GUEST BLOGGER-SOLOMON L. WISENBERG
Here is the slip opinion. According to the Court's syllabus, Section 1346 is not unconstitutionally vague, but only proscribes the "bribe-and-kickback core of the pre-McNally case law." More to come.
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Category: Securities
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GUEST BLOGGER-SOLOMON L. WISENBERG
Here is the Lee Bentley Farkas Indictment, unsealed this week in the EDVA. Farkas is charged with conspiracy, bank fraud, wire fraud, and securities fraud. I'm surprised they didn't throw in dancing with a mailman or impersonating Smoky the Bear. The government alleged securities fraud under 18 U.S.C. Section 1348, which, surprisingly, has seen very limited use since it was enacted as part of Sarbanes-Oxley. It will be interesting to see if this is part of a new trend. There are three securities fraud counts (Counts 14-16) based upon three separate reports (10-K, 8-K, and 10-Q) filed with the SEC, each one charged as an execution of the securities fraud scheme.
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GUEST BLOGGER-SOLOMON L. WISENBERG
Last week, in a significant decision construing SEC Rule 10b-5 in the context of criminal prosecutions, the Ninth Circuit held that "if a broker and a client have a trust relationship…then the broker has an obligation to disclose all facts material to that relationship." The case is United States v. Laurienti and can be accessed here. Laurienti involved a pump and dump scheme in which brokers failed to disclose commissions they received equal to 5% of the purchase price of certain "house stocks" sold to clients. The defendant brokers argued that they had no legal duty whatsoever to disclose the 5% commissions to their clients. The Ninth Circuit disagreed, and noted that the 5% commissions were clearly material under the facts developed at trial, since "every former client who testified said that he or she would not have bought the house stocks had he or she known about the bonus commissions." The case was brought under all three subsections of Rule 10b-5. The Court noted in dictum that "[u]nder subsection (b) of Rule 10b-5, even in the absence of a trust relationship, a broker cannot affirmatively tell a misleading half-truth about a material fact to a potential investor." The Court also held that the defendants could have been found guilty of conspiracy in the pump and dump scheme even if the disclosure of bonus commissions had not been required by law, because "a reasonable juror…could have concluded that Defendants intentionally acted contrary to the interests of their clients by pushing house stocks as part of a fraudulent scheme to line Defendants' pockets without regard for the interest of their clients." The undisclosed bonus commissions were "circumstantial evidence of Defendants' agreement to join the conspiracy." The Court relied heavily on the Supreme Court's opinion in Chiarella v. United States, and on Second Circuit precedent, in reaching its decision.
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GUEST BLOGGER-SOLOMON L. WISENBERG
Zachary Goldfarb has an interesting story in today's Washington Post about past turmoil and alleged retaliation in the SEC's Fort Worth District Office. The story highlights the difficulties facing the new SEC regime as it tries to kick-start an agency that rather miserably failed to spot the Madoff and Stanford frauds.
You may recall the name of Julie Preuitt. She is the Fort Worth Examination Branch official who sounded the alarm bell for years about R. Allen Stanford's alleged activities, only to see her complaints ignored or quashed by supervisors in the Fort Worth Enforcement Branch. All of this is detailed in SEC Inspector General H. David Kotz's excellent and shocking Report of Investigation of the SEC's Response to Concerns Regarding Robert Allen Stanford's Alleged Ponzi Scheme.
In 2007, according to Goldfarb, Preuitt's Examination Branch boss, Kimberly Garber, instituted a new super-short method, known as a rave, of examining certain brokerage firms. The exams lasted half a day. Only management personnel were interviewed during the raves, and the examiners did not actually examine any records, although company policies were reviewed. The raves were instituted by Garber, purportedly to boost Fort Worth's exam stats. Preuitt complained vociferously about the raves, and was rewarded with reassignment and demotion. This same management focus on stats over substance was what led to the Fort Worth Enforcement Branch's failure to publicize and halt Stanford's alleged activities in a timely fashion, according to Kotz's Report.
