Opinion

Alison Frankel

Can inside trader be guilty without knowledge of tipster’s motives?

Alison Frankel
Feb 13, 2014 21:44 UTC

There was a very interesting exchange of letters this week at the 2nd Circuit Court of Appeals, where former Diamondback Capital portfolio manager Todd Newman and his co-defendant, Level Global Investors co-founder Anthony Chiasson, are appealing their December 2012 convictions for insider trading in Dell and Nvidia stock. And after the 2nd Circuit Court addresses the issue highlighted in the letters, not only the Newman and Chiasson convictions but also the guilty verdict against SAC Capital portfolio manager Michael Steinberg and the government’s prosecution of Raj Rajaratnam’s brother Rengan could be imperiled.

Lawyers representing Newman and Chiasson – Stephen Fishbein of Shearman & Sterling for Newman and Mark Pomerantz of Paul, Weiss, Rifkind, Wharton & Garrison for Chiasson – contend that the jury’s guilty verdicts should be overturned because the judge in the case, U.S. District Judge Richard Sullivan of Manhattan, made a fatal mistake in his instructions to the jury. Sullivan decided not to instruct jurors that the government must prove Newman and Chiasson were aware that Dell and Nvidia insiders stood to gain from passing along non-public information. Instead, he told the jury that it could find the defendants guilty as long as prosecutors proved the defendants knew they were trading on information the insiders disclosed in breach of their duty of confidentiality.

Newman and Chiasson argue that Sullivan’s jury instruction is contrary to the law of insider trading. As Fishbein explained in Newman’s appellate reply brief, the defendants believe that two U.S. Supreme Court decisions, Dirks v. Securities and Exchange Commission in 1983 and Bateman Eichler v. Berner in 1985, stand for the proposition that if the recipients of insider information don’t know that the original tipster stands to benefit from disclosing the tips, then no crime has been committed.

Newman and Chiasson were so-called remote tippees, which means that they had no direct ties to the Dell and Nvidia insiders who first passed along information about the companies. At trial, their defense lawyers asked Judge Sullivan to instruct the jury that to reach a guilty verdict, jurors had to find that Newman and Chiasson knew the tipsters had disclosed inside information in exchange for personal benefits, citing the Supreme Court’s Dirks decision. The government argued that under the 2nd Circuit’s 2012 decision in a Securities and Exchange Commission enforcement action against Wynnefield Capital’s Nelson Obus and several co-defendants, it only had to show that Newman and Chiasson knew they were trading on non-public information that insiders had disclosed in breach of their duty of confidentiality.

Faced with similar arguments in the prosecution of Doug Whitman of Whitman Capital, U.S. District Judge Jed Rakoff held in November 2012 that remote tippees “must have a general understanding that the inside information was obtained from an insider who breached a duty of confidentiality in exchange for some personal benefit.” But Judge Sullivan sided with the government and instructed jurors that they could convict Newman and Chiasson if they found the defendants traded on inside information disclosed in a breach of the insiders’ duty of confidentiality.

Could an obscure 1994 law upend the Volcker Rule?

Alison Frankel
Feb 12, 2014 22:10 UTC

At the end of 2013, five regulatory agencies finally managed to adopt the Volcker Rule, the Dodd-Frank mandated regulation that curbs risky proprietary trading by financial institutions. Regulators from the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corporation, the Commodity Futures Trading Commission and the Securities and Exchange Commission took more than two years to refine their original proposal, after taking into account the 18,000 comments they received on the trading bars. Now comes the really fun part for the government: defending the 900-page behemoth of a law against the sort of industry-mounted challenges that have already felled shareholder proxy access and resource extraction disclosure rules that the SEC adopted in response to Dodd-Frank.

