by T. GormanPosted on Posted in SECActions

The exit from the staff at the Commission continued this week with the acting Director of Enforcement resigning. At the same time, it seems relatively certain that Gary Gensler, former CFTC Chairman, will become the new Chair of the SEC – but it is not official yet.

This week the Supreme Court made it clear that the federal fraud statutes are not going to be used to prosecute insider trading, thereby by-passing the elements created by the courts over the years. The case arose from an insider trading scheme based on information from federal agency CMS.

Be careful, be safe this week

SEC

Whistleblowers: The Commission awarded nearly $600,000 to a whistleblower, according to a January 14, 2021 announcement.

Supreme Court

Insider trading: Blaszczak v. U.S., No. 20-5649 (January 11, 2021) is an action in which David Blaszczak, a political intelligence consultant, appealed the affirmance of his convictions for violations of two federal fraud statutes, the wire fraud and securities fraud statute passed as part of the Sarbanes Oxley Act, Section 1343 and Section 666(a)(1)(A) of Title 18. The convictions were based on the illegal tipping of confidential information regarding changes in certain federal regulations by Mr. Blaszczak’s friend, and former co-worker, at Center for Medicare and Medicaid Services or CMS. The information was given to a hedge fund which Mr. Blaszczak was affiliated and used to profitably trade.

The Supreme Court granted his petition for certiorari based on a claim that the statutes on which his convictions are predicated only apply to property rights which were not implicated by the insider trading scheme. The Supreme Court granted the writ and remanded the case to the Second Circuit for reconsideration in view of its recent decision in Kelly v. United States . . .” 590 U.S. — (May 7, 2020) regarding property rights and certain federal fraud statutes. The decision of the Second Circuit is at Blaszczak v. U.S., 947 F. 3rd 19 (2nd Cir. 2019).

SEC Enforcement – Filed and Settled Actions

The Commission filed 2 new civil injunctive actions and 1 administrative proceedings last week, excluding 12j, tag-along proceedings and other similar matters.

Offering fraud: SEC v. Hoffman, Civil Action No. 19-cv-4409 (N.D. Ill.) is a previously filed action in which the Court entered a final judgment on January 8, 2021. The complaint in the case alleged that Mr. Hoffman and another individual raised over $3.3 million through the sale of securities to 46 investors in an offering fraud. Previously, Mr. Hoffman had served as an investment advisory representative. The judgement imposes a permanent injunction based on Securities Act Sections 17(a)(2) and (3), Advisers Act Section 206(2) and Exchange Act Section 15(a). In addition, Mr. Hoffman was ordered to pay disgorgement of $60,000, prejudgment interest of $10,788 and a penalty of $93,000. The litigation continues against Defendant Thomas Conwell. See Lit. Rel. No. 25008 (Jan. 14, 2021).

Offering fraud: SEC v. Malley, Civil Action No. 1:21-cv-00237 (S.D.N.Y. Filed Jan. 12, 2021) names as defendants: Eric Malley and his firm, MG Capital Management L.P. Mr. Malley, according to the complaint, solicited investments for two funds. Investors were told that the funds they were highly profitable. They were also told that the $250 million balance sheet of Capital Management assured no losses. The track record of the investments was false; the balance sheet was false. Defendants raised about $58 million. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The complaint is pending. See Lit. Rel. No. 25007 (Jan. 12, 2021).