The story also reveals that Garber is alleged to have violated the SEC's ethics rules by using her office for the private gain of relatives. During an official trip to Kansas, Garber arranged for her staff to stay at a bed and breakfast owned by her brother and sister-in-law.
The SEC has discontinued the raves, but hard feelings between management and staff persist in Fort Worth.
This is all interesting stuff, and it points toward a larger and endemic problem within federal regulatory and law enforcement–that is, the obsession with statistics as a sign of progress in the war against white collar crime. Too much of a focus on stats leads management to favor the quick hit and the easy, often small, target. Think about that every time you see an FBI press release touting the latest mortgage fraud guilty plea. My guess is that most of the mortgage fraud convictions in the last two years involved small fries.
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The opening panel of this conference was United States Sentencing Guidelines Developments and a View from the District Court Bench. Moderating this panel was Professor Frank Bowman. Judges Frederic Block (ED NY), Steven Merryday (MD Fl) and Robert Pratt (SD Iowa) offered their perspectives. Judge Pratt had some important advice for defense counsel – sentencing is fact intense and you need to bring out the facts. You need to make a record. My favorite line was when he said that there are a "number of opportunities to make the law more human."
The panel – Sentencing Issues in Securities Cases – had Henry "Hank" Asbill as the moderator. It's all about "loss" is the way it started. Listening to the speakers ( Mark Harris – Proskauser Rose, LLP; Michael Horowitz, Calwalder, Wickersam & Taft; Peter Spivack – Hogan & Hartson) it is clear that an expert is needed to assist in measuring loss. But as noted by one of the speakers, "[i]f you go down the expert road these are very complicated issues." Hank Asbill asked "[w]ere the guidelines based upon assumptions in the market?"
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In the Third Circuit Court of Appeals decision, U.S. v. Schiff, the court stated:
"Frederick Schiff and Richard Lane were high-ranking corporate executives at the pharmaceutical giant Bristol-Myers Squibb ("Bristol"). They were criminally indicted for allegedly orchestrating a massive securities fraud scheme related to Bristol’s wholesale pharmaceutical distribution channels in the early 2000s, in violation of, inter alia, 15 U.S.C. § 78j(b) and Securities and Exchange Commission ("SEC") Rule 10b-5. The Government filed this interlocutory appeal in response to the District Court’s March 19, 2008 opinion that addressed several contested theories of liability as well as expert witness issues under Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579 (1993).1 On appeal are two issues: (1) whether the DistrictCourt properly dismissed the Government’s theories of omission liability under Rule 10b-5 that attempted to hold Schiff accountable for omissions in quarterly SEC 10-Q filings based on his and Lane’s alleged misstatements in Bristol’s quarterly conference calls; and (2) whether the District Court abused its discretion in excluding the Government’s expert, following a Daubert hearing, who would have testified to Bristol’s stock price drop as evidence of Rule 10b-5’s materiality element. Because we agree that the Government’s omission liability theories are not viable, we affirm the District Court’s dismissal of these theories. As to the expert testimony, we conclude that the District Court’s ruling excluding the Government’s materiality expert was not an abuse of discretion." (footnote omitted)
A telling line from the decision –
"Throughout the pretrial proceedings, and even in this appeal, the Government has engaged in a game of musical chairs with their pursuit of changing legal theories under Rule 10b-5."
See also Jonathan Stempel, Reuters, Bristol-Myers ex-CFO wins ruling in criminal case
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The SEC has instituted a new initiative to provide for greater cooperation in hopes of encouraging individuals to assist in bringing to light improper activities. (see SEC Press Release) And cooperators may obtain a benefit of immunity in return for their cooperation (see Marketplace here). The framework for this cooperation can be found here. Some concerns –
- What if you are the last person in the chain and there is no one left to offer cooperation against – is it fair for cooperation to be a race to the SEC office? Will individuals with more resources be the ones to receive the most benefits, while poorer folks are left to suffer the consequences of others cooperating?
