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Thomas O. Gorman,
Dorsey and Whitney LLP
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    FINDING THE LINE BETWEEN CRIMINAL AND CIVIL SECURITES FRAUD

    The line between criminal and civil securities fraud is often difficult to detect. The federal securities laws give the SEC the right to bring civil enforcement actions based on violations of the antifraud provisions. The Department of Justice has the right to file criminal charges based on violations of those same sections if the conduct is also “willful.” The line between a “scienter” based violation of the antifraud provisions and a “willful” and “scienter” based violation of those sections is often difficult to detect.

    The issue is highlighted by an SEC case that concluded this week, but began in 2003. The SEC settled an insider trading case with Steven Nothern, formerly a senior vice president of Massachusetts Financial Services Company in Boston. SEC v. Nothern, Civil Act No. 05-10983 (D. Mass. Filed May 12, 2005). Under the terms of the settlement, Mr. Nothern consented to the entry of a permanent injunction prohibiting future violations of Section 10(b) of the Exchange Act and Rule 10b-5. Mr. Nothern also agreed to pay a civil penalty of $460,000. The settlement followed a jury trial that concluded in June 2009 in favor of the Commission.

    The settlement with Mr. Nothern stems from an action initially filed by the Commission in 2003. SEC v. Davis, Case No. 03-CV6672 (S.D.N.Y. Filed Sept. 4, 2003). That case was brought against: Peter Davis, Jr., who provided advice to broker dealers, financial analysts and investors regarding Washington political and financial events; John Youngdahl, formerly a Vice President and Senior Economist at Goldman Sachs’ Global Economic Group, who sat on the Treasury Desk where he advised traders on economic and political developments; and Mr. Nothern, tasked by MFS with the management of seven fixed income mutual funds, including one that invested in Treasury securities.

    According to the 2003 SEC complaint, Mr. Davis attended the Treasury Department’s quarterly refunding press conferences. The participants at those conferences were provided with market sensitive information which was subject to a press embargo. At an October 31, 2003 refunding press conference, Treasury announced that it would suspend issuance of the 30 year bond later that morning. The news was embargoed until 10:00 a.m. Mr. Davis had been attending these quarterly conferences since 1994. He had an explicit agreement with Treasury that he would comply with its regulations regarding disclosure. At the October 31 meeting, Treasury officials reminded participants of their obligation three times. Mr. Davis was also a paid consultant of Goldman Sachs and MFS.

    While the embargo was still in effect, Mr. Davis placed nine telephone calls to eight clients including Messrs. Youngdahl and Davis. The call to Mr. Youngdahl was in accord with an earlier agreement between the two men in which Mr. Davis agreed to provide Mr. Youngdahl with information prior to the lifting of the embargo.

    Before the embargo was lifted, Goldman Sachs’ Treasury Desk traders purchased $84 million in par value 30 year bonds. Mr. Nothern purchased $25 million in par value of 30 year bonds and tipped three MFS portfolio managers who purchased an additional $40 million in par value 30 year bonds. When the news of the suspension was released, the price of the bonds skyrocketed. Goldman sold the bonds for almost $1.6 million in profits. Mr. Nothern and the other MFS portfolio managers made profits of $3.1 million for the portfolios they managed. The complaint, which alleged violations of Exchange Act Section 10(b) and Rule 10b-5, sought permanent injunctions, disgorgement and civil penalties.

    The Commission also brought actions against Goldman Sachs and MFS. In the Matter of Goldman, Sachs & Co., Adm. Proc. File No. 3-11240 (Sept. 4, 2003); In the Matter of Massachusetts Financial Services Company, Adm. Proc. File No. 3-112411 (Sept. 4, 2003). Generally, each Order alleged a failure to establish and enforce adequate policies and procedures to prevent the misuse of material nonpublic information.

    Goldman settled, undertaking to pay disgorgement and prejudgment interest of approximately $1.7 million in bond trading profits and prejudgment interest and a penalty of $5 million. The firm also agreed to disgorge about $2.5 million in bond futures trading profits and prejudgment interest. Goldman’s legal department was directed to review and make appropriate recommendations which would be adopted to supplement its procedures. MFS undertook to reimburse the broker-dealer that sold it the 30-year bonds $717,858, representing the losses suffered by the broker dealer along with prejudgment interest. The firm also agreed to the entry of a censure and to pay a civil money penalty of $200,000. The MFS’ general counsel was directed to evaluate and provide suitable supplements for the firm’s procedures.

    Subsequently, the SEC voluntarily dismissed its claims against Mr. Nothern. At the time the Commission announced that, it retained the right to file charges against him based on or including the original claim. While noting that its investigation was continuing, the Commission offered no explanation for the dismissal.

    At about the same time, Mr. Youngdahl resolved the Commission’s case and a parallel criminal action. In the SEC’s case, Mr. Youngdahl consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions. He also agreed to pay a civil penalty of $240,000. In the parallel criminal case Mr. Youngdahl pleaded guilty to criminal securities fraud charges. See also Litig. Rel. 18453 (Nov. 12, 2003).

    Mr. Davis was also charged in a criminal case. U.S. v. Davis, No. 1:03-cr-01054 (S.D.N.Y. Filed Sept. 3, 2003). He pleaded guilty to three felony charges and was sentenced to two years probation and a $30,000 fine on each count. Previously, Mr. Davis had settled with the SEC, consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Section 10(b) and Rule 10b-5. He also agreed to the entry of an order requiring him to disgorge $29,598 which is the consulting fees he received from Goldman and MFS plus prejudgment interest and to pay a penalty of $120,000. See also Litig. Rel. 18322 (Sept. 4, 2003).

    What is clear after years of investigation and litigation is this: The SEC charged three men with an insider trading scheme. It settled with all three. The Government charged two of the three SEC defendants with criminal violations of the law. Both pleaded guilty.

    What is not known is the reason one SEC defendant was not charged with criminal violations. What is all too frequently unknown in securities fraud cases, is the line between civil and criminal charges.

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