This is the third in a series of articles examining future trends in securities enforcement
An examination of selected cases brought by the SEC last year in conjunction with the information about the reorganization of the Division suggests the future direction of enforcement. Key cases brought by the Commission can be classified into several groups including: 1) market crisis cases; 2) insider trading; 3) investment fund and Ponzi scheme cases; 4) financial fraud; 5) FCPA actions; 6) cases involving regulated entities and 7) other significant cases.
Market crisis cases
The on-going market crisis has dominated not only the news, but much of the activity on Capital Hill and apparently at the SEC. Commission officials have repeatedly referenced the dozens of investigation underway which are consuming substantial amounts of staff time.
To date, however, the market crisis investigations have resulted in few significant enforcement actions. A number of cases might be classified in this category. Four prominent cases are emblematic of those brought to date. Two were against the officers of former major lenders in the sub-prime real estate market, SEC v. Mozilo, Case No. CV 09-03994 (C.D. Cal. Filed June 4, 2009) (discussed here) and SEC v. Morrice, Case No. SAC09-01426 (C.D. Cal. Filed Dec. 7, 2009) (discussed here). The former names as defendants former executives of sub-prime lending giant Countrywide Financial, while the latter is against former officers of the third largest lender in that market, New Century Financial Corp.
Mozilo and Morrice are essentially disclosure fraud cases with additional elements. Each is based on allegations that the company failed to fully disclose the state of its sub-prime loan portfolio as the market was deteriorating. Mozilo adds insider trading claims and the manipulation of a 10b-5(1) plan to facilitate wrongful trading. Morrice lacks the insider trading claims of Mozilo, but adds allegations of account manipulation as the market crisis began to unfold.
SEC v. Rorech, Civil Action No. 09-CV 4329 (S.D.N.Y. Filed May 5, 2009) (discussed here) is the Commission’s first insider trading case based on claims involving credit default swaps. While the case centers on CDS, which many blame for much of the market crisis, whether this case is really a “market crisis” case is debatable. In any event, the case which is now in discovery following the recent denial of a motion to dismiss, is significant because it is the first to involve CDS.
Finally, SEC v. Reserve Management Company, Inc., Case No. 09 CV 4346 (S.D.N.Y Filed May 5, 2009) (discussed here) is an action against the principals of the Reserve Primary Fund, the first money market fund to “break the buck.” The complaint, based on alleged violations of the antifraud provisions, claims that the defendants failed to provide material information to Fund investors, the board and rating agencies following the bankruptcy of Lehman Brothers on September 15. At the time Lehman filed for bankruptcy, the Fund held $785 million in Lehman debt securities. Following the bankruptcy filing, the Fund was overwhelmed with redemption requests. In an effort to reassure investors and avoid breaking the buck, the defendants made a series of false and misleading statements.
Each of these cases is in litigation in contrast with most SEC cases which settle at the time of filing. Presumably, the SEC’s market crisis investigations are continuing. In view of the effort and resources being expended on those investigations, it seems reasonable to expect that more cases will be brought. At the same time these four cases do not suggest that there are blockbuster cases in the pipeline.
Insider trading has been a key SEC enforcement priority since at least the 1980s. Last year was no exception. Blockbuster insider trading cases were brought. Many of the cases involved market professionals. A number of the cases illustrate the aggressive posture of the Commission in this area.
Without a doubt the most significant insider trading case brought last year – and perhaps in years – is the one centered on the founder of the Galleon Fund, U.S. Rajaratnam, Case No. 09 mg 2306 (S.D.N.Y. Filed Oct. 16, 2009) and the Commission’s parallel action, SEC v. Galleon Management, LP, Civil Action No. 09-CV-8811 (S.D.N.Y. Oct. 16, 2009 (discussed here). The case centers on allegations that billionaire Raj Rajaratnam, the founder of Galleon Fund, along with other market professionals, has engaged in insider trading over a period of years. The on-going investigations which led to the filing of charges have already spawned a number of guilty pleas. One of the significant features of this case aside from the high profile defendants is the fact that investigators apparently listened on wire taps while the defendants exchanged inside information about a number of companies and subsequently used it to illegally trade. Rajaratnam and Galleon contrast sharply with the more typical insider trading case where the SEC or criminal prosecutors begin their investigation after the trading is over and then probe back in time to try and determine if there was insider trading.
While the Galleon cases are clearly being driven by the U.S. Attorney’s Office, the SEC did in fact bring high profile and aggressive insider trading cases. Two such cases are SEC v. Dorozhko, Case No. 08-0201 cv (2nd Cir. July 22, 2009) and SEC v. Cuban, Civil Action No. 3:09-CV-2050 (N.D. Tex. Decision Filed July 17, 2009). In the former, the Commission prevailed on appeal in an action brought against a computer hacker who misappropriated inside information after breaking into a secure compute and used that data to trade. In arguing that the district court incorrectly dismissed the case, the SEC contended that the key element of deception was supplied by the hacking. Since a computer hacker must electronically deceive the computer being hacked to get in there was deception. The Second Circuit reversed the dismissal with instructions to the district court to evaluate this question.
In Cuban, the SEC’s aggressive posture also yielded a dismissal in the district court. There, the Commission claimed that Mark Cuban traded on inside information after he was told about a pending PIPE offering following his statement that he would keep the information confidential. While the district court rejected defense claims that there had to be a breach of fiduciary duty as a predicate for insider trading, it concluded that there was not a sufficient obligation between Mr. Cuban and the company conducting the PIPE to sustain the charges. Whether the Commission can again turn its aggressive position into victory on appeal remains to be seen (both cases are discussed here).
The aggressive posture of the SEC in this area is also reflected in the case it recently brought against two French nationals residing in Belgium, SEC v. Condroyer, Case No. 1:09-cv-3600 (N.D. Ga. Filed Dec. 22, 2009) (discussed here). There, the Commission brought insider trading claims centered on the take over of a U.S. manufacturer by a French health care products company. The complaint, filed shortly after the deal announcement, is based on little more than the large option positions established by each defendant shortly prior to the deal announcement. This case, along with Cuban, Dorozhko and others clearly illustrates that while the headline grabbing Galleon case may belong to the U.S. Attorney’s Office, the SEC has been and likely will continue to be very aggressive in this area.
Next: Investment fund cases: A new priority.
Seminar: January 13, 2010, Enforcement Trends in Securities & Commodities Actions 2010, in person in Washington, D.C. and webcast. http://www.abanet.org/cle/programs/t10ets1.html
The program, co-chaired by Thomas Gorman and Frank Razzano, features a discussion of enforcement trends by senior officials from the Department of Justice, SEC, CFTC and the National Chamber Litigation Center.