White Collar Defense and Compliance : New Jersey White Collar Defense Lawyer & Attorney : Fox Rothschild Law Firm : Criminal Defense, Insider Trading, RICO, Consumer Fraud : New Jersey, New York City

Jana C. Volante writes:

On Monday, May 21, 2012, in the Southern District of New York, Rajat Gupta’s trial began. Gupta is charged with six criminal counts all related to insider trading, more specifically five counts of securities fraud and one count of conspiracy. If convicted, Gupta faces up to 25 years in prison. Barnini Chakraborty, "High-Profile Rajat Gupta Trial Underway; Blankfein, Buffett Could Be Called to Testify", FOXBusiness, May 21, 2012.

The prosecution of Gupta -- a former director at Goldman Sachs and Proctor & Gamble and as the former managing director at McKinsey & Co. -- by the U.S. Attorney’s Office shows that no corporate director or officer is “untouchable” in the government’s crusade against insider trading.

Gupta allegedly committed securities fraud and conspired to commit securities fraud when he leaked confidential – not to mention valuable – information about Goldman Sachs and Proctor & Gamble to the founder and former manager of the Galleon hedge fund, Raj Rajaratnam, who has already been convicted of related insider-trading charges and is currently serving an 11-year prison sentence. "Gupta Trial: A Who's Who of Those Who Will Come Up", Deal Journal, Wall Street Journal Blogs, May 22, 2012.

The government’s theory of prosecution indicates that, shockingly, Gupta was not paid for any of the insider tips that he allegedly provided. Although in the long term money may have played a part in his thinking, it may not have been his most prominent motivation. So, what motivated Gupta? Climbing the corporate ladder? He had already done that. Moving in elite social circles? He was already a part of those circles, counting Bill Clinton and Bill Gates among his many powerful business contacts.

Could the charges against Rajat Gupta be the result of his well-intentioned, but reckless, attempt to maintain and deepen those business contacts and relationships? Gupta and Rajaratnam were, by all accounts, good friends and frequently discussed business, sharing confidential details and improper tips which arguably should have remained in the Board room. Michael Rothfeld, "Gupta Case Targets Inside Culture", Wall Street Journal, Oct. 27, 2011.  In fact, the U.S. Attorney’s Office for the Southern District of New York seems to be proceeding on the theory that Gupta was motivated not by greed or profit, but by his desire to further his friendship, as well as his investing partnership, with Rajaratnam who was himself a billionaire. Gupta would allegedly share nonpublic, corporate information with Rajaratnam as soon as he received it, including information that Berkshire Hathaway, led by Warren Buffett, would soon be investing $5 billion in Goldman Sachs.

Although his motivation was undoubtedly complex, at least in part it seems that Gupta was confiding in a friend, peer, and colleague. And, in that case, it seems that if Gupta would have exercised a bit more discretion and if he would have better minded the confidentiality policies of Goldman Sachs and Proctor & Gamble, then he would not be facing criminal charges and, if convicted, an extended stay in prison. Supporting this theory, as speculated in a Wall Street Journal’s blog, Lloyd Blankfein as Chairman and CEO of Goldman Sachs as well as A.G. Lafley as former Chairman, President and CEO of Proctor & Gamble, among others, are expected to testify regarding the policies of each of their companies on confidentiality and inside information and how these policies apply to their respective Boards of Directors.

There is a lesson to be learned here for all corporate directors and officers: keep your friends close, but not so close that they are privy to confidential communications. 

(Jana C. Volante, Esq., the author of this entry, is an associate with Fox Rothschild LLP, based in our Pittsburgh, PA office. Her practice concerns white collar criminal defense and commercial litigation) 

• Print
• Comments
• Trackbacks
• Share Link

For years, the Securities and Exchange Commission has settled cases using a standard disclaimer stating that the defendant neither admits nor denies wrongdoing. This standard disclaimer allowed the SEC to claim victory and the defendant to avoid the type of public admission of wrongdoing that could be used against the defendant by shareholders or other injured parties in subsequent private lawsuits seeking damages. Thus, under this policy, the defendant could admit certain criminal conduct when criminally prosecuted by the Department of Justice or could be criminally convicted of that conduct, but the defendant could simultaneously settle civil charges with the SEC without admitting or denying nearly identical allegations in the SEC’s complaint.

Late last year, federal judge Jed Rakoff, sitting in the Southern District of New York, refused to approve a nearly $300 million settlement in an SEC action brought against Citigroup because the bank -- which had not been charged criminally -- had not been obliged under the terms of the settlement to acknowledge any wrongdoing. Chastened, the SEC on January 9th announced that it would be modifying the long-standing policy criticized by Judge Rakoff. The SEC will no longer allow defendants to settle cases involving civil fraud or insider trading charges without the defendant admitting or denying wrongdoing in circumstances where the defendant has admitted such conduct in its resolution with the DOJ or another government agency. Now, any civil settlement that the defendant enters into with the SEC will cite the admission of conduct or the conviction in the corresponding criminal case.

