Legal Developments in Securities Law

Federal Judge Critiques SEC’s Proposed Settlement with Citigroup
Could Force SEC to be More Aggressive in the Future
This blog post references Peter Latman’s NY Times article, “Judge in Citigroup Mortgage Settlement Criticizes S.E.C.’s Enforcement,” found here.

Yesterday, the Securities and Exchange Commission (“SEC”) was asked by Judge Rakoff to defend its proposed settlement with Citigroup Global Markets, Inc. (“Citigroup”) based on its structuring and marketing of a largely synthetic collateralized debt obligation. Specifically, the SEC alleged that Citigroup negligently misrepresented key deal terms, such as its own financial interest in the transaction and that Citigroup had exercised significant influence over the selection of assets.

Judge Rakoff questioned the SEC’s decision to accept a settlement of $285 million, while indicating that the SEC estimated that investors lost close to a total of $700 million in the investments. Judge Rakoff was equally inquisitive about the SEC’s injunction, to bar Citigroup from violating securities laws in the future. Notably, the Judge asked, “Why do you ask for an injunction when you never use it?” The SEC can file civil contempt proceedings if an organization or individual under an injunction not to violate securities laws in fact violates securities laws again in the future. Notably, no such charges have been brought in the last ten years. Such injunctive relief has been the subject of ridicule in the past – it is axiomatic that an organization or an individual is prohibited by law from violating securities laws. As is standard with settlements with the SEC, the entity or individual involved does not admit or deny any wrongdoing with regard to the allegations. Judge Rakoff likewise questioned Citigroup’s unwillingness to admit liability in this matter.

Some may remember that Judge Rakoff likewise questioned the SEC’s proposed settlement with Bank of America concerning whether Bank of America misled investors about its acquisition of Merrill Lynch. There, Judge Rakoff initially rejected a $33 million settlement proposal, and later reluctantly accepted a revised settlement for $150 million.

Judge Rakoff’s refusal to “rubber stamp” the SEC’s proposed settlements with large financial institutions could have potential ramifications on the settlements the SEC negotiates in the future. Judge Rakoff’s comment, “I won’t be cute and ask what percentage of Citigroup’s net worth is $95 million because I do not have a microscope with me,” indicates that this type of scrutiny is perhaps reserved for larger financial institutions, rather than their smaller counterparts or even individuals. Seemingly, given the alleged violations involved and the impact on the shareholders involved, the settlement amount was not proportionate to the harm based on Judge Rakoff’s observation. Although the SEC may adjust its disgorgement figures or civil penalties based upon a respondent’s showing of its/his/her financial inability to pay, an entity like Citigroup clearly does not face such a burden. As a result of Judge Rakoff’s refusal to acquiesce to whatever settlement proposal the SEC sets forth, the SEC may play hardball with large financial institutions to avoid future judicial scrutiny. Further, it is conceivable that the SEC may file a civil contempt proceeding the next time that an institution that has been barred from violating securities laws, violates securities laws. Although the SEC has not done so in at least ten years, pressure from the public may mount if an entity like Citigroup or Bank of America is accused of violating securities laws again. It seems unlikely, however, that respondents would be forced to admit liability as a condition of settlements – the practice of neither admitting nor denying liability is not only standard among settlements with the SEC, but in the general practice of law.

So-called smaller actors, such as smaller entities or individuals, may nonetheless find the SEC requesting large settlement amounts, especially given the impact, severity or frequency of their alleged securities law violations. The SEC takes into account a number of factors when determining an appropriate civil penalty, such as the egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that his occupation will present opportunities for future violations. Think of an individual like Raj Rajaratnam, who was recently ordered to pay a total of $156.6 million in fines and disgorgement, an amount that Judge Rakoff again questioned given Rajaratnam’s net worth and the fact that the civil penalty was designed, in Judge Rakoff’s words, “to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it.”

Further, although the SEC may request injunctive relief that an individual be barred from violating securities laws in the future, that individual may also be barred from serving as a director of a public company, from working in the securities industry, or from participating in the issuance of certain kinds of securities offerings, to name but a few examples. Judge Rakoff’s remarks should serve as a wake-up call for large financial institutions, but others are by no means less vulnerable to the range of consequences the SEC could request.