- It is clear that the SEC gives itself enormous discretion in deciding the value of the individual's cooperation. The four factors listed as the outline for determining "whether, how much, and in what manner to credit cooperation by individuals" sound wonderful, but the outline is clearly subject to many different interpretations. For example, will everyone be in agreement as to "[w]hether the individual's cooperation resulted in substantial assistance to the Investigation?" Also, the SEC will be determining if the person acted with scienter. Will those who could suffer consequences of an SEC action agree with the determination that is made?
- And what if the individual disagrees with the level of cooperation determined by the SEC, is there any place to obtain review? The rules explicitly state that it does not "create[] or recognize[] any legally enforceable rights for any person."
- Does this really go beyond the powers that the SEC presently has now? If cooperation is offered, couldn't they now decide not proceed against someone? Is this new initiative offered for a symbolic purpose?
- If there is a real incentive offered will it result in the possibility of misinformation being relayed to the SEC by those who desire to obtain immunity. How will the SEC handle cooperators who lie to save themselves from the consequences that they can face for their illegal activities?
- Until such time as a neutral third party enters this picture to evaluate the cooperation, it certainly seems like this "new" approach is vague and perhaps just more of the same.
- The real question is not whether the SEC will receive information on improprieties, but rather will they do something about it when the information is received. Would this situation have brought the Madoff case to light sooner, or was Madoff brought to their attention but they failed to follow up.
For more commentary on other aspects of the SEC announcement, like the use of deferred prosecution agreements, see Mike Koehler, FCPA Blog, Game-Changing" Day at the SEC
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Guest Blogger – Gail Shifman
In the 2009 sequel to the 1987 movie, Wall Street, one expects to see Michael Douglas’ Gekko talking on his cell phone on his way to a meeting in Baltimore where technology superstar and investor hottie, Tweetz, has its headquarters. The phone conversation is worth millions. Those on the phone know that to win you have to risk loss.
Welcome to the new reality: Wall Street meets The Wire.
The arrest and charging of Hedge Fund Managers, Fortune 500 Executives and a Management Consulting Director in the $20 Million Insider Trading case, the largest ever charged criminally, is just the beginning, says U.S. Attorney Preet Bharara. The arrests followed more than two years of investigation involving informants, cooperating witnesses, consensual monitoring and wiretaps on at least four phone lines. It is believed to be the first time that prosecutors have used a wiretap in an insider trading case. Bloomberg reports that federal investigators are now poised to file charges against a wider array of insider-trading networks, some linked to the criminal allegations against Rajaratnam and the other defendants. They report that some probes, like the one that focused on Rajaratnam, rely on wiretaps and that others stem from a secret Securities and Exchange Commission data-mining project set up to pinpoint clusters of people who make similar well-timed stock investments.
Beyond the initial issue of whether investigating Wall Street insiders with law enforcement tactics typically reserved for the Mob, gangs and terrorists is a wise use of resources, it also raises many legal issues quite distinct from those traditionally litigated in white collar cases. Wiretap litigation is a complex, multi-layered process. Questions arise early in the case regarding the discovery production obligations of the government. Following a review of the many months of electronic interceptions, questions will arise regarding whether the government properly sought, minimized, maintained and sealed the recordings. Did they seek proper extensions for the continued interception of the electronic recordings? And, of course, was there probable cause to seek the interceptions?
In this case, however, the legal issue regarding the use of wiretaps that immediately jump to the surface is the question about whether The Federal Wiretap Act specifically authorizes the interception of electronic recordings for alleged security fraud violations (Title 15 U.S.C. §§ 78j(b) & 78ff and Title 17 C.F.R. §§ 240.10b-5 & 240.10b5-2) as charged in the criminal complaint. These statutes are not specifically enumerated in Title III, 18 U.S.C. § 2516, which provides the authorization for electronic interception. Wire and mail fraud (18 U.S.C. §§ 1341 & 1343) anti-trust violations, money laundering and numerous other offenses are listed, but not securities fraud. Chances are good that the government could have charged these defendants with wire fraud but were they scared away by the fact that the Skilling, Weyrauch, and Black cases are on review before the Supreme Court? One would think (hope?) that the government has preliminarily determined that section 2516 provides them with the authorization they need lest they find themselves licking self-inflicted wounds.