In a terrific piece Tuesday, my Reuters colleagues Sarah Lynch and Emily Stephenson previewed two possible grounds for a challenge to the Volcker Rule (which is named for former Federal Reserve chairman Paul Volcker, who pushed for a bar on proprietary trading after the financial crisis hit in 2008). Both potential attacks would home in on regulators’ supposed failure to pay enough attention to the impact the new rule would have on financial institutions and the broader economy. According to the story, lawyers for business lobbying groups like the U.S. Chamber of Commerce are looking at the Unfunded Mandates Reform Act, which requires the OCC to assess the economic impact of proposed rules that will cost the government or the private sector more than $100 million. Volcker Rule opponents have been kicking around the idea of a challenge under UMRA for a while, but Dodd-Frank has created some uncertainty about its application. More recently, according to Lynch and Stephenson, the Chamber and other groups have begun to look at a different law that also imposes a cost-benefit analysis requirement on bank regulators: the Riegle Community Development and Regulatory Improvement Act of 1994.

Inspired by the Reuters piece – and by my utter ignorance of the Riegle law – I did some research at Westlaw. The Clinton-era statute turns out to be quite a hodgepodge of a law. Its primary purpose was to encourage small, community-based lending institutions. But it also reformed anti money-laundering and flood insurance laws and included provisions intended to streamline the bank regulatory process. The streamlining section of the law, entitled “Paperwork Reduction and Regulatory Improvement,” includes language that could justify a challenge to the Volcker Rule.

N.Y. judge: Mortgage securitization was not racketeering scheme

Alison Frankel
Feb 11, 2014 20:03 UTC

Did you happen to see the complaint Better Markets filed yesterday in federal court in the District of Columbia, accusing the Department of Justice of obfuscating the facts behind its $13 billion settlement with JPMorgan Chase? I have some doubts about Better Markets’ standing to sue Justice but none at all about the central point of the suit: We the public are still trying to understand the magnitude of wrongdoing by financial institutions that profited from the boom in residential mortgage securitization. The oft-mangled George Santayana quote has it that “Those who cannot remember the past are condemned to repeat it.” I’m sure the same condemnation awaits those whose memories of the past are circumscribed by the efforts of excellent defense lawyers. There has been virtually no market for private residential mortgage-backed offerings since the economic crash, but as the economy recovers and banks finally resolve liability from their boom-era offerings, that will probably change – especially because of court rulings that have blessed the instruments of securitization.

Last week’s ruling by New York State Supreme Court Justice Barbara Kapnick, mostly approving Bank of America’s $8.5 billion settlement with investors in Countrywide mortgage-backed securities, is one example. Kapnick didn’t provide much analysis, but she did provide some assurances to future MBS trustees about their rights and duties. (If, on the other hand, Kapnick had agreed with some of the experts who testified for objectors to the settlement about the inevitable conflicts hobbling MBS trustees, her ruling would have been a significant obstacle to any resurrection of the market for private residential mortgage securitizations.) I’ve also told you about a series of rulings from state and federal courts that have upheld the right of the bank-originated Mortgage Electronic Registration System to aid securitization by transferring promissory notes from bank to bank. Most recently, on Monday, a federal judge in White Plains, New York, tossed a sprawling, multiplaintiff case alleging that the entire mortgage securitization industry was a giant racketeering enterprise whose victims were homeowners duped into buying property they couldn’t afford. (Hat tip: S.D.N.Y. Blog.)

U.S. District Judge Cathy Seibel, like judges in other federal trial courts, found that under the Rooker-Feldman doctrine, former owners of foreclosed properties cannot recast their challenges to state-court foreclosures judgments as federal-court claims. The onetime homeowners, represented by KamberLaw and The Law Offices of Zoe Dolan, had argued in their brief opposing dismissal that there’s an exception to the doctrine in cases in which state-court judgments were procured by fraud on the court. Seibel conceded that federal circuit courts are divided on the fraud exception, but said the 2nd Circuit has never recognized it and so she would “decline plaintiff’s invitation to create an exception.”

New class action: Real victims of Samsung infringement are consumers

Alison Frankel
Feb 10, 2014 19:55 UTC

Once again, we are reminded that defendants underestimate the creativity of the class action bar at their own peril.

Last week, the firms Reese Richman and Halunen & Associates filed quite an interesting class action complaint in federal court in San Francisco. The case asserts that Samsung’s infringement of various Apple patents in its mobile devices – as established in a jury trial in federal court and in a proceeding at the U.S. International Trade Commission – has injured unwitting Samsung mobile device buyers who believed they were purchasing non-infringing products. According to the complaint, the resale market for Samsung devices has been hard-hit by infringement findings against the company; the suit claims that Samsung owners are actually in danger of violating the Tariff Act of 1930 if they attempt to resell infringing tablets and smartphones.

