MORE INSDIER TRADING CASES BUILT ON WIRE TAPS

The USAO in New York continues to unfold the results of its blockbuster insider trading investigation with an assist from the SEC. Overall, eight new defendants were charged, with five others having pleaded guilty. Three new criminal cases were brought, U.S. v. Goffer, Case No. 09 Mag 2438 (S.D.N.Y. Filed Nov. 4, 2009), U.S. v. Hariri, Case No. 09 Mag 2436 (S.D.N.Y. Filed Nov. 4, 2009) and U.S. v. Shah, Case No. 09 Mag 2437 (S.D.N.Y. Filed Nov. 4, 2009. Last month, the initial two other cases were filed, U.S. v. Rajaratnam, Case No. 09 Mag 2306 (S.D.N.Y. filed Oct. 15, 2009) and U.S. v. Chiesi, Case No. 09 Mag 2307 (S.D.N.Y. Filed Oct. 15, 2009), both of which are discussed here. Defendants in the new cases are alleged to have made trading profits of over $20 million. With the investigations continuing, it appears there will be more charges in the future.

The Goffer case names seven individuals as defendants: Zvi Goffer, a registered representative formerly employed at Schottenfeld Group and currently at Echotrade LLC; Arthur Cutillo, an attorney at Ropes & Gray; Jason Goldfarb, an attorney in private practice in New York; Craig Drimal, a trader formerly at Galleon Management and currently at Echotrade; Emanuel Goffer, a registered rep and trader formerly at Spectrum Trading and currently at Echotrade; Michael Kimelman, a trader formerly with Lighthouse Financial Group and currently at Echotrade; and David Plate, formerly at Schottenfeld and currently at G-2 Trading LLC, a registered broker dealer. The SEC has filed an action which essentially parallels this case (except it includes the entities and those who have pleaded guilty as discussed below). SEC v. Cutillo, Case No. 09-09208 (S.D.N.Y. Filed Nov. 4, 2009). See also Litig. Rel. 21283 (Nov. 5, 2009) and Litig. Rel 21284 (Nov. 5, 2009).

The criminal complaint details the operations of an insider trading ring headed by an individual known as “Octopussy” — that is, Zvi Goffer – because of his multiple sources of inside information. Two sources are identified in the complaint. One was ultimately Arthur Cutillo, an attorney at Ropes & Gray, who furnished information on corporate transactions in which his firm was involved. Mr. Cutillo funneled information through defendant Goldfarb. He is alleged to have misappropriated inside information on transactions involving Alliance Data Systems, Avaya Inc., 3Com Corporation and Axcan Pharma Inc. In each instance, the information concerned an upcoming corporate transaction. Typically, the information was funneled to Zvi Goffer who in turn furnished it to tippees including Messrs. Shankar (not named in this action, but in the parallel SEC case), Platt, Drimal, Goffer (his brother), Kimelman and two unidentified hedge fund advisers (referenced in the SEC complaint). Each defendant is alleged to have traded in the securities of the company involved and made a profit.

Many of the critical conversations regarding these transactions were taped, according to the complaint, by a confidential witness who worked at a hedge fund and is identified only as CS-1. That confidential source has agreed to a plea arrangement and has been working for the government since July 2007.

A second source of inside information is identified as CC-1. This source furnished inside information regarding transactions involving Kronos, Inc. and Hilton Hotels, both of which are involved in the initial criminal cases filed last month. The traders who received this information are alleged to have placed profitable trades in each instance. Portions of the telephone conversations involving these transactions were intercepted, according to the criminal complaint.

The Shah case involves trading in the securities of Hilton Hotels based on inside information. Here again, the information was supplied by a cooperating witness. Similarly, Hariri involved trading based on inside information about Atheros Communications which was supplied by a cooperating witness. Both of these securities were involved in the initial criminal cases filed last month.

Five defendants have pleaded guilty to criminal charges. These defendants include: 1) Steven Fortuna, formerly the Managing Director of S2Capital, a hedge fund. Mr. Fortuna pleaded guilty to a criminal information charging him with three counts of conspiracy to commit securities fraud and one count of securities fraud. 2) Richard Choo-Beng Lee, former president of Spherix, a hedge fund; and Ali Far, the founder of Spherix. Both men pleaded guilty to an information which contains one count of conspiracy to commit securities and wire fraud and one count of securities fraud. 3) Roomy Khan, previously identified in media sources as a confidential witness for the initial cases, pleaded guilty to an information charging one count each of conspiracy to commit securities fraud, securities fraud, and obstruction of justice. 4) Gautham Shankar, formerly a registered representative at Schottenfeld, pleaded guilty to conspiracy to commit securities fraud and securities fraud.

The SEC also amended its complaint in SEC v. Galleon Management, L.P, filed last month. The amended complaint adds thirteen new defendants including Roomy Khan, Deep Shah, Aki Far, Choo-Beng Lee, Far & Lee LLC, Spherix Capital LLC, Ali Hariri, Zvi Goffer, David late, Gautham Shankar, Schottenfeld Group LLC, Steven Fortuna and S2Capital Management LP. It alleges insider trading in twelve securities, two more than in the original case.

