” who Zachary Warren even is.

Warren graduated from Stanford in 2006, and applied to be a Dewey paralegal.  “Instead, he was offered a $40,000-a-year job helping partners collect client debts. His hard work so impressed his colleagues that he was promoted to “client relations manager” in June 2008, earning a salary of $100,000 a year.”  In 2009 he moved on to law school at Georgetown, and then to federal clerkships on the U.S. District Court in Baltimore and then the U.S. Court of Appeals for the Sixth Circuit, where he is currently working.  A job offer, apparently still open, awaits him at Williams & Connolly in Washington.

In the meantime, though, the SEC called and asked that he come to Washington, D.C., last November to discuss what he knew about the Commission’s investigation into a bond offering at Dewey LeBoeuf.  As Stewart writes:

In late October, an S.E.C. lawyer investigating the bond offering contacted him. Mr. Warren had had nothing to do with it and, because he had not been subpoenaed, was under no obligation to testify. But he wanted to be helpful and cooperative, and he agreed to take time off from work in Memphis and travel to Washington to provide what he continued to think was just background information in a civil investigation.

Then, in a subsequent call, an S.E.C. lawyer told him that a lawyer from the district attorney’s office would be sitting in. Did Mr. Warren mind?

Mr. Warren arrived at the S.E.C. offices on Nov. 15. After the S.E.C. lawyer asked some introductory questions, [Peirce] Moser, the assistant district attorney, took over. An F.B.I. agent was also present, and other prosecutors were listening from New York.

By all accounts, the interview was a disaster for Mr. Warren. He had trouble remembering details from his time at the firm, which prosecutors interpreted as evasion or, worse, lying. They showed him emails and documents, most of which he did not recall. He was not prepared for the hostile tone and became defensive. Prosecutors thought that Mr. Warren was arrogant, even that he was “playing them” by trying to ferret out what they knew, rather than offering to help the investigation.

At one point, it occurred to Mr. Warren that he might be a target, and he asked Mr. Moser if that was the case. The prosecutor did not answer directly, but said, “This is a serious matter.”

As Stewart acknowledges, this is Warren’s side of the story.  Maybe it happened differently.

Two Thoughts

But I have two quick thoughts here.  First, if this is what happened, I don’t think this is a great moment for the SEC’s Enforcement Division.  Calling a witness in for a voluntary interview and then later changing the terms by (1) asking if it would be okay for a criminal prosecutor to sit in, (2) allowing an FBI agent to sit in as well, (3) letting other prosecutors listen in from New York and (4) after an introduction, turning over the questions to the prosecutor, seems, I don’t know . . . unseemly if not unethical.  And yet, the SEC staff’s conduct here appears to have been legally defensible.  United States v. Stringer, 521 F.3d 1189 (9th Cir. 2008), is a decent guide for what is appropriate in parallel proceedings such as these.  The SEC appears not to have made any affirmative misrepresentations to Warren, and he was certainly aware at all points that a criminal investigation was ongoing as well.  It’s odd, though.  I don’t know what Warren could have added to the SEC’s investigation of the bond offering.  If the staff called Warren knowing that they were not interested in his information about that offering – and that they would merely be a vehicle to allow his questioning by criminal authorities – that is not a good practice.  Also, the SEC’s case against the Dewey executives was filed in the Southern District of New York and is being handled by staff in the SEC’s New York Regional Office.  Why was he being interviewed in the SEC’s Home Office in Washington?  He didn’t live there at the time.

Second, Stewart’s story quotes a spokesperson for the Manhattan D.A.’s office reacting to the notion that Warren was tricked into speaking to prosecutors without a lawyer.  Erin Duggan Kramer said, “The claim that an attorney with a federal clerkship could have any misunderstanding of what it means to speak with and agree to meet with the D.A.’s office is preposterous.”  Let me tell you a little secret.  Federal law clerks may know about the federal sentencing guidelines and Bluebooking and other law nerd things, but not many of them know anything useful about dealing with criminal investigations or SEC investigations.  They certainly don’t know much about the similarities and differences between the two.  The volumes of their ignorance would fill an ocean.  Kramer’s comment sounds like someone protesting too much to me.  I’ll be very interested to see how this plays out.

