by T. GormanPosted on Posted in SECActions

Insider trading is generally predicated on deception of the company and its shareholders or the source of the information. The SEC and the DOJ typically charge insider trading as a violation of Exchange Act Section 10(b). That antifraud section is broad, often described as a “catch-all,” but what it catches must be fraud. For an insider trading charge that fraud is usually deception. Under the classic theory of insider trading, where the corporate insider takes company information for personal benefit, that deception comes from the breach of a state law fiduciary duty that stems from diverting corporate information to a personal use. Under the misappropriation theory it comes from breaching a state law fiduciary duty to the one who furnished the person the confidential information.

What happens when the holder of the duty claims there is no breach? Stated differently, can there be deception and a violation of insider trading if the holder of the duty concludes that the duty it is owed has not been breached? The Second Circuit Court of Appeals and the SEC have answered the question in the affirmative, concluded that there still can still be a breach of duty, deception and insider trading.

In SEC v. Obus, Docket No. 10-4749 (2nd Cir. Decided Sept. 6, 2012) the Court held in a misappropriation theory case, that there could be insider trading despite a finding by a company internal investigation that there was no breach of duty. The case is based on the acquisition of SunSource, Inc. by Allied Capital Corporation, announced on June 19, 2001. About two weeks earlier, Wynnefield Capital, Inc., a major SuneSource shareholder, purchased a block of stock at the direction of fund manager Nelson Obus. The purchase was based on his hunch following a conversation with Peter Black, another fund employee. The SEC claimed that Mr. Black, and thus his boss Mr. Obus, were tipped by Thomas Strickland, an employee of GE Capital Corporation which was involved in financing for the deal, and long time friend of Mr. Black. An internal investigation conducted by GE Capital concluded that Mr. Strickland had not violated any duty to the company.

The Circuit Court reversed a ruling of summary judgment entered by the district court in favor of the defendants. That court concluded in part that Mr. Strickland had not breached any duty to GE Capital as the internal investigation found. The Second Circuit disagreed, disregarding the internal investigation findings because the inquiry was limited according to the Court and not binding on a jury. “More broadly, the GE investigation was motivated by corporate interest that may or may not coincide with the public interest in unearthing wrongdoing and affording a remedy,” according to the Circuit Court.

The SEC appears to have reached the same conclusion in SEC v. Knight, 2;11-cv-00973 (D. Ariz. Filed May 18, 20011). The case centers on trading in the shares of Choice Hotels, Inc., by Mary Beth Knight, a company senior vice president, and her friend prior to the announcement of disappointing 2Q06 financial results. Since the case settled on filing the only facts available are those in the Commission’s complaint. According to those allegations, Ms. Knight learned at a management meeting for senior company executives in June 2006 that the quarterly results would be disappointing.

Subsequently, Ms. Knight informed co-workers and her boss that she planned to sell some of her company shares. She also sent two e-mails to an associate general counsel of the company. The first stated that she planned to sell some company shares during the summer and inquired about black out days. The response specified the beginning of the next black out period and attached a copy of the insider trading policy. In a follow up e-mail written just before the beginning of the black out period Ms. Knight stated she planned on “exercising 12,000 shares today. I also mentioned to [my boss] last week I would be doing so.” There was no response. Ms. Knight then sold a block of shares two days before the black out period and prior to the release of the disappointing earnings. A friend also sold a block. Ms. Knight settled the SEC’s claim that her conduct violated Exchange Act Section 10(b) since she breached her duty to the company.

Orbus clearly stands for the proposition that there can be a breach of duty even if the company concludes otherwise. Kinight, while less clear, seems to stand for the same point. Since the state law duty in owed either to the company and its shareholders or the source of the information, it is unclear just how there can be a breach of duty when the person to whom it is owed says otherwise. The Second Circuit’s claim that the internal investigation may be motivated by “corporate interests,” rather than “affording a remedy,” offers little to support its conclusion. Indeed, brushing aside the GE findings appears be either a rewriting of state corporation law or the crafting of a new federal common law theory as the source of the fiduciary duties which supposedly were breached. In either case the authority of a federal circuit court to take such a step is at best questionable.

In the end both Obus and Knight appear to be rewriting insider trading law. While many may argue that permitting that the trading by the defendants under the circumstances of these cases is unfair, that is not the point. Insider trading law is not about fair, a parity of information or a level playing field. It is about fraud prevention and prohibiting those who engage in such conduct from profiting at the expense of others. If there is no breach of duty in Orbus and Knight then there is no deception, no fraud, no violation of Exchange Act Section 10(b) and no insider trading. To try and claim otherwise, as these actions appear to do, decouples insider trading from its Section 10(b) base, leaving it to float without foundation as a theory in search of congressionally authorized statutory moorings.