Legal Developments in Securities Law

Update: SEC Appeals Judge Rakoff’s Ruling Denying Proposed Settlement
One of our earlier blog posts referenced Judge Rakoff’s criticism of the SEC’s proposed settlement with Citigroup – found here. Unsurprisingly, Judge Rakoff rejected the parties’ proposed settlement. The SEC has now filed an appeal, citing legal error and claiming that, “We believe the district court committed legal error by announcing a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits,” as set forth in a statement by Robert Khuzami, the S.E.C.’s director of enforcement (see the New York Times article on this issue here).

The SEC’s appeal is certainly not unprecedented, as the New York Times notes that the agency has indeed appealed such rulings in the past, and in fact won such an appeal in S.E.C. v. Randolph. The SEC’s decision to appeal Judge Rakoff’s decision, which reasoned that the proposed settlement simply was not in the public interest and that more facts were necessary to approve such a settlement, suggests a reluctance to fight Wall Street. One could reason that the SEC may treat larger institutions that are repeat offenders, like Citigroup, less harshly than the “little guys,” or individuals and small companies involved in SEC enforcement actions.

Certainly, the resources involved in litigating against a large institution like Citigroup in federal court are not minimal, but given that investors experienced over $700 million in losses, a settlement amount of $285 million concerning charges of securities law violations pales in comparison to the harm caused. By comparison, the “little guys” cannot afford lengthy litigation against the SEC, and perhaps the SEC can use that as leverage to obtain a settlement that fully disgorges the defendant’s ill-begotten gains. Settlements, however, do involve a case of give and take – the SEC may not get the full amount requested and the defendant agrees to a sum that may be lower than the potential outcome in litigation. With an institution like Citigroup, the SEC may be additionally motivated to settle the matter more expeditiously to avoid a lengthy trial and potential failure in court. With the “little guys,” the SEC holds the upper hand, and it’s hard to imagine a scenario where the SEC would appeal a Judge’s ruling rejecting a settlement with such an individual.

It is no surprise that the reaction among members of the public toward the SEC has been one of outrage concerning the SEC’s decision to appeal Judge Rakoff’s decision. Dennis M. Kelleher, of Better Markets, Inc., wrote in the Huffington Post:

No one should be surprised that the risk-adverse, Wall Street friendly SEC chose not to litigate against Citigroup for pocketing more than $600 million from its $1 billion fraudulent subprime mortgage scheme that cost its customers more than $700 million. Instead, the SEC decided to litigate against the one federal judge who had the audacity to scrutinize their proposed settlements. As the Wall Street Journal headline correctly captured it, “SEC Cops Want to Fight U.S. Judge.”

Ironically, in the eyes of the SEC, Judge Rakoff is a repeat offender (first, Bank of American and now Citigroup!), but Citigroup is literally a repeat offender, having been toothlessly sanctioned by the SEC 5 times in the last 8 years for violations of the securities laws. Judge Rakoff had the nerve to ask the SEC what was the point of slapping their wrist one more time given that the prior five slaps appeared not to make much of an impression. (Such repeated toothless “sanctions” is common for the SEC.)

View Mr. Kelleher’s article here. The Wall Street Journal’s Law Blog featured a piece by Neal Lipschutz that stated:

Here’s a quote from Judge Rakoff’s decision, which I have cited before, that gets to the crux of the matter. “An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous … If its deployment does not rest on facts – cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.”

Khuzami said in part Thursday: “In fact, courts have routinely approved settlements in which a defendant does not admit or even expressly denies liability, exactly because of the benefits that settlements provide.”

But just because something happens a lot doesn’t mean it’s correct. Here’s hoping the power of Rakoff’s apparently singular argument sets a new precedent.

The Wall Street Journal Law Blog post can be found here.

Although it is certainly true that settlements routinely include language in which the defendant neither admits nor denies liability, it appears that perhaps Judge Rakoff took issue with that language in the Citigroup proposed settlement because the institution has been sanctioned multiple times in the last eight years. If the “little guys” commit multiple securities law violations, they would face injunctions and bars from practicing their profession which hit them much harder than a nominal monetary settlement for a large institution. If a large institution can pay only a nominal settlement without admitting or denying liability, what would prevent that institution from carrying on illegal activity that results in a profit? In this situation, Citigroup allegedly made around $600 million from its fraudulent scheme, but tried to settle the matter for $285 million – a $315 million profit. Even if the SEC’s recent actions are not out of the ordinary, appealing Judge Rakoff’s decision has not improved the agency’s image.

