THE SEC CONTINUES TO EXPAND ITS GALLEON INSIDER TRADING CASE

The SEC continues to expand the Galleon insider trading case, while the U.S. Attorney’s office rolls up more guilty pleas. SEC v. Galleon Management, LP, Civil Action No. 09-CV-8811 (S.D.N.Y.). In January, Anil Kumar pled guilty to one count of securities fraud and one count of conspiracy to commit securities fraud as discussed here. Mr. Kumar, a friend of Galleon founder Raj Rajaratnam, is a former senior partner and director of McKinsey, a global business consulting firm. He is also one of the claimed sources of inside information identified by the U.S. Attorney’s Office and the SEC from the beginning of the cases.

A Second Amended Complaint filed by the SEC on Friday provides new insight into the claimed relationship between Mr. Kumar and Galleon’s founder. See Litig. Rel. 21397 (Jan. 29, 2010). According to the SEC’s new complaint, in 2003 Mr. Rajaratnam agreed to pay Mr., Kumar $500,000 per year in return for inside information obtained from clients of McKinsey. Pursuant to this arrangement, Mr. Kumar was paid between $1.75 to $2 million by Mr. Rajaratnam through 2007, according to the complaint. The payments were channeled through a third party overseas. Eventually those payments were brought back to this country by Mr. Kumar and invested in Galleon under the name of a third party. While at Galleon, the funds grew to about $2.6 million.

In return for the payments, Mr. Kumar furnished Mr. Rajaratnam with inside information. For example, in 2004 Mr. Kumar provided information about AMD as described in earlier SEC and USAO filings. In 2006, Mr. Kumar again furnished Mr. Rajaratnam with inside information. In that instance, the information concerned the potential acquisition of ATI by AMD. Galleon purchased shares in ATI. As the deal negotiations progressed, Mr. Rajaratnam was furnished with updates. When this deal was announced in July 2006 Galleon made a profit of over $19 million.

The arrangement apparently ended in October 2007 when Mr. Rajaratnam told Mr. Kumar that he should no longer keep his investment at Galleon. Mr. Rajaratnam indicated that he was under increased scrutiny.

Just days prior to the filing of the SEC’s Second Amended Complaint, seven more individuals were indicted as part of the on-going Galleon insider trading investigation. The individuals named in that indictment, discussed here, were among fourteen previously identified. As this investigation goes forward, there seems to be little doubt that the USAO will bring more indictments and obtain more guilty pleas. At the same time, the SEC can be expected to continue to expand its case.

Seminar

Trends in SEC Enforcement 2010, a web cast by Thomas O. Gorman, Tuesday, February 2, 2010 from 12:00 p.m. to 1:00 p.m. Sponsored by West Legal Ed and Celesq Legal Ed. http://www.celesq.com/programs/view/trends-in-sec-enforcement-2010

DEFINING WHAT IS NOT LOSS CAUSATION

In Dura Pharmaceuticals, Inc. Broudo, 544 U.S. 336 (2005), the Supreme Court reversed a decision upholding the adequacy of a securities class action complaint. The Court held that the complaint did not adequately plead loss causation, that is, the economic link between the claimed fraud and injury. The decision resolved a conflict among the circuits. In Dura, however, the Court did not actually specify what constitutes loss causation. Rather, it stated what is not loss causation – only pleading price inflation. Since the decision in Dura, the courts have struggled to define what does and does not constitute loss causation.

In New York City Employees Retirement System v. Jobs, Case No. 5:06-CV-05208 (9th Cir. Decided Jan. 28, 2009), the circuit court eliminated another claimed theory of loss causation – dilution. The class action complaint against Apple, Inc. and fourteen of its directors and officers, alleged violations of Exchange Act Sections 14(a) and 20(a) for a misleading 2005 proxy solicitation. The complaint, grounded in option backdating claims, alleges that from 1996 through 2005 Apple shareholders unwittingly approved the issuance of 205 million shares based on a series of false statements. This resulted in a 20% dilution. The complaint sought rescission of the votes, compensatory damages for the share dilution, an accounting, and attorney’s fees and costs.

The district court dismissed the Section 14(a) claims without leave to amend, although the court did permit amendment of other derivative claims. In dismissing the Section 14(a) claims the court held, in part, that plaintiffs had failed to adequately plead loss causation.

The Ninth Circuit affirmed as to the pleading of loss causation, but remanded to permit plaintiffs to amend. To establish a claim under Section 14(a) the court held, a securities law plaintiff must plead loss causation. Under SOX, a plaintiff must show that the defendant “caused the loss for which the plaintiff seeks to recover damages.” Dura requires a plaintiff to prove economic loss. Accordingly, in the complaint, a securities law plaintiff must give notice of “what the relevant economic loss might be or of what the causal connection might be between that loss and the misrepresentation.”

Plaintiffs in this case tried to side step Dura, arguing that their claim is really grounded in rescission. SOX however does not differentiate between legal and equitable remedies according to the court. Therefore, plaintiffs must plead economic loss.

Furthermore, while it is correct that Dura does not specify the manner in which that loss must be established, as plaintiffs contend, the complaint must provide notice of that loss the court stressed. Here, the only claim is that ownership was diluted by 20%. As the district court concluded, economic loss does not necessarily accompany dilution. Accordingly, a claim of dilution, standing alone, is not sufficient to plead loss causation under SOX and Dura.