Raja Rajaratnam, the founder of the Galleon Group hedge fund lost his appeal on insider trading charges. U.S. v. Rajaratnam, Docket No. 11-4416-cr (2nd Cir. Decided: June 24, 2013). Mr. Rajaratnam was convicted on five counts of conspiracy to commit securities fraud and nine counts of securities fraud by a jury following a lengthy insider trading trial. He is currently serving an eleven year prison term.

The focus of Mr. Rajaratnam’s appeal was his challenge to the district court’s conclusion that the wire tap evidence was admissible. His case is one of the first insider trading cases to make extensive use of wiretap evidence. The district court admitted evidence drawn from eight wiretaps which began with one of Mr. Rajaratnam’s cell phone in March 2008. In admitting the evidence the district court considered two critical questions when securing the wiretaps: a) whether there was probable cause to wiretap the cell phone; and b) why the proposed tap was necessary.

In the initial application to establish probable cause the government presented statements made by Mr. Rajaratnam to Roomy Kahn and summarized conversations between the two which Ms. Kahn had taped, indicating that they had discussed inside information. To demonstrate “necessity” the government told the court that the use of grand jury subpoenas, the collection of documents and taking testimony had failed or appeared reasonably unlikely to succeed if tried. The district judge who considered this evidence issued the wiretap authorization.

Mr. Rajaratnam moved to suppress the wiretap evidence, claiming that the government made misstatements and omissions regarding the reliability of Roomy Khan and that the evidence regarding “necessity” was materially incomplete. Specifically, he argued that the government told the court in the wiretap application that Ms. Khan had not been charged with any crimes when in fact she had previously pleaded guilty to felony wire fraud while incorrectly stating the period in which she had been cooperating with the FBI. The government also failed to tell the court that Mr. Rajaratnam and Galleon had been the subject of an ongoing SEC investigation, that several Galleon employees had testified in that inquiry and that about four million pages of documents had been produced which were subsequently conveyed to the U.S. Attorney.

The district court concluded that in fact the search warrant application incorrectly stated Ms. Kahn’s background and the period of time she had been cooperating with the FBI. Two statements attributed to Mr. Rajaratnam were also incorrectly summarized and the evidence on “necessity” contained what the court called a “glaring omission.” Nevertheless, the district court refused to suppress the evidence finding that despite the errors and omissions there was sufficient evidence to establish probable cause and necessity.

The Second Circuit, while not agreeing with all the findings of the district court, affirmed. The analytical framework for evaluating the wiretap issue has been established by the Supreme Court’s decision in Franks v. Delaware, 438 U.S. 154 (1978) and is well grounded in Second Circuit precedent. Under Franks suppression is only warranted if it is demonstrated that the inaccuracies or omission in the affidavit are the result of the affiant’s deliberate falsehood or reckless disregard for the truth and the alleged falsehoods or omissions were necessary to the probable cause or necessity decision, according to the Court.

To establish deliberate falsehood or reckless disregard the defendant must do more than demonstrate an omission or error. Rather, “the reviewing court must be presented with credible and probative evidence that the omission of information in the wiretap application was ‘designed to mislead’ or was ‘made in reckless disregard of whether [it] would mislead.’” Here, even assuming that this standard was met with regard to Ms. Kahn’s background and the two paraphrased statements, the errors were not material to the district court’s determination and analysis on the probable cause issue. To the contrary, there were sufficient facts before the judge who issued the search warrant to establish probable cause.

Equally clear is the fact that the omission of evidence about the SEC investigation does not meet the required standard. In reviewing the district court’s finding de novo, the Court of Appeals rejected the conclusion that this was a glaring error. The representatives of the U.S. Attorney’s Office testified that the point about the SEC investigation simply did not occur to them. And, in any event the evidence actually supported the application for a warrant the appeals court concluded because many of the documents and chronologies compiled by the SEC demonstrated that “Mr. Rajaratnam had been careful to exchange nearly all of his inside information by telephone.” This meant that wiretaps were “particularly appropriate” in this case.

Finally, the Court rejected Mr. Rajaratnam’s claim that the jury instructions were erroneous. Those instructions specified in part that the jury had to find that the material non-public information given to Mr. Rajartanam “was a factor, however small” in his decision to buy or sell the stock. The claim that this permitted the jury to convict him without finding the necessary causal connection between the inside information and the trades executed is incorrect the Court found. To the contrary, the jury is only required to find that the defendant purchased or sold the securities while knowingly in possession of material non-pubic information. According, the instruction given here was “if anything more favorable” to Mr. Rajaratnam” than the required “knowing possession standard.” Thus, like the claim about the wiretap evidence, the alleged error regarding the jury instructions was rejected by the Court.

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The SEC continues to focus on offering fraud cases. This time the action is against a securities law recidivist, his company and a person working with the entity as an unregistered broker. SEC v. Hurd, Civil Action No. 13-cv-04464 (C.D. Cal. June 20, 2013).

The case centers on the sale of interests in defendant Your Best Memories International, Inc., beginning in 2010 and continuing through the fall of 2012. Your Best Memories, formed by defendant Robert Hurd, who had a cease and desist order entered against in the by the Pennsylvania Securities Commission in 2009, was suppose to raise money for the promotion of memory improvement products. Shares in the company were sold to investors by Mr. Hurd, defendant Kenneth Gross and others supervised by them.

The scheme began in June 2010 when Mr. Hurd entered into an arrangement with Moving Pictures, Inc., to promote its products. That company, formed in 2009, sold a DVD containing a digital slideshow of photographs familiar to an individual suffering from memory loss. The photos, set to select background music, were supposed to aid memory. Later the company developed a second product called Your Best Memory Oil. It was virgin coconut oil claimed to serve as a memory-enhancing therapy.

Under the arrangement between Mr. Hurd and the founder of Moving Pictures, securities would be sold in Your Best Memories to raise money for the development of the memory products. The investor funds raised would be split with 40% to Moving Pictures and 60% to Your Best Memories.

Beginning in July 2010 Messrs. Hurd and Gross supervised salesmen marketing the securities of Your Best Memories. Using a script, investors were told that their money would go toward two proven treatments for Alzheimers disease. Investors were assured orally and through written materials that in large part their funds would go for the marketing of Moving Picture products. Under the terms of the subscription agreement investors would be paid a cash distribution of 8% per year, payable quarterly.

The sales representations were false and misleading, according to the Commission’s complaint. In fact at least 37% of the investor funds were taken by Mr. Hurd. Portions of those funds were misappropriated by him. Only fractions of the money went to Motion Pictures. In addition, the offering materials contained misleading disclosures regarding the payment of commissions. While investors did in fact receive some payments, those were funded with money from other investors.

In mid-2012 investors were told in a newsletter that the Best Memory Oil product had received FDA approval. This claim was false, according to the SEC’s complaint.

Over the approximately two years shares of Your Best Memories were sold, about $1.2 million was raised from 50 investors in 18 states. The Commission’s complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b) and 20(a). The case is in litigation. See also Lit. Rel. No. 22732 (June 21, 2013).

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