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by T. GormanPosted on Posted in SECActions

Events surrounding the collapse of the first money fund to “break the buck” are being played out in a New York City courtroom on SEC charges that the principles of the fund misrepresented its financial condition in the wake of massive redemption demands. Investors lost confidence in the Reserve Primary Fund once its huge holdings in Lehman Brothers bonds became worthless with the collapse of the investment bank. The case is one of the few market crisis actions to go to trial. Its significant goes beyond the case however since it touched off a debate about money fund regulation which remains unresolved to this day.

The Commission brought another action in conjunction with the U.S. Attorney’s Office in Manhattan. This one centered on fraudulent mark ups. The CFTC published statistics showing that its enforcement division had another record year, filing more cases that the prior fiscal year which had also set a record.

Finally, the SFO issued additional guidance on certain key issues under the Bribery Act. Unfortunately, it offers few insights into the charging process beyond those contained in earlier guidance.

The Commission

Remarks: Chairman Mary Schapiro addressed the New England Securities Conference on October 11, 2012. Her remarks focused on enforcement strategy, discussing significant cases, the restructuring of the Division and its collaboration with other agencies (here).

SEC Enforcement: Filings and settlements

Statistics: This week the Commission filed 1 civil injunctive action and no administrative proceedings (excluding tag-a-long and 12j proceedings).

Fraudulent mark ups: SEC v. Leszczynski (S.D.N.Y. Filed Oct. 5, 2012); U.S. v. Condon (S.D.N.Y. Unsealed Oct. 5, 2012). The SEC and the U.S. Attorney’s Office in Manhattan brought charges against brokerage firm employees centered on illegal mark ups. Marek Leszczynski, Benjamin Chouchane, Gregory Reyftmann and Henry Condon were employed in the New York office of a London based broker. The firm charged clients fixed fees on a per share basis. Messrs. Reyftmann, Chouchane and Leszczynski were sales brokers while Mr. Condon and another executed the trades. The scheme focused primarily on manipulating the mark ups. This was done by altering the execution price of the stock and taking the difference for the firm in addition to charging the standard per share commission. A second facet of the scheme involved misappropriating portions of trades. The scheme resulted in customer overcharges of about $18.7 million. At the same time it earned the defendants millions of dollars in bonuses.

In the criminal case Messrs. Leszczynski and Chouchane have each been charged with one count of securities fraud and one count of conspiracy to commit securities and wire fraud. Mr. Condron pleaded guilty to one count of securities fraud and two counts of conspiracy to commit securities fraud. He also agreed to forfeit all proceeds traceable to the commission of the felonies. Mr. Reyftmann was not charged in the criminal case. The SEC’s complaint alleges violations of Exchange Act Section 10(b) and Securities Act Section 17(a). The case is pending.

CFTC

Remarks: Chairman Gary Gensler addressed the George Washington University Center for Law, Economics and Finance Conference (October 10, 2012) in remarks titled: The New Era of Swaps Market Reform. His remarks reviewed the history of swaps regulation and projected a time table for future rules. He also discussed benchmark interest rates (here).

Enforcement statistics: The Enforcement Division for the CFTC reported record filings for the second fiscal year. For the last fiscal year it filed a record 102 enforcement actions. That number eclipses the 99 filings made in the prior fiscal year. The Enforcement Division also opened 350 new investigations, among the highest in the history of the program.

FINRA

The regulator fined Guggenheim Securities LLC $800,000 for failing to supervise Alexander Rekeda, the former head of its CDO Desk, and Timothy Day, a trader on that desk. The charges alleged that in October 2008 the Guggenheim CDO Desk acquired a €5,000,000 junk rated tranche of a CLO. After failing to market the position, Messrs. Rekeda and Day lied to a customer to induce the sale at a price that was more than it had previously agreed to pay by falsely offering it as part of a package of securities a third party offered for sale. As part of the arrangement the customer was to be provided with pricing adjustments on other deals and other consideration. The arrangements were not detailed in the records. Mr. Rekeda was suspended for one year and fined $50,000. Mr. Day was suspended for four months and fined $20,000.

SFO

The Serious Frauds Office issued further guidance on facilitation payments, business expenditures and the self-reporting corruption. Essentially the guidance reiterates prior statements, offering little new on the prosecution standards in these areas that will be used under the Bribery Act.

SFC

The Securities and Futures Commission banned Ms. Chu Lai Sze, formerly employed at Dah Sing bank Limited, from re-entering the securities industry for three years. She had been employed at the bank to deal in securities. The action is based on her conviction for forging a customer’s signature on documents relating to the purchase of a Minibond product in April 2008 while working at the bank. The bank compensated the customer.

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