However, the SEC will continue to use the “neither admits nor denies” language in the large majority of SEC settlements, since most settlements are accomplished with defendants who have neither been prosecuted nor admitted wrongdoing to another government agency. Since Citigroup was not criminally prosecuted, the new policy would have left intact the formulation of that much-criticized settlement. It remains to be seen, therefore, whether the policy change implemented by the SEC will stem the judicial criticism so pointedly directed to the agency.
 

(Jana Volante, Esq., the author of this entry, is an associate with Fox Rothschild LLP, based in our Pittsburgh, PA office. Her practice concerns white collar criminal defense and commercial litigation)

• Print
• Comments
• Trackbacks
• Share Link

In a series of insider trading cases, the Second Circuit has appeared to hike the government’s burden of proof in showing the “willfulness” of conduct needed for conviction by requiring evidence that a defendant acted with the knowledge that he was violating the securities laws. This additional layer of proof, common to prosecutions of many regulatory offenses, helpfully requires a jury to find more than the usual mens rea standard of “knowing and intentional” conduct. Recently, a defendant sought to have the enhanced level of proof applied in a conventional securities fraud case, but the court declined to do so.

Mark Kaiser was a corporate officer of U.S. Food Service, a distributor of food products to restaurants, and he supervised the company’s purchasing department. He had received bonuses based on the amount of promotional allowances paid to USF by its vendors; those allowances increased as USF’s purchases from the vendors increased. Apparently not content with the ordinary course amount of the payments, Kaiser, according to the government, inflated the amount of payments USF appeared to receive, and his resulting bonuses, by having vendors pre-pay large bonuses based on purchasing targets not yet achieved. Kaiser then allegedly hid the scheme by causing false bookkeeping entries and by personally lying to outside auditors about the nature of various payments received by his company. He was convicted in the Southern District of New York of securities fraud and causing false filings to be made to the SEC.

Kaiser appealed on several grounds, including the claim that the jury instruction on the “willfulness” element under 15 U.S.C. § 78ff(a) (penalizing "[a]ny person who willfully violates any provision of this chapter ....") was erroneous because the trial judge failed to instruct that a defendant could only act “willfully” if he had knowledge that his actions were illegal. He succeeded in vacating his conviction and winning a new trial, but on other issues, including a flawed “conscious avoidance” charge; the Second Circuit flatly rejected his argument that “willfulness” in this context requires knowledge of illegality. United States v. Kaiser, 609 F.3d 556 (2nd Cir. 2010).

While noting recent its own precedent that endorsed a higher standard for willfulness in insider trading cases, the appeals court distinguished insider trading, which does not necessarily involve deception and, therefore, where an insider may be unaware that his conduct was illegal and therefore wrongful. The court explained that the same cannot be said of one who deliberately misleads investors about a security.

Although the appeals court held the district court erred in instructing the jury on “conscious avoidance”, the court upheld the district court’s instruction on willfulness. The Second Circuit disagreed with Kaiser’s argument that “willfulness” requires knowledge of illegality and held that Section 32(a) of the Exchange Act does not require proof that the defendant knew he was violating the law, only that which was charged in this case: knowingly false statements made with an intent to deceive, with an absence of good faith on the defendant’s part. Those requirements, the court noted, necessarily suffice to prove that Kaiser knew he was committing a wrongful act.
 

(With appreciation to Christine Soares, Esq., for contributing this entry)

• Print
• Comments
• Trackbacks
• Share Link

Defending a securities fraud prosecution brought under 15 U.S.C. § 78j and Rule 10b-5 on the theory of undisclosed material information can be enormously challenging because the standard for judging whether particular information would have been material to a reasonable investor is so elastic and unpredictable. Just how immaterial the supposedly “material” information may be was underscored recently by the Ninth Circuit.

The case of United States v. Laurienti, 2010 WL 2266986 (9th Cir., June 8, 2010), concerned the securities fraud prosecution of the owners, senior managers and brokers of a defunct broker-dealer called Hampton Porter. The indictment alleged that Hampton Porter made a practice of selling blocks of stock provided to it by issuers through a “pump and dump” scheme. Its brokers were incentivized to sell these house stocks through greatly enhanced commissions, and only retained those commissions if they could discourage clients from selling out of their positions in the house stocks. By stoking buying activity in these stocks, the shares’ prices rose artificially and dramatically, and then the broker-dealer and others would dump their shares of those stocks to realize the gains. Clients of the firm were not informed, of course, about the brokers’ increased commissions on the house stocks, as compared to their commissions on all other stocks. Naturally, former clients testified at trial that if they had known of the house stocks’ commission rates, they would not have purchased those stocks. There was also evidence at trial of high-pressure sales tactics and unauthorized transactions in certain accounts, but no evidence of any misrepresentations or undisclosed information about the issuing companies, their performance, or the intrinsic value of the stocks.