As you may recall, Samsung is on the hook to Apple for more than $900 million in damages after a partial damages retrial in November of its first round of patent infringement claims against Samsung in San Francisco federal court. The purported nationwide consumer class action actually claims far more than that on behalf of Samsung device purchasers. Under one of the suit’s causes of action, the class wants Samsung to repay the entire cost of the infringing mobile devices to the consumers who bought them – or at least the lost value consumers have realized as a result of Samsung’s infringement. Under another theory, class members assert that Samsung must disgorge to them all of its profits from selling infringing devices. That’s a lot of money: According to Apple, Samsung took in $3.5 billion in revenue from the sale of almost 11 million infringing devices.

The $44 mln Accenture judgment riddle: When is it time to pay up?

Alison Frankel
Feb 7, 2014 21:29 UTC

You might have thought that after nearly 225 years of American jurisprudence, the law was clear on whether a defendant can avoid surrendering a final award while it seeks review from the U.S. Supreme Court. But based on a $44 million fight between the consulting company Accenture and a would-be oil and gas services software company called Wellogix, it isn’t at all.

Wellogix’s business plan was to sell oil and gas companies proprietary software to streamline their planning and procurement processes. It made the apparent mistake, however, of partnering with other companies that supplied core accounting software. In 2005, Wellogix and SAP made a joint bid to provide global software for complex services to BP. Unbeknownst to Wellogix, however, SAP was also working directly with BP’s consultant, Accenture, on a software system. Wellogix came to believe that SAP and Accenture had hijacked pieces of its design and, in so doing, had destroyed the company. In 2008, Wellogix sued SAP, Accenture and BP, accusing them of stealing and misappropriating its trade secrets. U.S. District Judge Keith Ellison of Houston dismissed SAP for lack of jurisdiction. BP and Wellogix agreed to arbitration. Accenture went to trial.

A Houston federal jury returned a verdict against Accenture in May 2011, awarding Wellogix $26.2 million in compensatory damages and $68.2 million in punitive damages. Judge Ellison reduced the punitive damages to $18.2 million but otherwise denied Accenture’s post-trial motions for judgment as a matter of law or for a new trial. Accenture posted a $49 million bond to cover the judgment and interest, and took its case to the 5th Circuit Court of Appeals. Ellison stayed enforcement of the judgment “pending final disposition of Accenture’s appeal.”

Big guns roll out to defend securities class actions as SCOTUS amici

Alison Frankel
Feb 6, 2014 19:40 UTC

Conventional wisdom has it that the future of most securities fraud class actions will come down to U.S. Supreme Court Chief Justice John Roberts (and possibly Justice Samuel Alito, who, as a judge on the 3rd Circuit Court of Appeals, wrote quite interesting decisions about fraud-on-the-market reliance). Last term, in dissents in Amgen v. Connecticut Retirement Plans, Justices Antonin Scalia, Clarence Thomas and Anthony Kennedy made clear their skepticism about the court’s 1988 precedent in Basic v. Levinson, the case that made securities fraud class actions possible via its holding that shareholders may be presumed to have relied on corporate misstatements about a stock that trades in an efficient market. Based on the Amgen majority opinion, Justices Ruth Bader Ginsburg, Stephen Breyer, Elena Kagan and Sonia Sotomayor seem disinclined to overturn Basic when the court once again takes up the issue of classwide shareholder reliance on March 5 in Halliburton v. Erica P. John Fund.

Presumably with Chief Justice Roberts in mind, the Erica P. John Fund and its lawyers at Boies, Schiller & Flexner made deference to Supreme Court precedent a major theme of the merits brief they filed last week. As I told you, Boies Schiller cast Basic as a decision rooted in the 80-year-old history of this country’s securities laws, entwined with government regulation of the securities markets and implicitly endorsed by Congress, which has had multiple opportunities over the last 25 years to roll back the presumption of reliance and has repeatedly declined to do so.