Assuming they overcome this hurdle, the wiretap issue that likely will be the most heavily litigated, and potentially the most fruitful for the defendants, will be a motion to suppress the wiretaps because the government lacked ‘requisite necessity’ for the lawful use of electronic recordings . Electronic surveillance is one of the most intrusive means of investigation. Indeed, the inherent intrusiveness of wiretapping is the cornerstone of the so-called "necessity requirement." As the Supreme Court stated in its landmark case which led to the enactment of the current wiretapping statutes, "[f]ew threats to liberty exist which are greater than that posed by the use of eavesdropping devices." Berger v. United States, 388 U.S. 41, 63 (1967). The Court in Berger went on to recognize that although wiretapping is a more expedient form of investigation, expediency in law enforcement must ultimately yield to the requirements of the Fourth Amendment "before the innermost secrets of one's home or office are invaded." Id.
In response to the concerns and standards enunciated in Berger, Congress enacted the electronic surveillance statutes, Title III, 18 U.S.C. § 2510 et seq. Congress mandated that the government make their wiretap applications upon oath, accompanied by [A] full and complete statement as to whether or not other investigative procedures have been tried and failed or why they reasonably appear to be unlikely to succeed if tried or to be too dangerous. 18 U.S.C. § 2518(1)(c).
Title 18 U.S.C. § 2518(3)(c) provides that a court issuing a wiretap authorization order must determine whether normal investigative procedures have been tried and have failed or reasonably appear to be unlikely to succeed if tried or to be too dangerous. This "necessity requirement" obligates the government to set forth a full and complete statement of specific circumstances explaining why traditional investigative techniques were insufficient or the application must be denied. In determining the sufficiency of an affidavit, a reviewing court must ensure that the issuing court properly performed [its] function and did not 'serve merely as a rubber stamp for the police'. The government is not under an obligation to exhaust all alternative means of investigation in satisfying the necessity requirement but, neither should it be able to ignore avenues of investigation that appear both fruitful and cost-effective.
Given that the government had three co-conspirators, including one as early as January 2006, acting as informants and cooperating witnesses, and that these individuals had unfettered access to Rajaratnam and others involved in the alleged conspiracies, the question arises whether the government deliberately stalled this investigation and actively resisted utilizing normal investigative techniques, hoping to induce the court into believing that only a wiretap could succeed. Were deliberate decisions made by the government not to pursue avenues which would have been fruitful, in its effort to persuade the court that it had no alternative but to seek a wiretap? Given my experience in wiretap litigation, I suspect that the government had the means through traditional, cost effective, and innovative methods to uncover the alleged conspiracies. Through the use of their informants and cooperating witnesses, data mining and analysis, trap and trace and pen register analysis and sometimes even through trash covers (yes, combing through the garbage), it is likely that the conspiracies could have been revealed and prosecuted.
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The opening session of the second day of the ABA's Securities Fraud Conference is a plenary session pertaining to the Foreign Corrupt Practices Act (FCPA) – clearly a "hot" topic these days. A panel moderated by Phillip H. Hilder, started with Mark F. Mendelsohn, deputy chief of DOJ's fraud section -criminal division, answering a question regarding how many individuals he has working on FCPA cases and which areas are most vulnerable to FCPA matters. I didn't quite catch the final count of individuals handling these cases but it was clear that there were at least three folks exclusively handling FCPA cases and a good few many more working on them. Although he listed some areas that have seen prosecutions– it was expressed more as "targeting is the wrong word." He said that its more like "following up on leads from existing cases." Peter Clark and CE Rhodes, Jr.(US Operations & Compliance Counsel – Baker Huges, Incorporated) spoke to the representation of individuals and both talked about the use of independent/separate counsel to represent individuals.
