A Look Back at 2011: The Biggest Securities Law News of the Year
2011 was a big year in securities law – from the Galleon Group insider trading convictions to the beginning of the SEC’s whistleblower program under Dodd-Frank. Here, we’ll review the top five securities law stories from 2011.
5. Judge Rakoff Challenges Settlements Made “Without Admitting or Denying Wrongdoing”
In 2010, Judge Rakoff first questioned the SEC’s proposed settlement of $33 million with Bank of America for misleading shareholders concerning its acquisition of Merrill Lynch. In 2011, Judge Rakoff started off the year by expressing his distaste for settlements between the SEC and wrongdoers that were made “without admitting or denying wrongdoing,” a standard practice in the industry. In the SEC’s settlement with Vitesse Semiconductor and three former executives over improper accounting of revenue and backdating of stock options, Judge Rakoff wrote:
The result [of neither admitting nor denying wrongdoing] is a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C. The defendant is free to proclaim that he has never remotely admitted the terrible wrongs alleged by the S.E.C.; but, by gosh, he had better be careful not to deny them either (though, as one would expect, his supporters feel no such compunction). Only one thing is left certain: the public will never know whether the S.E.C.’s charges are true, at least not in a way that they can take as established by these proceedings.
This might be defensible if all that were involved was a private dispute between private parties. But here an agency of the United States is saying, in effect, “Although we claim that these defendants have done terrible things, they refuse to admit it and we do not propose to prove it, but will simply resort to gagging their right to deny it.”
In the Vitesse Semiconductor settlement, however, the Judge found that the amount was fair, reasonable and in the public interest. See article here. Later in 2011, however, Judge Rakoff outwardly rejected the SEC’s proposed settlement of $285 million with Citigroup, which represented only a fraction of the losses involved (the SEC alleged that Citigroup bet against its customers in housing related investments and made profits of $160 million while the customers lost more than $700 million). Judge Rakoff again questioned why Citigroup could get away with neither admitting nor denying liability, and even questioned the SEC’s practice of obtaining injunctions against defendants, prohibiting them from violating securities laws in the future (Judge Rakoff also questioned the factual basis for the charges involved). The SEC has appealed Judge Rakoff’s decision, rather than returning to the Judge with a different settlement, as they did with the Bank of America case in 2010. Judge Rakoff’s actions have instigated a great deal of public debate over the standard language used in SEC settlements, and could have an effect on the SEC’s settlements in the future.
4. Federal Agencies Target Ponzi Schemes in Greater Numbers
In 2011, federal agencies noted that they were attacking Ponzi schemes in greater numbers than ever before. As an example, the CFTC carried out a record 32 enforcement cases involving Ponzi schemes, a 45 percent increase from 2010. See article here. The FBI had over 1,000 inquiries concerning Ponzi schemes, 150% more than in 2008. The SEC notes that it has brought more than 100 enforcement actions against nearly 200 individuals and 250 entities for carrying out Ponzi schemes since the year 2010. Faced with the embarrassment of discovering the Madoff Ponzi scheme 20 years after it started, it seems the agency is striving to prevent another oversight.
Some notable Ponzi scheme allegations this year included James Davis Risher, who was accused of targeting elderly and unsophisticated investors in a $22 million Ponzi scheme and who pleaded guilty in federal court in August 2011, Allen and Wendell Jacobson, a father and son accused of perpetrating a $220 million Ponzi scheme that targeted members of the Mormon Church, and the Fair Finance Company and three executives, accused of orchestrating a $230 million offering fraud involving at least 5,200 investors, many of whom were elderly. Many Ponzi related actions resulted in parallel criminal actions as well.
3. SEC’s Whistleblower Program Launches
In May 2011, the SEC adopted the final rules that would launch the whistleblower program created under the Dodd-Frank Act. The whistleblower program was launched with a very enticing incentive – a percentage ranging from 10-30% of any recovery by the SEC of over $1 million in a successful enforcement action that was spurred by the whistleblower’s tip. In addition to offering legal protection to employees from retaliation for reported potential securities law violations, the monetary incentive is likely to encourage detailed and effective tips from individuals or employees with knowledge of potential violations. In the first seven weeks of the program alone, 337 tips were received by the SEC. The whistleblower program also allows individuals to submit tips anonymously through an attorney. For more information, see our previous blog posts on the subject, here and here.
