This Week In Securities Litigation (Week ending Jan. 11, 2019)

The Government partial shutdown continued this week with no end in sight. That left the SEC with a skeletal staff handling essential matters such as litigation since the federal courts continue to operate even if their websites do not. Despite the dysfunction, the agency did manage to partially settled one enforcement action.

The Supreme Court agreed to hear another securities case this Term. The issue for resolution centers on whether Exchange Act section 14 has a negligence standard. Last month the High Court heard argument in Lorenzo which focus on the scope of primary liability under Exchange Act section 10(b), discussed at the Federal Enforcement Forum on December 5, 2018 (here). Together these two cases could have a significant impact on the scope of primary liability in SEC and private securities fraud and tender offer cases.

Foreign securities regulators continued to operate during the U.S. government partial shutdown. ESMA, the EU regulator, issued a release suggesting points to consider in the regulation of crypto currency. The U.K.’s Serious Fraud Office narrowed the scope of its corruption investigation involving Rolls Royce, notifying a number of individuals that they are no longer under investigation.


National Exam Program: The Commission’s Office of Compliance Inspections and Examinations or OCIE announced its 2019 Examination Priorities just before Christmas and the beginning of the current Government partial-shutdown (here). The focus of the 2019 Program differs from that of 2018, although its risk-based essence and key points are similar. This year the program is built on five points: Promoting compliance; preventing fraud; identifying and monitoring risk; and informing policy. Those pillars distill into five broad exam topics: Retail investors and seniors; registrants responsible for critical market infrastructure such as clearing agencies and exchanges; FINRA and MSRB; digital assets; cybersecurity; and AML.

Supreme Court

The High Court agreed to hear another securities case this week. Emulex Corporation v. Gary Varjabedian, No. 18-459. The question the Court agreed to hear, as phrased by Petitioner, is: “Whether the Ninth Circuit correctly held, in express disagreement with five other court of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.”

Private suits

Gage order: The Cato Institute filed suit against the SEC claiming that section 202.5 of 17 C.F.R. – what the it calls a “Gag Regulation” — violates the First Amendment guarantee of free speech. The section is the predicate for provisions in Commission settlement agreements that preclude those resolving an action without admitting or denying from later denying the allegations in the charging document. The Institute’s complaint is based on an agreement to publish a book by a person who settled a Commission enforcement action containing such a provision. The book contains claims of overreaching and misconduct by the SEC staff. The Gag Regulation prohibits the publication of the book, according to the complaint. The Institute seeks the entry of a permanent injunction “against enforcement of the Gag Regulation” and a declaratory judgment that the provision is “unenforceable as a matter of law.” The identity of the book’s author is not revealed in the complaint. Cato Institute v. United States Securities and Exchange Commission, Civil Action No. 1:19-cv-00047 (D.D.C. Filed Jan. 9, 2019).

SEC Enforcement – Filed and Settled Actions

No new enforcement actions were filed this week in view of the Government shutdown. One action was partially settled however.

Offering fraud: SEC v. American Growth Funding II, LLC, Civil Action No. 16-cv-00828 (S.D.N.Y.) is a previously filed action which named as defendants: American Growth; Portfolio Advisors Alliance, Inc., a registered broker dealer; Ralph Johnson, the managing member of the AGF entities; Howard Allen III, a registered representative and an indirect owner of PAA; and Kerri Wasserman, President of PAA. The complaint alleges that American Growth, which supposedly provides loans to businesses, raised about $8.6 million from 85 investors through the sale of its units under a private placement memo from early 2011 through the end of 2013. The sales were predicated on on a series of misrepresentations, according to the complaint. During the period the primary asset of American Growth was a loan from an affiliate that had greatly deteriorated in value and for which the likelihood of repayment was imperiled. Nevertheless, investors were promised 12% returns. The complaint alleges violations of Exchange Act section 10(b) and each subsection of Securities Act section 17(a). On January 4, 2018 Judge Kimba Wood held a settlement conference in anticipation of the start of trial on January 7. The company and Mr. Johnson agreed to settle. Although the terms were not disclosed, and no papers were filed with the Court, Judge Wood continued the trial as to the remaining defendant.

Court of Appeals

Rajat K. Gupta v. U.S., Nos. 15-2707 & 15-2712 (2nd Cir. Jan. 7, 2019). Defendant was at one time a director of Goldman Sachs and McKinsey & Co. Mr. Gupta’s initial appeal of his insider trading conviction centered on the question of whether certain wire tape evidence regarding the claimed illegal tips he made to Raji Rajaratnam of Galleon Fund 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 – whether the personal benefit element of an insider trading claim was incorrectly defined. Specifically, the Court told the jury that the government must prove 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 argued that default should be excused because of prejudice or actual innocence.

To excuse the default Mr. Gupta was required to demonstrate either cause or actual prejudice, according to the Court. To sustain this burden 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,” the Court stated. More importantly, Mr. Gupta has failed to show prejudice – that the personal benefit instructions he challenged were “so flawed as to deny him due process.” Indeed, his contention that the personal benefit must be more than just the relationship between the two men and financial in nature ignores the context here and the teachings of the Supreme Court in Dirks v. SEC, 463 U.S. 646 (1983) and 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. A record built on such evidence fails to establish actual innocence.


Crypto currency: The European Securities and Market Authority published its Advice to the European Union Institutions – Commission, Council and Parliament. Specifically, ESMA, in conjunction with the National Competent Authorities, has analyzed the questions surrounding crypto-currency and identified a number of concerns. For those that qualify under MiFID, there are areas that require potential interpretation or reconsideration to ensure effective regulation. Where the assets are not financial instruments, at a minimum the Anti-Money Laundering requirements should apply. In addition, there should be appropriate disclosure so that consumers are aware of the potential risks prior to committing funds to crypto-assets (here).


CFDs: BaFin, the Federal Financial Supervisory Authority, published a general draft administrative act which is intended to maintain the existing prohibition against the use of contracts-for-a-difference or CFDs by retail investors. The ban was first imposed by BaFin in May 2017. Subsequently, ESMA implemented a similar ban in August 2018. The new draft is intended to keep regulations in accord with those of ESMA and prevent attempts to circumvent regulation.

Hong Kong

Consultation: The Securities and Futures Commission released a consultation paper on the reform of fees and costs discourse for superannuation and managed investment schemes. Specifically, the agency is seeking to ensure that consumers can obtain adequate information regarding fees and costs and that the disclosure regime is practicable for the industry (here).


Insider trading: The Financial Conduct Authority announce that Fabina Abdel-Malek and Walid Anis Choucair will each be re-tried on five counts of insider dealing beginning on 15 April 2019 at Southwark Crown Court.

Corruption: The Serious Fraud Office has narrowed its investigation of bribery and corruption in the on-going Rolls-Royce inquiry. The company admitted wrongful conduct in entering into a deferred prosecution agreement with the SFO and U.S. and Brazilian regulators in 2017. The SFO has continued to investigate in an effort to identify those involved. Recently the SFO confirmed that it had notified a number of individuals that they were no longer suspects in the Rolls-Royce investigation. The charging decisions in the matter have not been made however (Jan. 8, 2019).

Tagged with: , , ,