As my panel was next, I did not get to hear the remainder of the FCPA panel, which clearly was an important one. My panel on blogging was moderated by David Z. Seide and included Bruce Carton (Securities Docket), Thomas O. Gorman, (SECActions.com) and myself. It was wonderful to see and hear about the wonderful blogs and sites by my fellow panelists and to hear about what Bruce Carton was doing with Twitter and Thomas Gorman's thoughts on making resources accessible to attorneys.
One of the final breakouts of the day pertained to sentencing. The panel, moderated by Professor Steve Chanenson, (Villinova) had panelists Hon. Amy St. Eve, Christine Ewell (AUSA, Chief, Criminal Division – USAttorneys Office Central District of California), James Mutchnik, Gil Soffer, and Brian Sun. The hot topic here was a discussion about the disparity in sentencing. And as Brian Sun brought out – it is not just disparity between cases, it is also the disparity within the same case – such as disparity between those who are cooperating and your client. The Hon. Amy St. Eve noted that it's the obligation of the attorneys to bring the issues of disparity to the attention of the judge.
Risk can be a key factor in sentencing, as noted by James Mutchnik. The uncertainly and not knowing is difficult for the client, and reaching a deal with the prosecutor provides some certainty to the situation. But this won't always work, as Christine Ewell, noted the "limited circumstances when they do binding pleas." In some cases they do a range of sentence, such as in corporate "fines" cases. Hon. Amy St. Eve reminded attorneys that they need to think about pleas that might be out of line with later defendants within the same case. Atorney Mutchnik noted that so much rests on the "risk" that your client can take.
Christine Ewell noted how the guidelines can be "off the charts" in some cases. But the guidelines shouldn't be discarded in these circumstances, she said. It is more that this should be an indicator that the offense is so egregious that it merits a longer sentence. She spoke about "message sentences" when a sentence comes in at an amount that exceeds the person's life (Madoff, and a sentence in her district that was 100 years were used as examples).
Mutchnik noted that we should move away from "loss" by looking at what the client gained. Gil Soffer said that its appropriate to recognize the policy behind the guidelines, but the guidelines are just one factor. And Brian Sun reminded listeners of the sentences in cases years back (e.g., Boesky). He also noted how sentencing today can differ – it can be like doing a "murder case versus a DUI" because of the high sentences that white collar offenders are subject to. One example offered by Gil Soffer to bring to life your defendant's cause is to use a video, for example using video to show a day in the life of a doctor who was about to be sentenced.
An interesting question examined was whether "the 20 years in the middle of a person's life is more valuable than the the 20 years at the end of [his or her] life?" This was clearly a thoughtful panel that presented material to those present for the last set of breakouts.
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The Ninth Circuit Court of Appeals issued a decision in U.S. v. Hickey, a case "from a massive fraud scheme that resulted in protracted civil and criminal proceedings spanning more than ten years." The court stated that the accused and his business partner "induced over 700 individuals to invest approximately $20 million in two real estate development funds." The "investors were duped by false representations regarding land title, guarantees, and securization of the funds." The court stated that "[a]s the investment scam progressed, it devolved into a Ponzi scheme." Several grounds were raised on appeal including jurisdiction, statute of limitations, evidentiary errors and sentencing. The court affirmed the decision of the lower court rejecting these issues.
There were two superseding indictments in this case, and a concurring opinion takes issue with the court's definition of the word "superseding" and offers an interesting approach. Circuit Judge Reinhardt states in part:
Here, I see no reason, rational or otherwise, to treat the word "superseding" as meaning "not replacing," as we have done before and as we do again here. An abundance of judicial creativity has been devoted to tasks like interpreting "another" to mean "the same"; "slight" to mean "substantial"; and "superseding" to mean "not superseding." I propose redirecting that creativity to better uses, such as finding terms that actually mean what they appear to mean. We could start by using "second indictment" or "first additional indictment" to describe an indictment that follows the original indictment, but does not "supersede" it. Were we to do so, we might earn more public trust and respect than we are accorded now. Any additional amount, no matter how slight, i.e. substantial, would be most welcome.
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MattBray.net 