As of late Wednesday, it’s not only Boies Schiller saying so to the Supreme Court. Erica P. John – and, by extension, the securities class action industry – has received powerful support in amicus briefs from (among many others) the Justice Department; two former chairmen of the Securities and Exchange Commission (one Republican, one Democrat); 11 current and former members of Congress; and scholars of the doctrine of stare decisis, whose filing was authored by Harvard Law professor Charles Fried – the onetime U.S. solicitor general who wrote the Justice Department brief supporting investors in the original Basic case at the Supreme Court.

Two judges question proposed discovery limits in Federal Rules

Alison Frankel
Feb 5, 2014 22:12 UTC

You’ve got only 10 days left to offer your opinion of the U.S. Judicial Conference’s proposed changes to the Federal Rules of Civil Procedure: The comment period ends on February 15. I don’t share the apocalyptic vision of the U.S. civil justice system that Senator John Kyl described in a Jan. 20 Wall Street Journal op-ed on the proposed new rules, but I do endorse his advice that you speak up if you’ve got something to say about how the changes will affect your practice.

Nearly 600 people and organizations already have, according to Regulations.gov, where their letters are posted. I spent several hours Wednesday reading public comments on the proposed rule changes. (I confess. I was preparing to moderate a panel on the proposals on Thursday at Hofstra Law School.) For the most part, the comments reflect the deep divide I’ve already described: Defense lawyers and business groups laud the Judicial Conference for attempting to reduce the burdens of discovery in civil litigation in the federal courts; plaintiffs lawyers are gravely worried that proposed limits on depositions, interrogatories and other discovery tools – and more discretion to defendants opposing discovery demands – will exacerbate the challenge of acquiring legitimate information from defendants who don’t want to surrender it.

I read more than a dozen letters from public interest groups and private lawyers who specialize in plaintiffs work, and all of them said the same thing: Presumptive limits on discovery will unfairly disadvantage people suing corporations and governments and will lead to more motions practice as lawyers ask judges to lift those limits. Plaintiffs lawyers are also very concerned about a new emphasis on “proportionality” in the new rules, which would permit defendants to refuse discovery demands if they believe the cost of production is disproportionate to the size and significance of the case. That unilateral discretion, according to detractors, is going to cause them undue harm.

How SemGroup trustee survived summary judgment in $1.1 bln PwC case

Alison Frankel
Feb 4, 2014 22:37 UTC

If any law firm out there has learned from bitter experience the difficulty of suing audit firms for supposedly helping companies run themselves into ruin, it’s Quinn Emanuel Urquhart & Sullivan. The firm represented litigation trustees for Refco and the Italian dairy company Parmalat, and though Quinn sued the auditors of both fraud-beset corporations, the trustees’ claims foundered on the doctrine of in pari delicto, which holds that one wrongdoer can’t sue another over their joint misconduct. It’s a weird irony of litigation against audit firms: In pari delicto defenses are most powerful in cases brought by former clients (or the shells that remain of those clients) whose fraud is unequivocal.

So when Quinn Emanuel sued PricewaterhouseCoopers on behalf of the litigation trustee of the private oil transport and storage firm SemGroup, it carefully pleaded around in pari delicto. The complaint, filed in 2010 in state court in Tulsa, Oklahoma, asserted claims for professional negligence and breach of fiduciary duty. It does not argue that PwC enabled Thomas Kivisto, the former CEO of SemGroup, when he lost hundreds of millions of dollars in corporate funds through risky trades in oil price derivatives through a separate company owned by him and his wife, or that PwC abetted Kivisto when his similarly speculative trades for SemGroup drove the company into Chapter 11. Instead, the suit asserted that PwC failed to comply with professional standards when it signed off on SemGroup’s financial statements, homing in on the auditor’s supposed failure to assure accurate reporting and adequate corporate controls.

“Kivisto and others were responsible for SemGroup issuing corporate financial statements that misreported these activities,” the complaint said. “PwC, in turn, audited and ‘blessed’ these financial statements year after year as fair and accurate, even though they were not. Had PwC conducted its audits of SemGroup according to even minimal standards of care, Kivisto’s self-dealing and speculative trading would have been revealed, and the devastating financial consequences of each would have been avoided.” (Kivisto settled a Securities and Exchange Commission case accusing him of misleading SemGroup investors about his risky trading in 2011; he and four other former SemGroup executives settled with the litigation trustee for $30 million in 2010.)

