by T. GormanPosted on Posted in SECActions

The war on insider trading hit another milestone this week with the conviction on insider trading charges of Rajat Gupta, former Goldman Sachs director. Unlike others who have been convicted or pleaded guilty in the recent string of insider trading cases, Mr. Gupta is from the upper echelons of the corporate world where directors and senior executives are routinely privy to the secrets of Wall Street and the inner workings of corporate America. He is perhaps the most prominent member of this exclusive club to be put on trial and convicted for insider trading. The message from this case is clear – anyone who trades on inside information will be prosecuted.

Perhaps more important than Mr. Gupta’s position, is the nature of the case. Coming into the Gupta trial, the Manhattan U.S. Attorney’s Office, aided by the SEC, had an unbroken record of convictions or guilty pleas a series of insider trading cases. Those cases however were built on mountains of FBI wire taps which secretly recorded defendants such as convicted hedge fund mogul Raja Rajaratnam discussing inside information about pending mergers or upcoming earnings announcements.

The case against Mr. Gupta had none of that. There were no tapes of him actually telling anyone anything. There were no tapes of Mr. Gupta discussing inside information he learned at a board meeting. There were no tapes of Mr. Gupta talking to Mr. Rajaratnam. Rather, this time the U.S. Attorney’s office built its case the old fashioned way in the manner of a classic SEC insider trading action – on bits and pieces of evidence carefully woven together into a tapestry of illegal conduct. Board meetings were followed by phone calls by Mr. Gupta ending with securities trades by his long time friend and business associate at Galleon. While there were no cash profits for the already wealthy Mr. Gupta, there were plenty for his friend and the reward of a close personal relationship for a man who had worked hard to climb into the privileged inner circle.

Proving insider trading cases is notoriously difficult. Meeting the high standard demanded in a criminal case using only circumstantial evidence against a defendant with a sterling reputation such as Mr. Gupta is a significant accomplishment. There should be little doubt that the verdict in the Gupta case will propel the war on insider trading forward.

The impact of the verdict is likely to extend beyond the U.S. Attorney’s Office and also bolster the SEC’s insider trading program. After all, it is the Commission which is often on the advanced edge of the insider trading wars. It is the Commission which typically proves its charges with circumstantial evidence while the U.S. Attorney’s Office relies on the defendant’s own words captured on tape. If circumstantial evidence can be used to prove the guilt of Mr. Gupta in a criminal case, it will surely suffice in a civil SEC enforcement action where the proof requirement is significantly less.

The verdict may also embolden the Commission’s push on the contours of what constitutes insider trading. While criminal cases such as Gupta and Rajaratnam garner huge headlines, those actions are based on passing tips about information that is clearly material and non-public, that is, inside information. The SEC however, as the front edge of the war on insider trading, has been focusing on more difficult cases that may well redefine what actually is insider trading. These include actions such as:

  • SEC v. Cuban, the much discussed case against Mark Cuban which focuses on when a person has a duty to refrain from trading;
  • SEC v. Dorozhko, the so-called “computer hacker” case, that centered on what constitutes deception, a key element;
  • SEC v. Tedder, SEC v. Steffes and SEC v. Carroll, a series of cases that may redefine the mosaic theory since the charges were brought against corporate employees who learned what might typically be viewed as small bits of information while on the job and later traded; and
  • SEC v. Knight, which concerned in part corporate insider trading policies since the employee defendant traded prior to a black out period and with the knowledge of the company.

The common thread through all of these cases is that an individual obtained information others in the market place did not have and then traded. While insider trading policy has always sought to create a fair playing field, its goal in not a level one. Parity of information is not required. Yet these cases move in that direction. If the Gupta verdict emboldens an already aggressive SEC, the drive toward a parity of information may accelerate. That would represent a significant policy shift which could ultimately undercut the efficiency of the markets by deterring the constant quest by traders for bits of information, a process which is essential to the price discovery mechanism of the markets.

