The collateral class action consequences of SAC’s guilty plea

November 4, 2013

Last Friday, with rumors of SAC Capital’s imminent guilty plea as inescapable as stale candy corn on Halloween, class action lawyers from Wohl & Fruchter filed a first-of-its-kind letter with U.S. District Judge Laura Swain, the judge presiding over the Justice Department’s criminal case in Manhattan against Steven Cohen’s infamous hedge fund. The firm explained that it is co-lead counsel in a securities class action in federal court in Manhattan, alleging that SAC harmed investors in the Irish drug company Elan when the hedge fund dumped Elan shares based on inside information. Along with Wyeth investors, whose parallel class action has been consolidated with the Elan case, Elan shareholders claimed that they’re a victim of SAC’s crimes. And under the federal Crime Victims Rights Act of 2004, wrote Wohl & Fruchter, Elan and Wyeth shareholders have a right to present her with their view of SAC’s plea.

Never mind that the plea hadn’t actually been entered when the law firm sent the letter. The class action lawyers wanted to go on record with a demand that Swain reject any plea deal that did not require SAC to admit to insider trading in Elan and Wyeth shares. (The Wall Street Journal had reported Wednesday that prosecutors had agreed to that concession.) The $276 million Elan and Wyeth scheme, investors told Swain, was the core of the SAC indictment. She should not accept a guilty plea that would permit the hedge fund to skirt the most serious charges it faced.

Why were Elan and Wyeth investors so hot for prosecutors to wring an admission of illegal trading from SAC? Because it would save them an awful lot of trouble in their class actions. If SAC pleaded guilty to insider trading in Wyeth and Elan shares, they wouldn’t have to prove the hedge fund’s misconduct in their cases. As you know, the collateral consequences of defendants’ admissions to the Securities and Exchange Commission have been in the news since the agency changed its policy in June. JPMorgan Chase’s settlement in September with the SEC showed that artful crafting of regulatory admissions can limit the damage in related securities class actions. But a defendant can’t get around a guilty plea to fraud. That’s an admission that can’t subsequently be denied.

So you have to give Wohl & Fruchter credit (along with Elan investors’ co-counsel from Pomerantz Grossman Hufford Dahlstrom & Gross and Wyeth shareholders’ lead counsel from Scott + Scott and Motley Rice) for really creative deployment of the Crime Victims law. It’s not unprecedented for civil litigants to use the 2004 law to protest a corporate plea deal; in 2009, victims of an oil refinery explosion in Texas asked a federal judge to reject the government’s plea agreement with BP because they said the oil company’s penalty wasn’t high enough. Friday’s letter to Swain, however, appears to be the first time that plaintiffs in a securities class action have cited the Crime Victims law to try to better their litigation position. There haven’t been a lot of opportunities, of course, because the law was enacted after the corporate guilty pleas for securities fraud of the Enron era. But Wohl & Fruchter’s tactic should give class action plaintiffs a little extra leverage against defendants under criminal investigation: Settle with me or I’ll protest your plea deal.

Shareholders’ letter to Swain will probably turn out to be moot. When U.S. Attorney Preet Bharara finally announced the terms of SAC’s plea on Monday, there was no mention of a carve-out for the Elan and Wyeth trades described in the indictment. SAC pleaded guilty to all five counts, including the wire fraud charge that encompassed insider trading in Elan and Wyeth. SAC’s counsel from Paul, Weiss, Rifkind, Wharton & Garrison and Willkie Farr & Gallagher referred me to a spokesman for the fund, who declined to comment. But I don’t see how SAC can deny in the class action that it illegally traded the shares.

By itself, that admission won’t win the case for Elan and Wyeth shareholders. Remember, they’re not pursuing typical securities fraud claims because they can’t allege that they reasonably relied on misrepresentations by SAC. They have a more novel theory, that investors who didn’t have the inside information SAC possessed were on the wrong side of trades by the hedge fund. SAC’s liability to Elan and Wyeth investors, in other words, isn’t a sure thing even if SAC’s illegal conduct is a given. The class action lawyers will also have to show that investors’ alleged losses aren’t covered by the $260 million SAC disgorged to the SEC in its settlement in May. In the Elan case, shareholders claim SAC realized $685 million in profits on top of what it disgorged to the SEC. Judge Victor Marrero, who is presiding over the class actions, authorized the early release of government investigations to shareholder counsel this summer; trading records that are part of that discovery should help sharpen their damages claim.

Elan class counsel Ethan Wohl was in a day-long deposition and unavailable to comment on the SAC plea. Wyeth class counsel Gregg Levin of Motley Rice declined to comment.

(Reporting by Alison Frankel)

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