A critical question if a penalties is to be assessed in an SEC enforcement action is the starting point. That was the key question in the appeal of Galleon Management, L.P. founder Raj Rajaratnam. SEC v. Rajaratnam, No. 11-5124 (2nd Cir. March 5, 2019). While the statute provides some guidance, its language is less than definitive.
Mr. Rajaratnam was convicted on multiple counts of insider trading following a weeks long jury trial. District Court Judge Jed Rakoff sentenced the one-time hedge fund mogul to 132 months in prison and directed that he pay a $10 million criminal fine. He was also directed to pay $53.8 million in forfeiture. That amount was based on the profits gained or losses avoided in the Galleon accounts as a result of all the offenses – the conspiracy counts and the substantive counts in the indictment on which he was convicted.
Following the conviction, the Commission moved for partial summary judgment on its insider trading claims. The agency argued it that summary judgment should be granted based on the five counts for which Mr. Rajaratnam had been convicted. While the SEC agreed its claim for disgorgement was moot in view of the $53.8 million forfeiture order entered in the criminal case, it demanded a civil penalty and argued that the amount be trebled – the highest amount permitted by the statute. Mr. Rajaratnam claimed that no penalty should be imposed in view of the sentence in the criminal case. Alternatively, he argued that any penalty should be limited to the profits he personally received as a result of the wrongful conduct – about $4.7 million that came from his share of the firm’s fees and returns on his personal investments in the funds.
The district court rejected Mr. Rajaratnam’s contentions, concluding that under the statute a penalty of up to three times the profits from the five illegal trades could be imposed. In view of the years of wrongful conduct in this action the court ordered a penalty of three times the base amount of profit gained and loss avoided. The Second Circuit affirmed.
The question regarding the amount of the penalty was reviewed as a matter of statutory interpretation. Mr. Rajaratnam’s claim that the statutory text, structure and legislative history counsel that the base amount be limited to profits/losses avoided personally is incorrect, the Court noted.
First, Exchange Act Section 21A authorizes the SEC to bring an action against Mr. Rajaratnam as “the person who committed” the violation, here insider trading. Subsection (a)(2) then provides that “The amount of the penalty . . . shall be determined . . . in light of the facts and circumstances, but shall not exceed three times the profit gained or loss avoided as a result of the unlawful purchase, sale, or communication.” The plain text of the statute thus authorizes the imposition of a penalty based on the total profit. There is nothing in the text which requires limiting that amount in the manner claimed by Mr. Rajaratnam. To the contrary, since he executed the illegal trades, the profit is the amount that came from the five transactions at issue here.
Second, this reading is consistent with the overall structure of the statute the Circuit Court found. Other sections of the statute limit the “amount of the penalty” for particular violations to the “gross amount of pecuniary gain to such defendant as a result of the violation.” Since the limitation imposed by Congress in those sections does not appear here, it is clear that it does not apply.
Third, the reading of the statute proffered by Mr. Rajaratnam cannot be squared with the manner in which the statute treats tippers who do not personally trade. Subsection (a)(1) makes tippers violators, eligible for a civil penalty. Subsection (a)(2), in turn, permits the imposition of a penalty as a result of an “unlawful purchase, sale, or communication.” The tipper’s penalty must, of necessity, be based on a trade placed by another.
Finally, basing the penalty on the total amount resulting from the transaction is consistent with the purpose of the statute. Penalties are imposed for deterrence. Here “Rajaratnam was motivated to orchestrate not merely a scheme to gain a few million dollars by trading in his own account, but a massive project that gained tens of millions for his clients and associates. As Congress recognized, in order to remove the motivation, an appropriate penalty must be keyed to the total scope of the scheme.” In this case that starts with the amount resulting from the five transactions and is trebled — $92,805,705.