For Municipal Bond Issuers, SEC’s New Cooperation Initiative Could Be a Good Idea (Unless It’s a Bad Idea)

Posted in Municipal Securities, Whistleblowers

You know how every few years libraries will offer an amnesty program and give delinquent borrowers a chance to bring in their old books without prohibitive late fines?  The SEC is sort of trying out that approach with its new Municipalities Continuing Disclosure Cooperation (MCDC) Initiative™.

Rule 15c2-12

Some brief background here:   Rule 15c2-12 generally prohibits any underwriter from buying or selling municipal securities unless the issuer has committed to providing continuing disclosure regarding the security and issuer, including information about its financial condition and operating data.  The rule also generally requires that any final official statement prepared in connection with a primary offering of municipal securities contain a description of any instances in the previous five years in which the issuer failed to comply with any previous commitment to provide that continuing disclosure.

The Program

Here’s how the program will work:  If municipal bond issuers and underwriters who may have made materially inaccurate statements self-report possible violations involving materially inaccurate statements under Rule 15c2-12, the SEC’s Enforcement Division will recommend favorable settlement terms for those violations.  Well, how favorable?  They’ll be able to agree to violations of Section 17(a)(2) of the Securities Act, a negligence-based charge.  Issuers will also have to agree to a number of undertakings, including:

  • establish appropriate policies and procedures and training regarding continuing disclosure obligations within 180 days of the institution of the proceedings; and
  • comply with existing continuing disclosure undertakings, including updating past delinquent filings within 180 days of the institution of the proceedings.

Underwriters will have to retain an independent consultant to conduct a compliance review and, within 180 days of the institution of proceedings, provide recommendations to the underwriter regarding the underwriter’s municipal underwriting due diligence process and procedures.

Issuers would not have to pay a civil penalty.  Underwriters would pay based on how large the offering is, but in no case would they pay more than $500,000.  The MCDC Initiative offers no assurances to individuals.

Finally, this offer will not last long!  Issuers and underwriters have until midnight on September 9, 2014, to take advantage of this program.

My Take

If issuers or underwriters are sitting on what they know is a huge disclosure issue that they’ve been scared to report – and they’re willing to throw their individual officers to the wolves – the MCDC Initiative could be a great solution.   Issuers will escape with a negligence-based charge and no penalty.  Underwriters will get the same and only a $500,000 maximum penalty.  True, paying for an independent monitor is no fun, but for real problems it could get much worse than that.  But if the disclosure issues are negligible or debatable, I’m not sure this program is a magical solution.  One would be signing on for sanctions when sanctions might not be appropriate.  Of course, you have to consider the possibility that a whistleblower will beat you to the SEC’s door in any event.  Ominously, the SEC notes in Section II.E. that it offers “no assurances for entities that do not take advantage of [the] MCDC Initiative.”

Pick your poison.

The SEC Will Take “Your” Money, Thanks

Posted in Insider Trading, SEC Litigation

So let’s say you work for a hedge fund or some other financial institution that engages in proprietary trading , and you’re inclined to do some insider trading on your employer’s behalf.  You make your trades, but you’re a company man and the profits go to the fund, not your own pocket.  And let’s also say you get caught and the SEC sues you for the illicit trading.  Not a very fun thought so far, right?  It gets worse.  Because if the SEC wins its case, it can force you to disgorge your fund’s profits.

The Second Circuit just addressed this issue in a split decision in SEC v. Contorinis.  There, Joseph Contorinis had been a managing director at Jeffries & Company, and had executed several trades in the shares of grocery store chain Albertson’s that were based on material, nonpublic information.  Contorinis made the trades on behalf of the Jeffries Paragon Fund, and realized profits of $7.3 million and avoided losses of $5.3 million.  He didn’t use his own funds or directly profit himself.

Contorinis argued that because he never personally controlled the profits that accrued to the Paragon Fund – he could make investment decisions, but he didn’t control disbursement of the proceeds – ordering him to disgorge the entire amount gained through his insider trading misapplied the disgorgement principle.  As the court put it, “Contorinis argue[d], in effect, that one can only ‘disgorge’ what one has personally ‘swallowed.’ ”

The court, or at least Judges Lynch and Carney, wouldn’t have it.  They looked at this case through the tipper-tippee lens, in which tippers are liable for third parties whose gains can be attributed to the wrongdoer’s conduct.  They held that “it must follow that the insider who, rather than passing the tip along to another, directly trades for that other’s account must equally disgorge the benefit he obtains for his favored beneficiary.”

