by T. GormanPosted on Posted in SECActions

When making choices it is always prudent, according to the old saying, to be careful what you wish for – you might just get it. Such is the case of former Goldman Sachs director Rajat K. Gupta. In early 2011 Mr. Gupta was charged by the SEC in an administrative proceeding with insider trading. In the Matter of Rajat K. Gupta, Adm. Proc. File No. 3-14279 (March 1, 2011). The Order detailed alleged illegal tipping to his close friend and business partner, Raji Rajaratnam of the Galleon Fund who was also convicted of insider trading based largely on tape recordings from government wire taps.

At the time the proceeding was instituted, the venue selection issue that underlies Lucia was emerging. Mr. Gupta filed suit against the agency, claiming essentially that his rights under the Due Process and Equal Protection clauses of the Constitution were violated because every insider trading case stemming from the Galleon Fund investigations had been brought in district court, not as an administrative proceeding. While the SEC moved to dismiss arguing that the question had to be presented in the administrative proceeding, Judge Rakoff denied the motion – the opposite of what occurred in virtually every other similar case. Gupta v. SEC, Civil Action No. 11 Civ 1900 (S.D.N.Y. Ruling July 11, 2011).

A few months later Mr. Gupta – unlike Mr. Lucia – got his wish. The insider trading litigation was instituted in district court and the Commission’s administrative proceeding was dismissed. The SEC filed a civil action. SEC v. Gupta, Civil Action No. 11 Civ. 7566 (S.D.N.Y. Oct. 26, 2011). And, the U.S. Attorney’s Office filed a parallel criminal action. U.S. v. Gupta, No. 10 crim 907 (S.D.N.Y. Oct. 26, 2011). Mr. Gupta, of course, did not actually get what he wanted. Rather, he was convicted on multiple counts of conspiracy and securities fraud and sentenced to prison.

This week Mr. Gupta’s second appeal of his criminal convictions was rejected by the Second Circuit. Rajat K. Gupta v. U.S., Nos. 15-2707 & 15-2712 (2nd Cir. Jan. 7, 2019). His initial appeal centered on the question of whether certain wire tape evidence regarding the claimed illegal tips to Mr. Rajaratnam should have been excluded while other evidence he offered should have been admitted at trial. The Court rejected the claims. U.S. v. Gupta, 474 F.3d (2nd Cir. 2014).

The current appeal was based on one key issue regarding the jury instructions – a claim that the personal benefit element of an insider trading claim was incorrectly defined. Specifically, the Court told the jury that the government must prove that Mr. Gupta engaged in insider trading “in anticipation of receiving at least some modest benefit in return” and that the benefit “does not need to be financial . . . It could include . . . maintaining a good relationship with a frequent business partner . . .” In presenting this issue Mr. Gupta admitted that he failed to properly present the issue at trial, but argues that default should be excused because of prejudice or actual innocence.

To excuse the default Mr. Gupta must demonstrate either cause or actual prejudice, according to the Court. To sustain this burden the defendant must establish some objective factor external to the defense. This means that “the prejudge that must be shown is ‘not merely whether the instruction is undesirable, erroneous, or even universally condemned,’ but rather ‘whether the ailing instruction by itself so infected the entire trial that the resulting conviction violates due process.’ Quoting U.S. v. Frady, 456 U.S. 152, 165 (1982).

Although Mr. Gupta ties his objection to the Court’s determination in U.S. v. Newman, 773 F. 3d 438 (2nd Cir. 2014) which was decided after his trial, “he presents no viable claim that the personal benefit challenge was unavailable to his counsel on appeal.” More importantly, Mr. Gupta has failed to show prejudice – that the personal benefit instructions he challenges were “so flawed as to deny him due process.” In this regard, it is axiomatic that the instruction must be viewed not in isolation but in context. Although Mr. Guta argued that it was error to instruct the jury that a personal benefit of “maintaining a good relationship” was sufficient, in fact the instruction went on to state “with a frequent business partner.” That statement is consistent with the teachings of the Supreme Court in Dirks v. SEC, 463 U.S. 646 (1983). And, Mr. Gupta’s claim that the benefit had to be financial is contrary not just to that decision but also Salman v. U.S., 137 S.Ct. 420 (2016).