Offering fraud: SEC v. Contxt, Inc., Civil Action No 2:21-cv-00013 (D.Ut. Filed Jan. 7, 2021). Named as defendants are: ConTXT, Inc., a firm formed in 2016; Thomas Robbins, an undisclosed owner of ConTXT; Daniel Merriman, also an undisclosed owner of ConTXT; Mark Wiseman, chief marketing officer of ConTXT; and Clark Madsen, President and CEO of ConTXT. The case centers on two interrelated offering frauds created by Messrs. Robbins and Merriman who met while in prison for unrelated securities fraud cases. The two men were behind each of the offerings in this action. The first centered on a trading program tied to ARC Holdings, a firm controlled by the two recidivists. Investors solicited to put their funds into the firm were told that Mr. Robbins had a “spiritual revelation” in 2008 about an exclusive algorithm for trading currencies, commodities, indices, stocks, bonds, ETFs and other instruments. The vision would become a reality in 2011 when the necessary technology could be developed according to the story. It did not – the program was a fraud. The second program centered on the sale of shares in ConTXT. In 2017 Defendants Madsen and Wiseman, along with their firm, entered into an agreement with Messrs. Robbins and Merriman to raise funds for ConTXT. The firm and its executives were aware that Defendants Robbins and Merriman had criminal records which would have to be concealed. Under the terms of the agreement between ConTXT and its two executives and Defendants Robbins and Merriman, the two recidivists would receive 37.5 million shares of the company in exchange for a payment of at least $1,018,769.41. The funds would come from selling shares of ConTXT and the trading program. The ConTXT shares were marketed through the use of a PPM and related documents. Those documents falsely attributed the corporate duties of Messrs. Robbins and Merriman to a nominee. The PPM also contained false financial information for the company. Much of the money raised was never invested in the company. The complaint alleges violations of Securities Act Section 5(a), 5(c) and each subsection of 17(a) and Exchange Act Sections 10(b) and 15(a). To resolve the action each Defendant consented to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, Defendant Robbins and Merriman agreed to the entry of conduct-based injunctions. Each Defendant also agreed to pay disgorgement and prejudgment interest as follows: Robbins, $828,567 and $142,714; Merriman $744,191 and $121,869 along with a penalty of $192,384; Madsen $29,00 and $3,531 and a penalty of $96,384; Wiseman $68,500 and $8,341 and a penalty of $96,187; and ConTXT $269,187 and $32,779. In the parallel criminal case based on the trading program, Mr. Robbins pleaded guilty to securities fraud and money launderings. He was sentenced to serve five years in prison and ordered to pay $10,170,700.69 in restitution. See Lit. Rel. No. 25005 (January 8, 2021).

Anti-Corruption/FCPA

In the Matter of Deutsche Bank AG, Adm. Proc. File No. 3-20200 (January 8, 2021). Deutsche Bank is a multinational financial service company based in Germany. Its shares are traded on the NYSE. The firm had a Global Anti-Corruption Policy that prohibited the payment of bribes and required that before any Business Development Consultant or BDC could be retained rigorous procedures be met. Despite what appeared to be a comprehensive policy, beginning in 2009, the Bank repeatedly employed numerus BDCs to obtain and retain business. Those retained included foreign officials and their relatives and associates in at least three different countries. While there were risks of bribery, they were not assessed. In each instance the Bank was able to obtain and/or retain business as a result of payments through the BDCs. The Order alleges violations of Exchange Act Sections 13(b)(2)(A)_ and 13(b)(2)(B). In resolving the matter, the Commission considered the cooperation of the Bank, its remedial acts and the disposition in the related criminal case with the Department of Justice. To resolve that matter the firm entered into a three-year deferred prosecution agreement. The Bank also agreed to pay a criminal penalty of $85,329,622, criminal disgorgement of $681,480, and victim compensation payments of $1,223,738. U.S. v. Deutsche Bank, No. 20-CR-584 (E.D.N.Y. Jan. 8, 2021).To resolve the action with the Commission, the Bank consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Respondent agreed to pay disgorgement of $35,145,619 and prejudgment interest of $8,184,003.

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by T. GormanPosted on Posted in SECActions

The question of what constitutes insider trading has been litigated for decades. While many thought that a series of Supreme Court cases such as Dirks v. SEC, 462 U.S. 646 (1983) and its progeny had largely resolved the question about the basic elements of the unlawful conduct, an action prosecuted under the federal wire fraud statute and an fraud statute created as part of the Sarbanes-Oxley Act suggested that perhaps proof of elements like the “personal benefits” test can be by-passed — a short-cut to insider trading lability. Blaszczak v. U.S., 947 F. 3rd 19 (2nd Cir. 2019).

Perhaps; but perhaps not. In a January 11, 2021, the Supreme Court granted a Petition for a Writ of Certiorari in Blaszczak v. U.S., No. 20-5649. In granting the writ the Court vacated the decision of the Second Circuit upholding convictions for insider trading based on the federal wire fraud and SOX fraud statue, and remanded the case to the Circuit court “for further consideration in light of Kelly v. United States . . .” 590 U.S. — (May 7, 2020).

Second Circuit decision –inside information is property

David Blaszcak, a political intelligence consultant employed by a hedge fund, was convicted by a jury based on a scheme which appeared to be insider trading. The charges trace to inside information transmitted by Christopher Wordell, an employee at Centers for Medicare and Medicaid Services or to his former co-worker, Defendant Blaszczak. The agency issues proposed and final rules that set the Medicare reimbursement rates. The releases often impact the share price of firms that offer products and services covered by the impacted fee changes. Accordingly, the rate changes are made after the close of the market.