State and Justice agree: No retroactive immunity for Indian diplomat

Alison Frankel
Feb 3, 2014 21:17 UTC

Remember the diplomatic crisis with India that followed the arrest last December of a deputy consul general named Devyani Khobragade? Khobragade, who worked at the Indian consulate in Manhattan, was picked up by the Diplomatic Security Services for allegedly committing visa fraud to get her nanny into the United States. Indian officials were outraged when Khobragade said she’d been strip-searched, even though the U.S. Marshals later said that she was not subjected to an internal cavity search. The crisis took a peculiar turn when Manhattan U.S. Attorney Preet Bharara – whom the Indian government criticized for abusing his prosecutorial discretion – put out a statement defending Khobragade’s arrest and processing. Among Bharara’s points in the Dec. 18 announcement: State Department agents had arrested the deputy consul, not prosecutors from his office.

The State Department, meanwhile, was re-evaluating Khobragade’s diplomatic status after the Indian government, following her arrest, appointed her to India’s permanent mission at the United Nations. Khobragade’s lawyer, Daniel Arshack of Arshack, Hajek & Lehrman, told Reuters at the time that Khobragade’s new post entitled her to retroactive diplomatic immunity for her supposed crimes. With the State Department issuing vaguely worded statements of regret about Khobragade’s treatment, I wondered if State might make the whole mess quietly disappear by granting the Indian diplomat immunity. That action would leave U.S. Attorney Bharara and the Justice Department stranded, but would quell foreign allies in India.

Instead, State has chained itself to Justice in the Khobragade case. On Friday, Bharara’s office filed its response to Khobragade’s motion to dismiss the indictment against her. According to the Justice Department brief, which attaches a declaration from the State Department’s Office of the Legal Advisor, Khobragade surrendered any claim to full diplomatic immunity when she left the United States earlier this month. Nor is she entitled to limited retroactive immunity for her conduct as deputy consul, the brief said, because her alleged crimes were not connected to her official duties. What’s interesting is the filing’s lack of ambiguity: The brief leaves no quiet escape route open for the U.S. government. Both State and Justice, in other words, are determined to keep charges against Khobragade alive, in the event she ever falls within the jurisdiction of U.S. courts.

Can this brief save securities fraud class actions?

Alison Frankel
Jan 30, 2014 19:56 UTC

There is an awful lot of weight on David Boies‘s shoulders in the U.S. Supreme Court case known as Halliburton v. Erica P.John Fund. The renowned litigator and his partners at Boies, Schiller & Flexner represent the EPJ Fund, but in a larger sense, they represent everyone who invests in shares listed on U.S. exchanges. If Boies and his firm can’t persuade the justices of the Supreme Court to leave intact the court’s 1988 precedent in Basic v. Levinson, securities fraud class actions will be decimated. Small investors without the resources to bring their own fraud claims will be stranded – as will all of the lawyers, economists, academics and consultants who make a living in the multibillion-dollar securities class action industry.

So how does Boies Schiller intend to convince the Supreme Court not to meddle with private securities litigation? Based on the firm’s newly filed merits brief, by appealing to the court’s respect for its own precedent and deference to Congress and regulators.

As you would expect, Boies Schiller’s 85-page filing offers a long list of arguments to counter Halliburton and the many pro-business organizations urging the Supreme Court to overturn Basic’s holding that investors trading in an efficient market can be presumed to have relied on alleged corporate misstatements. (That presumption of reliance, as you know, is what permits investors to band together as a class to pursue securities fraud claims; without the presumption, individual investors would be forced to prove that they relied on misinformation when they made trading decisions.) Some of the new brief’s points are technical, such as its discussion of whether defendants should be permitted to rebut the presumption of reliance by offering evidence that the supposed misrepresentations had no impact on share price. Some are political, emphasizing defendants’ success in fending off unwarranted fraud class actions. Boies Schiller also dedicates several pages to defending what the brief calls “the simple economic truth” at the heart of Basic v. Levinson. Regardless of debate among economists about the mechanisms of market efficiency, the brief argues, there’s no controversy around “the proposition that developed markets generally respond to material information.”

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