Finally, on the claim of actual innocence, Mr. Gupta failed to demonstrate in view of all the evidence that no reasonable juror would have convicted him. To the contrary, the record is replete with examples of Mr. Gupta calling Mr. Rajaratnam with inside information; of trading by Galleon in which Mr. Gupta had a stake; and of profits being made. For example, on September 23, 2008 Mr. Gupta participated in a board meeting at Goldman Sachs Group, Inc. in which he learned that Warren Buffett was about to invest $5 billion in the investment bank. The deal was to be announced at 6 p.m. At 3:45 p.m. – one minute after the meeting ended – Mr. Gupta called his friend Mr. Rajaratnam. The two men spoke briefly. Galleon immediately began buying Goldman shares before the announcement and purchases by Mr. Buffett. A record built on such evidence fails to establish actual innocence.

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by T. GormanPosted on Posted in SECActions

The Commission’s Office of Compliance Inspections and Examinations or OCIE announced its 2019 Examination Priorities just before Christmas and the current Government partial-shutdown (here). While the inspection program is currently at a stand-still, at some point in the near future it is reasonable to assume that OCIE will begin inspections.

The focus of the 2019 Program differs from that of 2018, although its risk-based essence and key points are similar. As the glossy brochure discussing the program makes clear, the Office “measures performance in multiple ways . . .” that are tied to four key points or “pillars:” Promoting compliance; preventing fraud; identifying and monitoring risk; and informing policy. While not identical to the five key principles or building blocks of last year’s program of risk, data, transparency, resources and technology, they inform and drive the program in a similar manner (last year’s program is discussed here):

Promoting Compliance is a critical goal of the entire OCIE program. The goal is built on transparency, identifying weaknesses and education. To that end, over the last year the Office has issued five Alerts discussing best execution, fee and expense compliance issues, exams and registered investment companies, adviser compliance issues tied to the cash solicitation rule and observations related to electronic messaging.

Preventing fraud is another key goal of the overall inspection program. Indeed, the point of promoting compliance, educating those examined as well as the public with Alerts and, when necessary, referring matters to the Division of Enforcement for further action is to safeguard investors and prevent fraud. Fortunately, only a small fraction of the over 3,000 exams conducted last year resulted in an actual Enforcement referral – not every examination where infractions are uncovered results in an Enforcement action just as not every rule infraction means the compliance systems and efforts have failed.

Identifying and monitoring risk is the underlying predicate for all of the inspections. As the Brochure makes clear “OCIE will continue to stay abreast of changes in the SEC’s registrant base, the markets, and investor needs and preferences, and will adjust its risk-based program in response to these changes.” This translates to a focus on matters such as Regulation SCI, fixed income best execution obligations and advisers recommending digital assets.

Informed policy is an outgrowth of the inspection program since it enables the Office to provide “further insight to other SEC Divisions and Offices regarding how registered entities have implemented the SEC’s rules, the practical difficulties and challenges faced . . .” and common areas of noncompliance thus complementing the overall compliance focus.

The five 2019 pillars of the National Exam inspection program translate into six focal points for the National Exam Program:

1) Retail Investors: This includes “seniors and those saving for retirement.” This focus mirrors that of the Enforcement Division which formed a special task force to foster the protection of retail investors. Indeed, SEC Chairman Jay Clayton has repeatedly emphasized the protection of retail investors and seniors since the beginning of his tenure. To implement this goal the OCIE program will thus concentrate on:

a. Fees and expenses and, in particular, business models which have or create a risk of inadequate disclosure;

b. Conflicts of interest, including those from the use of affiliated service providers, securities-backed non-purpose loans and borrowings from clients and products directed at seniors;

c. Portfolio management and trading;

d. Securities professionals such as municipal advisers and broker-dealers holding customer assets; and

e. Microcap securities.

2) Registrants responsible for critical market infrastructure: This includes clearing agencies, transfer agents and national securities exchanges.

3) FINRA and MSRB: Each organization serves as a regulator, monitoring and assessing critical market infrastructure and market professionals.

4) Digital assets: These assets have grown rapidly and are frequently volatile as recent market action reflects. Chairman Clayton has repeatedly addressed the risks associated in these assets. Congress has held hearings. And, the Division of Enforcement has initiated a series of fraud and registration violation actions.

5) Cybersecurity: The protection of the financial markets and participants is crucial. The Office intends to prioritize this area in each of its exam programs. The threat to, and impact on, market participants is well illustrated by recent breaches at public companies.

6) Anti-Money Laundering: OCIE intends to continue prioritizing AML programs at broker- dealers, assuring compliance with the Bank Secrecy Act while scrutinizing policies and procedures governing the filing of suspicious activity reports with FinCEN which are critical in detecting and combating terrorist financing and corruption.

Collectively these points represent not just the focus of OCIE in its 2019 inspection program, but more importantly the Commission’s efforts in its overall administration of the federal securities laws. For a discussion of key issues for exam preparation see Dorsey Federal Enforcement Forum here.

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