INSIDER TRADING: ANOTHER GUILTY PLEA

Insider trading continues to be a key enforcement priority for prosecutors, as well as the SEC. Earlier this week, Michael Koulouroudis, who received inside tips from former UBS Director of Mergers and Acquisitions Nicos Stephanou, pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud. The charges were based on an insider trading scheme which centered on information obtained by Mr. Stephanou through his employment at UBS in London. U.S. v. Koulouroudis, Case No. 1:09-mj-00287 (S.D.N.Y. Filed April 30, 2009).

According to the court papers, Mr. Koulouroudis, a close friend of Mr. Stephanou, received inside information from 2005 through 2008 about transactions involving International Steel Group, Albertson’s and Elk Corporation. In each instance, Mr. Koulouroudis traded in the securities of the company based on the information he received. As a result of these traded Mr. Koulouroudis made at least $270,000 in illegal trading profits according to the indictment.

Previously, criminal charges were also brought against Mr. Stephanou. U.S, v. Stephanou, Case No. 1:08-mj-02825 (S.D.N.Y. Filed May 6, 2009). In that case Mr. Stephanou pleaded guilty to seven felony charges including six counts of conspiracy to commit securities fraud and one count of securities fraud. His co-defendant, George Paparrizos, pleaded guilty to one count of conspiracy to commit securities fraud and one count of securities fraud on August 7, 2009. U.S. v. Paparrizos, Case No. 1:09-mj-00288 (S.D.N.Y. Filed April 21, 2009).

The initial case against this insider trading ring was brought by the Commission. SEC v. Stephanou, Case No. 09 CV 325 (S.D.N.Y. Filed Feb. 5, 2009), discussed here. See also Lit. Rel. 20884 (Feb. 5, 2009). The SEC settled with Messrs. Stephanou and Paparrizos on November 6, 2009. In that settlement each defendant consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act and the Exchange Act. Mr. Stephanou also agreed to pay disgorgement of over $460,000, along with prejudgment interest and to the entry of an order in a related administrative proceeding barring him from associating with any broker or dealer. Mr. Paparrizos agreed to pay disgorgement of about $24,000 along with prejudgment interest and a civil penalty equal to the amount of the disgorgement. See also Lit. Rel. 21285 (Nov. 6, 2009).

NOT GUILTY VERDICTS FOR THE BEAR STEARNS MANAGERS

The government suffered a significant loss yesterday when a jury in the Eastern District of New York returned not guilty verdicts on all counts in the trial of former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin. U.S. v. Cioffi, Case No. 1:08-cr-00415 (E.D.N.Y. Filed June 18, 2008). The case has been billed as the first major market crisis action to proceed to trial. The parallel civil case filed by the SEC is still pending. SEC v. Cioffi, Case No. 08-2457 (E.D.N.Y. Filed June 19, 2008).

The rejection of the government’s case by what many described as a “blue collar” jury strongly suggests that the government reassess the line of demarcation between criminal and non-criminal conduct in the charging process for business cases. The indictment against Messrs. Cioffi and Tannin alleged one count of conspiracy to commit securities and wire fraud, one count of securities fraud with respect to each of the two hedge funds involved, insider trading as to Mr. Cioffi, and four counts of wire fraud. These charges centered on what the government claimed was a fraud in which the two defendants realized the funds they managed were in grave financial condition and at risk of collapse, but concealed this from investors and lenders.

The building blocks of the fraud were supposed to be misrepresentations and omissions by Messrs. Cioffi and Tannin to investors and others which included the facts that:

• Beginning in March 2007 Mr. Cioffi moved about one-third of his $6 million investment out to another investment without disclosing this fact to investors who considered his position material to their investment decisions;

• Although the two men recognized that the funds could collapse, and discussed changing the investment strategy or closing the funds following the receipt of a report stating that certain assets were over valued, these facts were not disclosed;

• During investor calls the two defendants stated they were “very comfortable with exactly where we are . . .,” in contrast to their actual dark views about the funds;

• In discussing the issue of redemptions, the two defendants failed to state that a major investor had withdrawn; and

• In May 2007, as the funds were collapsing, the two men continued to misrepresent their financial condition.

Jurors were not convinced. They reportedly only deliberated a few hours before rejecting all of the government’s claims.

The quick rejection of the government’s case suggests overreaching in the charging process. Prosecutors have extremely wide latitude in bringing criminal charges. In exercising that authority it is critical that the government not overreach and criminalize conduct which, at best, may be on the margin. This is particularly true in view of the harmful impact such accusations have on an individual. Indeed, the harm from those allegations never truly dissipates, even in the wake of a not guilty verdict. The verdict here suggests that the government should reassess where it draws the line in the future.