I wonder, though, if this result squares with Great-West Life & Annuity Ins. Co. v. Knudson, 534 U.S. 204 (2002).  Remember, disgorgement is available in SEC enforcement actions under a federal court’s inherent powers and under Section 21(d)(5) of the Exchange Act.  But Great-West has this to say about ill-gotten money that a defendant has already spent:

[W]here “the property [sought to be recovered] or its proceeds have been dissipated so that no product remains, [the plaintiff’s] claim is only that of a general creditor,” and the plaintiff “cannot enforce a constructive trust of or an equitable lien upon other property of the [defendant].” Thus, for restitution to lie in equity [and not at law], the action generally must seek not to impose personal liability on the defendant, but to restore to the plaintiff particular funds or property in the defendant’s possession.

That is to say, if the court isn’t taking the money from the defendant itself, what it’s doing is a legal remedy and not an equitable one.  And if it isn’t an equitable remedy, it’s not available to the SEC.  This isn’t my idea; it’s Russ Ryan’s.  I don’t know that Contorinis argued this theory.  The court doesn’t acknowledge it in the majority opinion or Judge Chin’s dissent.  But I think it could apply equally to a situation where a defendant has traded on behalf of his employer.  Regardless, this decision gives a lot of leverage to the SEC in similar situations.

Two Thoughts about the Jury Verdict in SEC v. Steffes

Posted in Insider Trading, SEC Litigation

As you may have heard by now, on January 27th a jury in the Northern District of Illinois sided with the defendants and against the SEC in an aggressive insider trading case.  Here were the facts as alleged by the SEC and summarized by Gibson Dunn’s Joel Cohen in late 2010:

Defendant Gary Griffiths worked in a rail yard as a vice president and mechanical engineer of a subsidiary of Florida East Coast Industries, Inc. (“FECI”), and his nephew, defendant Cliff Steffes, worked as a trainman in another rail yard.  Both defendants allegedly signed FECI’s Code of Conduct prohibiting them from trading or tipping in FECI securities if they possessed material nonpublic information about FECI, including merger or acquisition information.

According to the SEC, once FECI put itself in play, several bidders met with FECI management and toured FECI properties, including the rail yards where Griffiths and Steffes worked. The SEC claims Griffiths knew about the sale because the CFO asked him for asset valuations, he noticed an unusually high number of rail yard tours, and employees questioned him about a possible takeover. Likewise, Steffes noticed an uptick in tours by people in business attire, and his co-workers were discussing the possible sale. Steffes allegedly purchased FECI call option contracts in an amount equal to his net worth and sold them after the takeover announcement, making a 350% profit.  Steffes and Griffiths also allegedly tipped Steffes’s father, brothers, and another uncle, who settled with the SEC at the end of October for $225,000. Collectively, the tippees netted more than $1 million in gains.

At the end of the day it wasn’t enough for the jury, which found no liability for the non-settling defendants.  Some thought the SEC had filed its case with the hopes of finding more incriminating evidence than it started with.  Others thought the Commission had stretched materiality beyond recognition, and based on the complaint, I’m not sure that’s a crazy thought.

Anyway, two thoughts here:

First, this isn’t a total loss for the SEC.  I thought it might not happen, but the Commission did survive a motion to dismiss on the materiality point.  The district court’s opinion is quite gracious to the SEC’s position, and I could envision the agency citing it in other cases at some point down the road.

Second, without a specific statutory prohibition, the SEC has relied on notions of unfairness for the development of insider trading law for over 50 years.  In the SEC’s very first insider trading case, In re Cady, Roberts & Co. in 1961, the Commission pointed to two key elements in describing where liability would be appropriate: (1) the existence of a relationship affording access to inside information intended to be available only for a corporate purpose, and (2) the unfairness of allowing a corporate insider or tippee to take advantage of that information by trading without disclosure.

But as Don Langevoort asks in his comprehensive treatise, how is it that, absent any real inducement of shareholder trading (i.e., in a faceless electronic transaction, and not a face-to-face deal), such unfair conduct could properly be termed fraudCady implicitly rests on the insider’s duty to act affirmatively to prevent the other party’s disadvantageous trade.  In theory, had disclosure been made to the public, marketplace buyers and sellers would not have traded (at least not at that price), and that’s how the Commission got to the deception necessary for a violation of Rule 10b-5.