The owners and managers pled guilty, leaving several brokers to go to trial; they were convicted. On appeal, the brokers maintained that there was no legal obligation to disclose their commissions, so they could not have committed securities fraud by failing to make the disclosure, and there was no other evidence of fraudulent statements or omissions.

Initially, the court of appeals opinion suggested, with an almost imperceptible wistfulness, that if the government had proceeded solely on a conspiracy to commit securities fraud theory, then the appeal would have been more easily resolved in its favor. In that scenario, the evidence of undisclosed commissions, “even if not independently criminal conduct,” would have amounted to circumstantial evidence of the brokers’ agreement to join the conspiracy of the owners and managers, and the conspiracy proof would have been complete against the brokers with no evidence at all of their committing actual acts of fraud. However, the opinion notes almost ruefully, the government did offer the failure to disclose bonuses not just on the conspiracy charge “but also as an independent violation of Rule 10b-5,” leaving the court no alternative but to decide the precise question: is it illegal to fail to disclose increased commission rates?

Reaching first the existence of a duty to disclose, the court held that in the presence of a relationship of trust and confidence between broker and client, Rule 10b-5 imposes on the broker an obligation to disclose all facts material to the relationship, citing Chiarella v. United States, 445 U.S. 222 (1980) (which concerned subsections (a) and (c) of Rule 10b-5, involving respectively, employing a device or scheme to defraud and engaging in a practice which operates to defraud, and which required disclosure of material facts if there was a relationship of trust). In dictum, the Laurienti court extended the obligation to disclose to subsection (b) of Rule 10b-5 (omitting material facts necessary to render other statements not misleading), even when there is not a relationship of trust. Although the jury instructions here were errant in failing to require the essential element of a trust relationship, the Ninth Circuit held that the broker defendants had waived their objections to the error.

Turning to the issue of the materiality of the commissions, the appeals court rejected the argument that the enhanced commission rates were immaterial as a matter of law, since, it held, a reasonable investor would consider them important. However, the court hastened to add, not all compensation arrangements are material and de minimis variations among different commission rates would indeed be immaterial.

Finally, the brokers argued that even if enhanced commissions are now to be deemed material, they had no way of anticipating that holding and so had no warning of the bounds of the criminal law. The court had two curt responses: (a) its holding was not unforeseeable in light of Chiarella; and (b) the failure to disclose is not illegal unless accompanied by an intent to defraud. A perfectly appropriate defense counsel response to the second point would be to firmly grasp one’s head with both hands and shake slowly from side to side, since the court’s guidance hardly illuminates the path between criminal and non-criminal conduct and leaves that demarcation entirely to the government’s charging decisions.
 

• Print
• Comments
• Trackbacks
• Share Link

The Third Circuit Court of Appeals this week reaffirmed the limited circumstances under which a duty to disclose arises under Rule 10b-5, rejecting in a criminal case the Government’s theory that a fiduciary duty attaches to “high corporate executives” obliging them to correct alleged misstatements by others in management.

The case of United States v. Schiff, 2010 WL 1338141 (3d Cir., Apr. 7, 2010) involves the prosecution of two former top executives of Bristol-Myers Squibb. Frederick Schiff, former CFO, and Richard Lane, former president of a Bristol-Myers unit, were both indicted on conspiracy and securities fraud charges related to statements and alleged omissions in 2002 concerning the company’s business practice of incentivizing its wholesalers to purchase and inventory more products than were needed based on actual demand. The Government maintained that this practice fraudulently inflated corporate sales in the short term, and was covered up in public pronouncements to analysts and in the company’s filed financials.

On appeal was the district court’s dismissal of a Government theory that Schiff could be convicted for failing to correct misleading statements as to wholesale inventory levels made by Lane on analyst calls. The Court of Appeals affirmed the lower court’s rejection of any duty to speak in order to correct another’s statements, emphasizing that in only three scenarios does a duty to disclose arise: (a) insider trading; (b) a statutory requirement of disclosure; and (c) an inaccurate, incomplete, or misleading prior disclosure by the same individual. The notion of a generalized fiduciary obligation upon “high corporate officers” to correct others’ omissions or inaccuracies, what the Government also called a “corporate spokesman fiduciary duty,” finds no basis in 15 U.S.C. § 78j(b) or Rule 10b-5.

The Court also addressed a Daubert ruling limiting the Government’s proof of the materiality of certain charged affirmative misstatements by the defendants. In so doing, it noted that the Government’s proposed use of an expert to link a stock-price drop to the making of certain statements was a “widely used” method of proof of materiality, but that a party could also rely on fact testimony from analysts or corporate employees that wholesale inventory levels were material to either investment decisions or financial forecasts.

Reading the Third Circuit's opinion is also commended in order to appreciate the district court’s very active, and detailed, management and criticism of the Government’s shifting and conflicting theories of prosecution. Defense counsel had not only obtained a constraining bill of particulars in the trial court, but persuaded the judge to extract stipulations from the Government to confine it to particular theories of securities fraud, leading to success on appeal and probably improving the prospects at the eventual trial.
 

• Print
• Comments
• Trackbacks
• Share Link