2. Continued Aggressive Enforcement of FCPA Violations
Although 2008 marked the year of the largest settlement ever for Foreign Corrupt Practices Act (“FCPA”) violations (the Siemens case), 2011 marked a continued effort by the SEC and the US DOJ to aggressively prosecute FCPA violations. For example, the sixth largest FCPA settlement to date took place in 2011 – a massive $218.8 million settlement from the Japanese corporation JGC, for allegedly paying $180 million in bribes to Nigerian officials. Just days before the year’s end, the SEC & DOJ marked the tenth largest FCPA settlement ever when it was announced that Magyar Telekom Plc of Hungary and its majority owner Deutsche Telekom AG of Germany would pay $95 million in criminal penalties, disgorgement and prejudgment interest in connection with sham consultancy contracts with an intermediary that paid €4.875 million to Macedonian officials and falsifying books and records concerning Magyar’s activity in Montenegro.
Deloitte reported that nearly 2/3 of corporate executives, investment bankers, private equity executives and hedge fund managers whom they surveyed stated that they renegotiated or pulled out of planned business relationships, mergers or acquisitions in the last three years due to FCPA concerns. Indeed, even though only 16 corporate cases were pursued this year, compared to 20 in 2010, 18 individuals were charged with FCPA violations, second only the number of individuals charged in the record-breaking year of 2009. See article here. This significant number of individual prosecutions marked an interesting shift toward individual responsibility for FCPA violations, which are viewed as corporate violations. See article here. In fact, the largest individual FCPA forfeiture to date occurred in 2011, when Jeffrey Tesler paid nearly $149 million based on allegedly bribing Nigerian officials in exchange for certain contracts in the state. Mr. Tesler was the former middleman to KBR and its TSKJ partners Snamprogetti, Technip, and JGC. The FCPA Blog has an interesting post on Mr. Tesler’s forfeiture here. This large forfeiture certainly should serve as a warning signal for individuals heading into 2012 – the SEC and DOJ will not hesitate to pursue individuals for FCPA violations, and all signs indicate that enforcement will continue aggressively in the new year.
1. The Year of Insider Trading
The SEC and US Attorney’s Office aggressively pursued insider trading cases in 2011, more so than the year before. In 2011, the SEC and the US Attorney’s Office obtained a record prison sentence and record financial penalty for insider trading, and have showed no signs of slowing down. Judge Rakoff even remarked that decades have passed and insider trading is still rampant, noting that deterrence is an important aspect of handing out penalties and prison sentences. 2011 was monumental in the SEC’s and US Attorney’s Office’s efforts to crack down on insider trading.
The most notable case was that of Raj Rajaratnam, who was convicted of 14 counts of conspiracy and securities fraud in connection with his insider trading in several public companies. Mr. Rajaratnam was arrested along with other former and current traders at Galleon Group, one of the largest hedge fund management firms in the world at the time, which Mr. Rajaratnam founded. Mr. Rajaratnam received an 11 year prison sentence, the largest ever in an insider trading case, and a $92.8 million penalty, the largest ever assessed against an individual for insider trading. A number of his co-conspirators also received prison sentences, with one individual receiving a ten year sentence and the other 13 receiving an average 3 year sentence. The Rajaratnam case certainly underscored the US Attorney’s Office eagerness to pursue record-breaking prison sentences for insider traders, as exemplified by the 19-24 years in prison the prosecution requested in Raj Rajaratnam’s case. Rajat Gupta, who was on the boards at many large public companies, educational institutions and charitable organizations, was also charged this year, and has been accused of providing inside information to Mr. Rajaratnam for him to trade on.
In April 2011, the SEC charged a former Wilson Sonsini Goodrich & Rosati, Cravath Swaine & Moore and Skadden Arps attorney and a Wall Street trader for their involvement in a $32 million insider trading ring. The US Attorney’s office made arrests in a parallel action. The attorney allegedly accessed information on 11 mergers and acquisitions involving the law firm’s clients and then tipped a middleman. This case highlighted how federal agents were able to obtain wiretapped conversations among the attorney, the trader and the middleman, despite the group’s belief that they were acting in an abundance of caution by using disposable cell or pay phones and by using cash from small bank accounts to pay off the scheme.
More recently, James Fleishman, a former hedge fund consultant who worked at Primary Global Research, received 2 and a half years in prison for orchestrating a secret exchange of information between hedge fund traders and employees at companies. Mr. Fleishman had faced 25 years in prison, which is even greater than the sentence requested in Mr. Rajaratnam’s case. This case has had an impact on the financial services industry – expert-network consultants and companies who use such consultants may face regulatory inquiries in light of cases like Mr. Fleishman’s. As a result of the arrests associated with Primary Global and even with Raj Rajaratnam (who claimed his research came from a network of private individuals), many financial firms have stopped or reduced the use of expert-network firms, which connect large investors with outside specialists, simply to avoid the appearance of impropriety. See article here.
This small sample of the insider trading cases that took place in 2011 illustrates the SEC’s and the US Attorney’s Office’s continued effort to aggressively prosecute insider trading violations. The new year will likely continue in the same vein, although it will be hard to top the record breaking year the agencies had in 2011.