I think the absence of unfairness was doubly risky to the SEC in the Steffes case.  What the defendants did just doesn’t seem that unfair.  It seems like a bunch of dudes piecing together information and making a bet on it.  From a purely legal perspective, the Commission was able to survive the defendants’ motion to dismiss.  But on the facts, the jury doesn’t seem to have cared.  I think the lack of injustice in the facts is why the SEC had trouble with the jury, and will continue to in marginal cases like this one.

SEC Not Kidding about Subpoena Enforcement Actions, Obtains Coronati’s Arrest

Posted in SEC Litigation

Here’s one of the questions I get from some individual clients when they receive subpoenas from the SEC:  Could I get arrested over this?  Well, no.  First things first – The SEC has civil authority, not criminal authority.  Unless the Justice Department or some state criminal authority gets involved, you’re not going to be arrested.  But Anthony Coronati may make me modify this answer.

We covered his case late last year as part of a recent spate of subpoena enforcement actions filed by the SEC in New York and California.  We ended with the anodyne warning that you might want to take the Commission’s administrative subpoenas seriously, lest you get dragged into a fight over subpoenas that supersede the underlying investigations.

Coronati doesn’t appear to have been listening.  The SEC had been investigating whether entities controlled by Coronati solicited investments relating to the securities of companies such as Facebook that investors hoped would later hold IPOs.  The SEC is interested in knowing whether Coronati commingled investor funds with other money in an account he controlled and used it to pay personal expenses.  Despite two SEC investigative subpoenas, at that point Coronati had neither produced documents nor appeared for testimony.

A November 17, 2013 court order required Coronati to comply with the subpoenas.  On January 17, things went from bad to worse, and the district court found Coronati in civil contempt for ignoring the prior order.  The order requires Coronati to pay $4,812 to the SEC to reimburse the agency for its costs of serving him with court papers in this proceeding.  The U.S. Marshals Service arrested Coronati on January 23rd.  At a hearing, the court ordered Coronati released on $50,000 bond and restricted his travel to the Southern and Eastern Districts of New York.

After all that, it appears that Coronati may have gotten the message.  The court ordered a further hearing on Feb. 6th, but that hearing has been suspended for two weeks while his attorneys give assurances of his cooperation with the SEC.  You know how Jalen Rose and Bill Simmons warn each other in their podcasts not to get fired when they get too close to politically sensitive subjects?  If you get a subpoena from the SEC, be smart, consult with competent counsel, and don’t get arrested.

SEC Charges Hao He with Insider Trading, for Some Reason or Another

Posted in Insider Trading

Here are two things about insider trading law:  First, it’s hard to know exactly what the parameters are.  The United States doesn’t have a specific statute prohibiting it.  It grows out of the general anti-fraud provisions of the Exchange Act and the Securities Act, but the SEC and the courts over the years have outlined what insider trading is and how far one can go in that sphere.  Second, it’s not impossible to know what the parameters are.  Clues are out there in the form of court cases and, for settled matters, complaints filed by the SEC in federal courts.

One such complaint was filed last Thursday in the Northern District of Georgia.  In the litigation release for that complaint, we learn that on November 13 and 14, 2012, Hao He bought $162,000 of short-term put options in Sina Corporation.  On November 15, Sina announced it had beaten analyst forecasts for third quarter earnings, but also announced unexpected negative guidance for the fourth quarter of 2012.  As a result of this negative guidance, Sina’s stock price declined approximately 8.5%, opening at $48.60 compared to the previous day’s close of $53.10.  The next day, He sold all of his put options for $331,530, generating illicit profits of $169,819.  Okay, fine.  But why was this illegal?

Facts According to the Litigation Release

According to the litigation release, He “obtained material nonpublic information concerning Sina’s upcoming, negative, future earnings guidance while visiting China and/or through phone calls to China.”  That’s all we know.  It may be worth noting here that it is perfectly legal both to visit and to make phone calls to China.  Is He a Sina insider?  An accountant or lawyer for the company?  Is this a misappropriation case?  You’re not going to learn from the litigation release.  The SEC hasn’t posted the complaint along with the release, which is its usual practice.  Strong forces encouraged me to stop there, but . . .

