Opinion

Alison Frankel

Can SAC insider trading target Elan force hedge fund to pay legal fees?

By Alison Frankel
April 8, 2014

Elan Pharmaceuticals believes it was victimized twice over by SAC Capital, the notorious hedge fund now called Point72. The first time was when SAC obtained insider information about unsuccessful trials of the Alzheimer’s drug bapineuzumab and dumped $700 million in shares of the Irish drug company and its drug development partner Wyeth. But to add insult to that injury, Elan had to spend a small fortune, about $1.6 million, in legal fees and costs stemming from the government’s investigation of SAC’s insider trading. That is money SAC should have to pay, according to Elan. With the hedge fund due to be sentenced Thursday by U.S. District Judge Laura Taylor Swain of Manhattan, the pharma company’s lawyers at Reed Smith have submitted a letter asking Swain to recognize Elan as a victim of SAC’s crimes and order the hedge fund to pay it $1.6 million in restitution.

It’s a fascinating request. You probably recall that in a couple of high-profile cases in the recent spate of insider-trading prosecutions, Morgan Stanley and Goldman Sachs won rulings that former employees (in a broad sense of that word) were on the hook for legal fees the banks incurred as a result of the employees’ crimes. In February 2013, U.S. District Judge Jed Rakoff held that under the federal victims’ restitution law, former Goldman director Rajat Gupta owes the bank $6.2 million — the money Goldman laid out to Sullivan & Cromwell to investigate Gupta’s conduct internally and to cooperate with government investigators. Last July, the 2nd U.S. Circuit Court of Appeals affirmed a similar ruling by U.S. District Judge Denise Cote. She had concluded in 2012 that Morgan Stanley was the victim of insider trading by FrontPoint hedge fund manager Chip Skowron, so Skowron was responsible not just for repaying the bank the cost of his own defense but also for restitution of the legal fees Morgan Stanley advanced to other FrontPoint employees.

The 2nd Circuit’s ruling in the Skowron case didn’t leave much doubt that employers can receive restitution as victims for the money they spend to cooperate with government investigations of employees who go on to plead guilty or be convicted. Elan, however, didn’t employ SAC or Mathew Martoma, the former SAC trader who was convicted of trading on inside information about the company. On Monday, in a response to Elan’s letter requesting restitution, SAC’s lawyers at Paul, Weiss, Rifkind, Wharton & Garrison said Elan’s theory of restitution is “without precedent.”

“Elan is not seeking restitution against its own agents (Drs. Oilman and Ross) who admitted breaching their duties to it by disclosing confidential information, but from entities that had no fiduciary or other relationship to Elan,” wrote SAC counsel Daniel Kramer of Paul Weiss. “We are aware of no court that has ever held a defendant responsible for legal fees incurred by a public company whose information was misused, where the defendant was not an employee or agent of the company, but rather a tippee of the company’s employees — much less an employer of the tippee.” The victims’ restitution law requires a showing that the supposed victim was directly harmed by the underlying crime in the case. Here, SAC said, Elan couldn’t show that its legal fees were attributable to SAC’s criminal actions.

The hedge fund made its broad argument about Elan’s theory in a footnote, choosing to emphasize in its main arguments that the pharmaceutical company had waited too long to request restitution and hadn’t adequately shown in its 188-page compendium of bills from Shearman & Sterling that the law firm’s fees were specifically tied to the government’s investigation of SAC, rather than other supposed insider trading cases or the Elan shareholder class action against SAC.

Elan’s restitution is not the only big question hanging over SAC’s sentencing hearing. Last fall, when the hedge fund first struck its plea deal with prosecutors, Elan shareholders called on Judge Swain to reject the agreement because it did not require the hedge fund explicitly to admit to insider trading in Wyeth and Elan shares. (The shareholders, represented by Wohl & Fruchter and Pomerantz Grossman Hufford Dahlstrom & Gross, are pressing for such an admission to boost their securities fraud and racketeering case against SAC, also under way in Manhattan federal court.) On Nov. 8, the judge requested a presentence investigation and report and adjourned the sentencing until March 14, then subsequently, until April 10.

The government submitted a sentencing memo last week, arguing that SAC’s financial penalties (a $900 million fine and $284 in forfeiture, on top of the $616 million SAC already agreed to pay to the Securities and Exchange Commission) and the concessions the hedge fund has made to deter future wrongdoing, including the appointment of a compliance tsar, are sufficient punishment. (The presentence report by the Probation Office is not in the criminal case docket.)

Late Tuesday, Judge Swain issued an order warning the government and SAC to be prepared to answer questions about (among other things) how much money the hedge fund actually realized from its insider trading (in profits and avoided losses) and whether the compliance monitor has the power to police implementation of the hedge fund’s new policies. Her only hint regarding admissions came in a question about whether the compliance and other provisions in the plea deal are sufficient “to promote respect for the law, protect the public and deter re-offense.”

The judge has up to 90 days after sentencing to rule on Elan’s restitution request and may ask for briefing on it. Elan counsel Terence Healy of Reed Smith declined to comment. SAC lawyer Kramer of Paul Weiss didn’t return my phone call.

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