Tagged with: , , ,

by T. GormanPosted on Posted in SECActions

The jury heard final argument in the high profile insider trading case against former Goldman Sachs director Rajat Gupta this week. In a court room in the Southern District of Texas the high profile action against R. Allen Stanford concluded with his sentencing to 110 years in prison for a $7 billion financial fraud.

The SEC brought two civil injunctive actions this week. One was against the salesmen involved in the huge Ponzi scheme run by Nicholas Cosmo known as Agape World. The second was another investment fund fraud.

The Commission

Derivatives; The Commission issued a “Roadmap” on Phase in of Derivatives Regulation this week (here).

Speech: Lori Schock, Director, Office of Investor Education and Advocacy, delivered remarks tilted Outline of Dodd-Frank Act and JOBS Act at InvestEd 2012 in Charlotte, North Carolina (here).

Supreme Court

Materiality: Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, Docket No. 11-1085. The Court granted certiorari in this securities fraud class action on two questions. The first is whether in a misrepresentation action based on Exchange Act Section 10(b) and Rule 10b-5 the district court must require proof of materiality before certifying the class based on a fraud-on-the-market theory. The second focused on whether the district court must permit the defendant to present evidence rebutting the applicability of the fraud-on-the-market theory before certifying the class based on that theory.

SEC Enforcement: Filings and settlements

Statistics: This week the SEC filed two civil injunctive actions and no administrative proceedings (excluding tag-along and 12(j) actions).

Investment fund fraud: SEC v. Arias, CV 12-2937 (E.D.N.Y. Filed June 12, 2012) is an action that focuses on the Agape World, Inc. Ponzi scheme operated by Nicholas Cosmo. Agape sold investment contracts. The securities were supposed to represent participations in short-term, high interest bridge loans made by the fund to specific commercial borrowers. They were claimed to have incredible returns and virtually no risk. In fact the securities were interests in a huge Ponzi scheme. By 2009 investors filed an involuntary Chapter 7 petition against the fund. Mr. Cosmo pleaded guilty to criminal charges and was ordered to serve 300 months in prison. In an earlier case he had been sentenced to serve 21 months in prison for fraud before which he had been banned from the securities business by the agency now known as FINRA. In selling interests in the fund the defendants ignored red flags, according to the complaint, such as the prior conviction of Mr. Cosmo for fraud; the too-good-to-be-true returns; the incredible claims regarding the safety of the principle; Agape’s status as a relatively small, unknown, private issuer of securities; a series of extensions and defaults by Agape; and warnings about the fund’s financial condition. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.

Misappropriation: SEC v. Dehaan, Civil Action No. 1:12-cv-01996 (N.D.Ga. Filed June 11, 2012) is an action against Benjamin DeHaan and his controlled entity, Lighthouse Financial Partners, LLC. Lighthouse is an investment adviser operated by Mr. DeHaan. During an exam initiated by state officials in February 2012 the firm furnished the examiner with materials listing 114 client accounts with about $39 million in assets under management. The accounts and assets could not be verified for the most part. Between January 2011 and May 2012 however the defendants transferred $1.2 million from client accounts into a “pass through” account under the control of Mr. DeHaan. Clients were told that the funds were being moved to open TD Ameritrade custodial accounts for them. The presentation was false. The new accounts were never opened. Later portions of the funds were moved to a personal account and about $600,000 in client funds could not be accounted for. Mr. Dehaan also provided the staff with false bank account statements. The complaint alleges violations of Sections 206(1) and (20 of the Advisers Act. The defendants have consented to the entry of a preliminary injunction and a freeze order.

Criminal cases

U.S. v. Stanford (S.D. Tx.) is the action against R. Allen Stanford. Following a six week jury trial Mr. Stanford was convicted on 13 of 14 counts. The jury also found that 29 financial accounts worth about $330 million were proceeds of the fraud and should be forfeited. This week Mr. Stanford was sentenced to serve 110 years in prison as a result of his $7 billion investment fraud scheme.