Facts According to the Complaint

My curiosity overcame my laziness, and I pulled the complaint from PACER.  In the complaint we learn:

12. Between on or about October 10, 2012 and November 5, 2012, He traveled to Shanghai, China, the headquarters of Sina. On or about November 5, 2012, He returned to the United States, shortly after which he had several telephone conversations with an unknown person or persons in China.

13. During his visit to China and/or during those subsequent phone calls, He obtained material, nonpublic information concerning Sina’s upcoming future guidance, directly or indirectly, from a Sina officer, director, corporate insider or other person with a duty of trust and confidentiality to Sina’s shareholders.  Such information was provided by the tipper to He with an expectation of personal benefit from the disclosure.

14. Alternatively, during his visit to China and/or during those subsequent phone calls, He misappropriated material, nonpublic information concerning Sina’s upcoming future guidance from a person with knowledge of such information and to whom He owed a duty of trust and confidence.

My Take

This is fairly baffling.  The litigation release declines to discuss how the insider acquired this material, nonpublic information.  The complaint, meanwhile, says, well, it could have been a tipping situation or it could have been a misappropriation.  In failing to specify which, the SEC has missed an opportunity to educate the market on what it views as insider trading under Section 10(b) of the Exchange Act and Rule 10(b)(5).  I think it has also given up some credibility when it didn’t need to.  This is a settled case, so at some level I suppose it doesn’t matter.  But what happened here?  What was the discussion at the closed Commission meeting where the case was approved?  Were the Commissioners aware the complaint would be this ambiguous?

Given the fairly intense doubts about the insider trading prohibition in some circles, and some thoughts that insider trading law is inappropriately vague, the Commission would be smart to make the facts about its cases clear.

 

UPDATE:  The complaint is now linked above.

S.D.N.Y. Prosecutors Get Martoma, but Probably No Closer to Steve Cohen

Posted in Insider Trading

Yesterday, a jury in the Southern District of New York convicted Mathew Martoma in what is in dollar terms the largest insider trading case in captivity.  As we’ve discussed before, Martoma had been accused of paying a medical professor at the University of Michigan for information related to clinical trials of a potential Alzheimer’s drug and using that information to trade in the securities of Elan Corp. and Wyeth Pharmaceuticals.  The $276 million in losses allegedly avoided here would have made the case interesting all by itself.  What made the case much more interesting and the focus of the white collar criminal world for a time was Martoma’s then-employer and where the trades took place: Steve Cohen’s SAC Capital.

Prosecutors apparently suspected that Martoma told Cohen exactly why his thoughts about Elan and Wyeth had changed so dramatically.  And they dearly hoped Martoma would let them in on that conversation, if it happened.  But if it happened, he never let on.  It turns out his willingness to stand tall didn’t work out, but here we all are.

Now, publications are suggesting that the government is “inching closer” to Steve Cohen and that prosecutors may be “emboldened” to go after the SAC Capital boss in a criminal matter.  It may happen, but I don’t think Martoma’s conviction by itself will do it.

In the recent spate of insider trading cases in the S.D.N.Y., the government has secured 79 convictions.  Say what you will about the Justice Department’s record in financial crisis cases, but Preet Bharara has figured out what it takes to get a jury verdict in insider trading cases.  And the evidence suggests that his office is quite interested in Cohen’s potential insider trading.  But they haven’t brought a case against him personally yet, and a great potential link between Cohen and actual insider trading just endured a conviction rather than testify against his former boss.

There is at least one more potential mini-drama to play out, though.  It is still possible for Martoma to cooperate with the government against Cohen or anybody else.  Under Rule 35(b) of the Federal Rules of Criminal Procedure, prosecutors can move for a reduction in the sentence of a convicted defendant in exchange for “substantial assistance” against co-conspirators or others.  Some judges, when convinced a defendant knows more than he’s told through trial, will test this commitment to principle by imposing wildly long, but legally appropriate, sentences to see if his lips loosen in hopes of a such a motion.  I sort of doubt that will happen here.  Also, Martoma’s cartoonish expulsion from Harvard Law School surely undermines, and probably destroys, his credibility as a witness going forward.  We’ll see what happens over the coming months.