Mr. Worrall had access to material non-public CMS decisions concerning reimbursement amounts under the applicable regulations. As a CMS employee he was subject to Section 21A(h) of the Exchange Act which imposes a duty of trust and confidence on executive branch employees to the U.S. Government and citizens of the United States with respect to material, non-public information. CMS, in addition, has an Employee Nondisclosure Policy that imposes similar duties regarding “market sensitive” information. The Standards of Ethical Conduct for Employees of the Executive Branch fortified those duties.

Despite his obligations, in three instances over a period of about one and one-half years, Mr. Worrall furnished inside information on CMS rate changes that lowered reimbursement rates to his long-time friend, Defendant Blaszczak. The information on each occasion was transmitted in personal meetings, on the telephone, in emails and through text messages. In each instance the information was conveyed by Mr. Blaszczak to Deerfield Management Company, LP, a healthcare-focused hedge fund with which he was affiliated. The Management Company traded securities on behalf of certain funds while in possession of the material, non-public information. The trading resulted in over $3.9 million in illicit trading profits. A jury found Mr. Blaszczak guilty under each statute.

On appeal Mr. Blaszczak argued that the CMS information at the center of the trading scheme was not “property” within the meaning of the charging statutes, citing Cleveland v. U.S., 531 U.S. 12 (2000). The Circuit Court rejected this contention.

The Circuit Court began its analysis by noting that the word “property” in each statute has the same meaning. Cleveland, which considered the property question, involved licenses to operate video poker machines. The licenses were found not to be property within the meaning of the statutes. The conclusion was based on the fact that the licenses had no economic value until issued. Similarly, the state’s right to control issuance of a license was not property within the meaning of the statute. To the contrary, it implicated only its role as a sovereign. While the decision was “good law,” according to the Circuit Court, it has been read narrowly by most courts.

In contrast, the CMS rights here are property rights, the Court found. The agency has what the Court called a “right to exclude” that is “comparable to” a property right. CMS has a “property right in keeping confidential and making exclusive use of its nonpublic pre-decisional information” (quotes and citations omitted). This view is consistent with the High Court’s ruling in Cleveland and those of other circuits construing that case. The point is bolstered by evidence submitted by CMS that it has an economic interest in the information. The convictions were affirmed. U.S. v. Blaszczak, 947 F. 3d 19, (2nd Cir. 2019).

Kelly and the petition for certiorari

Kelly, cited by the Supreme Court in its ruling, is the “Bridgegate” case. It arose from the closure of certain traffic lanes to the George Washington Bridge, a gateway to Manhattan from New Jersey, for political purposes. Charges were brought against the officials involved under two federal fraud statutes, Section 1343 and Section 666(a)(1)(A) of Title 18. Those statutes target, respectively, wire fraud and fraud on a federally funded program or entity.

Each fraud statute is grounded on property rights, Justice Kagan wrote for a unanimous Court. There was no doubt that the evidence demonstrated wrong doing such as deception, corruption and abuse of power, the Court noted. The realignment of the traffic lanes at issue in the case focused on an exercise of regulatory power, however, not the taking of a property right. Since the statutes on which the charges were based only involve property rights and “do not proscribe schemes to defraud citizens of their intangible rights . . .” there was no violation. The convictions were thus reversed.

In his Petition For a Writ of Certiorari the issue presented by Mr. B.aszczak is: “Whether information about a proposed government regulation is “property” and a “thing of value” belonging to the regulatory agency such that its disclosure can constitute the federal crimes of fraud or conversion.” The Supreme Court granted the petition, reversed the convictions, and remanded to the Second Circuit for further consideration.

Discussion

The Court’s order granting the petition and citing Kelly leaves little doubt that neither the wire fraud statute nor the SOX fraud statute were violated by the insider trading scheme at the center of the case. As in Kelly, there is no doubt that the conduct of a CMS employee tipping his friend with material nonpublic information to trade in the securities markets is wrongful. That does not mean it constitutes a violation of the wire fraud and SOX fraud statute under the decisions in Cleveland and Kelly. Property rights, as defined in those decisions, simply are not implicated.

The teachings of Blaszczak seem clear – prosecutors who want to charge insider trading should rely on Exchange Act Section 10(b) as the SEC did in filing parallel charges against Mr. Blaszczak. Stated differently – there are no shortcuts to proving insider trading.