Accounting fraud: U.S. v. Hansen, No. 1:12-cr-00188 (S.D.N.Y.). Todd Hansen was the president of the U.S. subsidiary of a UK corporation in the outdoor advertising business. Its shares were traded on the London Stock Exchange. Over a five year period beginning in 2004 Mr. Hansen, along with Finance Director James Buckley, had the controller of the company make fictitious accounting entries in the books and records, inflating the income figures. This permitted the company to meet its financial objections. It also resulted in the preparation of false financial statements with inflated monthly income.

Over the five year period the revenue of the company was falsely inflated by about $19.75 million. This permitted Mr. Hansen to earn about $1.1 million in salaries and bonuses over the period. Mr. Hansen pleaded guilty to one count of conspiracy to commit wire fraud and one count of wire fraud. He is scheduled for sentencing on October 4, 2012. Previously, Mr. Buckley pleaded guilty. He will be sentenced on October 4, 2012.

Fraudulent share issuance: U.S. v. Durland, 3:11-cr-00009 (N.D. Cal.). Jasper Knabb is the former CEO of Pegasus Wireless Corporation of Fremont, California. From May 2005 through January 2008 Mr. Knabb implemented a scheme in which 31 fraudulent promissory notes were claimed to be debt of the company. He then had the company issue shares to satisfy the debt. Overall 490 million shares of stock were issued, about 75% of the outstanding shares of the company. Sales of the shares netted Mr. Knabb and his family and friends over $35 million. At the height of the scheme Pegasus shares traded for $18 per share. Previously, Mr. Knabb pleaded guilty to one count each of conspiracy to commit securities fraud, securities fraud and falsifying books and records. Last week he was sentenced to serve 253 months or 21 years and one month in prison.

Anti-corruption/FCPA

Paul Jennings, the former CEO of Innospec Ltd. pleaded guilty in London. He was charged with conspiring to make corrupt payments to public officials in Indonesia from February 2002 through December 2008 and in Iraq between January 2003 and January 2008. To other company executives, Miltos Papachristos, the Regional Sales Director for the Asia-Pacific region, and Dennis Kerrison, the former CEO, entered not guilty pleas.

Report: A report by Kroll Advisory Solutions, titled “FCPA Benchmarking Report 2012,” provides insights into impact of aggressive enforcement of the Act. Key points in the Report include:

  • 95% of those who responded believe their companies’ exposure to bribery risk has increased or held steady over the last two to three years;
  • 85% believe their exposure to bribery risk will increase or stay the same in the future;
  • 53% have increased the budget for anti-bribery compliance in the last year while 45% have not;
  • The most frequently cited challenges to anti-bribery compliance “include the inability to anticipate regulators’ next moves” followed by ensuring that employee training is taken seriously and used when a risk situation is presented;
  • 42% of those who responded to the survey stated that robust compliance policies and procedures provide a competitive advantage with benefits that include enhancing their reputation with customers, enabling better service for clients, improved relations with vendors, positive employee morale and freeing up management time to focus on the business;
  • 81% of those who responded stated that they require the other party in an M&A deal to complete a due diligence questionnaire or similar document to vet their level of anti-bribery compliance;
  • 78% noted that in an M&A deal they review existing contracts and third party relationships to minimize noncompliance;
  • 65% stated that in an M&A deal they review their target companies’ third parties for potential corruption;
  • While the FCPA permits facilitation payments, 60% said they do not allow them while another 36% stated that they can be used under certain circumstances;
  • About 22% indicated they have little concern about anti-bribery compliance.

Australia

The Australian Securities and Investments Commission, or ASIC, secured orders winding up an unregistered investment scheme known as Master Fund. It had been operated by Secured Bond Ltd. From 2004 through the end of 2008 when ASIC obtained a restraining order against the entity, about 40 investors invested about $3.6 million in Master Fund. About $1 million has been returned to investors.

Tagged with: , , , ,