The new cases are clearly a continuation of the investigation which spawned the initial criminal and civil cases filed last month. As in those case, the new charges are built on wire taps, confidential witnesses, and tape recorded conversations. A review of the court papers lists at least several sources of inside information, not all of which have been identified to date. At the press conference the U.S. Attorney’s Office made it clear that their investigation into these matters is continuing. No doubt the confidential witnesses are hard at work as are those listening to the wire taps.

Finally, while the new cases were being filed and the USAO and SEC were holding another joint press conference Mr. Rajaratnam was in court today seeking a reduction in his bail. That request was denied, although the court did ease his travel restrictions.

Note: Generally on Friday we post This Week In Securities Litigation which recaps key events of the week. In view of the significance of these cases This Week will appear on Monday and return to its usual Friday slot next week.

ARE MONITARY PAYMENTS SUFFICIENT TO PREVENT A REPETITION?

The Commission brought two more actions in a series of civil and criminal cases arising out of the payments made by a brokerage firm to obtain municipal bond underwriting and interest rate swap agreement business in Jefferson County, Alabama. The criminal case is resolved. Two of the Commission’s actions are on-going, while an administrative proceeding is settled. That settlement with the securities firm raises a critical question about the adequacy of the relief.

The first is a settled administrative proceeding captioned In the Matter of J.P. Morgan Securities Inc., Adm. Proc. File No. 3-13673 (Filed Nov. 4, 2009). This action alleges that, over a two year period beginning in 2002, the securities firm, through former managing directors Charles LeCroy ad Douglas MacFaddin, paid more than $8.2 million at the direction of local county commissioners essentially to obtain business.

The payments were made to close friends of the county commissioners who either worked at, or owned, local broker dealers. The individuals who received the payments had no official role in the transactions and typically performed few if any services. These fees, in many instances, dwarfed those paid to others involved in the deals such as the lawyers and bankers who advised the county and worked extensively on the transactions. In taped telephone conversations Messrs. LeCroy and MacFaddin referred to the payments as “payoffs,” “giving away free money” or “the price of doing business.”

In return for the payoffs, the county commissioners were instrumental in directing the offering and swap business to J.P. Morgan Securities. In the offerings, not only did the firm fail to disclose the payments made to direct the business to it, but the “payoffs” were incorporated into higher swap interest rates charged to the county thereby increasing the transaction costs for the government and the taxpayers. The Order for Proceedings states that J.P. Morgan Securities willfully violated Section 17(a)(2) and 17(2)(3) of the Securities Act as well as Section 15B(c)(1) of the Exchange Act and MSRB Rule G-17.

To settle the case, the securities firm agreed to make a $50 million payment to Jefferson county and to terminate all obligations of the county to make any payments to J.P. Morgan Chase Bank under the swap agreements. In addition, the firm consented to the entry of a cease and desist order, a censure and to pay a penalty of $25 million which will be placed in a Fair Fund.

A second case was brought against Messrs. LeCroy and MacFaddin, SEC v. LeCroy, Civil Action No. CV – 09-U/B 2238-S (N.D. Ala. Filed Nov. 4, 2009). The complaint in this action is based on the same conduct detailed in the J.P. Morgan Securities action. The complaint however, alleges violations of Section 17(a) of the Securities Act and Sections 10(b) and 15B(c)(1) of the Exchange Act as well as violations of rules of the Municipal Securities Rulemaking Board. See also Litig. Rel. 21280 (Nov. 4, 2008). This case is currently in litigation.

Previously, the SEC brought an action based on essentially the same conduct against certain local officials, discussed here. SEC v. Langford, Civil Action No. cv-08-B-0761-S (N.D. Ala. April 30, 2008). That action is pending. The defendants in that action were also charged in a criminal case, discussed here, U.S. v. Langford, Case No. 2:08-CR-00245 (N.D. Ala. Filed Dec. 1, 2008). Defendants Albert LaPierre and William Blount have pleaded guilty and agreed to pay certain forfeitures. Mr. Langford was convicted on 60 counts of bribery, mail fraud, wire fraud and tax evasion. The three defendants are awaiting sentencing.

In these cases, the taxpayers were the victims of greedy local officials who obtained millions of dollars for the friends and a broker hungry for business. The settlement in the administrative proceeding against the broker should help local taxpayers recoup their losses. It does not however, provide any significant assurance against a replication of the conduct in the future.

A key point of a Commission action is not only to discover and halt violations, but to ensure that they do not reoccur. While the payment to the county and the penalty have, respectively, a remedial impact in the nature of restitution and a punitive, deterrent effect neither assures against future repetition.

The conduct here, at its core, is a simple bribery scheme using millions of dollars of money belonging to the securities firm. The repeated bribes over a two year period raise a critical question regarding the adequacy of the firm’s compliance procedures and its controls. Yet, no new procedures are being instituted. No safeguards have been undertaken to prevent a reoccurrence. To ensure against a future repetition of this kind of conduct appropriate procedures should have been included in the settlement.