Legal Developments in Securities Law

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.

FINRA Settles Matter Against Registered Representative For Failing to Timely Amend his Form U4 to Disclose Misdemeanor Charge, State and Federal Tax Liens, and Civil Judgment

FINRA settled a matter involving a registered representative who failed to timely amend his Form U4 to disclose a misdemeanor charge, state tax lien, federal tax lien and civil judgment. In June 2009, the Commonwealth of Pennsylvania’s Department of lnsurance filed a criminal charge against the representative in the Court of Common Pleas of Montgomery County, alleging that the representative paid “an unlicensed person commissions from the sale of fixed insurance products between 2005 and 2007.” In August 2010, the Commonwealth of Pennsylvania filed a tax lien against the representative in the amount of $18,687 for unpaid taxes in 2005, 2006 and 2007. In October 2011, the Internal Revenue Service (IRS) filed a tax lien against the representative in the amount of $50,220 for unpaid taxes in 2005, 2006 and 2007. Finally, in January 2013, the representative was the subject of a civil judgment in the amount of $35,157.

SEC Reaches Settlement With Evercore Insider Trader

The U.S. Securities and Exchange Commission reached a $682,000 settlement with a former Evercore Partners Inc. investment banker who was sentenced to 30 months in prison for insider trading. Under the terms of the deal, Frank Perkins Hixon Jr., formerly a senior managing director in Evercore’s mining and metals group, would pay the sum and be restrained from future securities violations, according to court documents. The settlement has been in the works since September, court filings said. Hixon pled guilty in April to related criminal charges in New York, admitting that he traded the stocks of Evercore clients based on inside information about upcoming deals in a scam that netted more than $700,000.

Blackstone Group To Pay $39 million to Settle SEC Charges

The SEC last week ordered the $330 billion mega-firm Blackstone Group to pay $39 million to settle charges related to inadequate disclosure of fees charged to portfolio companies. The Blackstone enforcement action represents the SEC’s fourth PE fees and expenses case, with the others involving KKR, Lincolnshire Management and Clean Energy Capital. The Commission’s enforcement division said it will continue to investigate abuses of fees and expenses by private equity firms. It also cautioned firms that it is better to voluntarily come forward when problems are discovered internally rather than wait for the SEC to find out about them later.

Final Judgment Entered Against California-Based Unregistered Broker Alleged to Have Fraudulently Offered and Sold Pre-IPO Facebook and Twitter Shares; Defendants Ordered to Pay Over $3 Million in Monetary Relief

The Securities and Exchange Commission announced that on September 29, 2015, a final judgment was entered against Efstratios “Elias” Argyropoulos of Santa Barbara, California, and his solely owned company, Prima Capital Group, Inc., by a United States District Judge in Los Angeles. In addition to the permanent injunction to which the defendants had previously consented, the Court granted the Commission’s motion for monetary relief, finding the defendants jointly and severally liable for disgorgement of $1,495,657, together with prejudgment interest of $84,239.59 totaling $1,579,896.59, and additionally ordering Argyropoulos to pay a civil penalty of $1,495,697.

On December 23, 2014, the Commission filed the action, alleging that the defendants fraudulently raised nearly $3.5 million from investors purportedly to purchase Facebook and Twitter shares prior to the companies’ initial public offerings (IPOs). Instead of purchasing the shares in the secondary market as promised, the defendants misappropriated investor funds. They used the money primarily for day trading of stocks and options as well as to pay off certain investors who complained when they didn’t receive the promised Facebook or Twitter shares.

Argyropoulos and Prima Capital agreed to settle the SEC’s charges and to be barred from working for an investment adviser or broker-dealer when the action was filed, and further agreed that monetary relief would be determined at a later date.

Without admitting or denying the allegations in the SEC’s complaint, Argyropoulos and Prima consented to a judgment permanently enjoining them from violations of the antifraud provisions of Section 17(a) of the Securities Act of 1933 and the antifraud and broker-dealer registration provisions of Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.