SEC: Difficult to Prove

Institutional Insider Trading  

“But to get the evidence to prove a violation of the statute under which we allege insider trading is difficult.”

Joe Cella, Head of SEC’s Office of Market Surveillance.

Gretchen Morgenson, Whispers of Mergers Set Off Bouts of Suspicious Trading, N.Y. Times, 26 Aug. 2006

SEC: Difficult to Prove Ponzi Schemes

“The staff told [the SEC Inspector General] that senior SEC management did not favor the pursuit of Ponzi schemes and other frauds that were difficult to investigate and time-consuming to prosecute.”

The SEC’s Impeccable Timing, The Wall Street Journal Apr. 20, 2010

SEC: Difficult to Prove Market Manipulation

“Since the almost overnight collapse of Bear Stearns earlier this year, top-level Wall Street executives have been pleading with regulators to investigate what they see as efforts by short sellers to plant false information and profit from it…The issue is a notoriously challenging one for the S.E.C.”

Stephanie Clifford and Jenny Anderson, S.E.C. Warns Wall Street: Stop Spreading the False Rumors, N.Y. Times, July 14, 2008

Highly Leveraged Banks

“[A]s of 2007, the five major investment banks—Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley—were operating with … leverage ratios … as high as 40 to 1. … Less than a 3% drop in asset values could wipe out a firm.”

The Financial Crisis Inquiry Report January 2011 xix

Hidden Leverage

“And the leverage was often hidden—in derivatives positions, in off-balance-sheet entities, and through “window dressing” of financial reports available to the investing public.”

The Financial crisis Inquiry Report January 2011 xx

Lack of Transparency

“Panic fanned by a lack of transparency of the balance sheets of major financial institutions, coupled with a tangle of interconnections among institutions perceived to be ‘too big to fail,’ caused the credit markets to seize up.”

The Financial crisis Inquiry Report, xvi, January 2011

Bear Stearns Collapse

1) Leverage, 40-1

2) Off balance sheet exposure and more leverage through arcane derivatives not disclosed.

3) Market abuse by banks and hedge funds.

The SEC’s Clarion Call: We need this: 

Why can’t the SEC make these big cases?

“There are no smoking guns …. Evidence is almost entirely circumstantial.”

Thomas C. Newkirk, Associate Director, Division of Enforcement, Sep. 19, 1998

So Congress Created the First Ever …

Dodd Frank’s Smoking Gun Magnet 21F (b)(1)

• Original information of securities violation. • Voluntarily provided to SEC • Leads to a successful enforcement• More than $1 million recovery;• Whistleblower award not less than 10% or

more than 30%• Some whistleblowers disqualified, e.g., SEC

and DOJ staff• Appellate review of denial of the claim, but

not amount.

Criteria increasing a whistleblower’s award percentage

• significance of the information provided by the whistleblower

• assistance provided by the whistleblower

• law enforcement interest in making a whistleblower award

• participation by the whistleblower in internal compliance systems.

Criteria decreasing a whistleblower’s award percentage

• culpability of the whistleblower;

• unreasonable reporting delay by the whistleblower;

• interference with internal compliance and reporting systems by the whistleblower.

SEC Final Rule p. 123

What if SEC already has a case against the company?

“Thus, a whistleblower will be eligible for an award in a matter already under investigation if his or her information ‘significantly contributes’ to our success.”

SEC Final Rule p. 100

Criteria for deciding if whistleblower award in an ongoing investigation

In applying this standard, among other things, we will look at factors such as whether the information allowed us to bring: (1) our successful action in significantly less time or with significantly fewer resources; (2) additional successful claims; or (3) successful claims against additional individuals or entities.

What is a smoking gun?

_________________________

AS DZAsks for earnings “tidbits”

DZ ASTo get back “on MSFT

ASAP”

DZ ASPresumed MNI communication

MSFT Beats Estimates

4/6/01 4/7/01 4/9/01 4/9 - 4/11 4/20

35,000 option Contracts

$18 million

From: Mark SpainSent: Sunday, April 8, 2001, 11:08 AMTo: David ZilkhaSubject RE: Any visibility on the recent quarter?

March was the best march of record. Made up the shortfall in us sub. w2k pro major contributor. on track for revised forecast (MYR)

----Original Message--------

From: David ZilkhaSent: Saturday, April 07, 2001 11:37 PMTo: Mark SpainSubject: Any visibility on the recent quarter?

Hey there,Have you heard whether we will miss estimates? Any other info?David

“After a scathing 2007 report by the Senate criticized the SEC’s handling of Aguirre’s Pequot investigation, and after Aguirre dredged up the smoking gun e-mails and passed them along to the Senate, the FBI and the SEC in late 2008, the SEC reopened the case in January 2009.”

Liz Moyer, Scales of Justice Look Skewed for Rajaratnam, Samberg, May 27, 2010, Forbes

Delivery of the Smoking Gun (Full letter available on Government Accountability Project website)

Gregory Zuckerman and Kara Scannell, Pequot Capital, a Top Fund, to Close as Firm Faces Probe, The Wall Street Journal May 29, 2009

Gretchen Morgenson, Pequot Capital and Its Chief Agree To Settle S.E.C. Suit for $28 Million, N.Y. Times May 28, 2010

 

“Mr. Samberg and Pequot will return $18 million in profits and interest and pay $10

million in penalties.”

What happened to the whistleblower?

What happened to the fired SEC attorney?

Gretchen Morgenson, S.E.C. Pays Settlement to Staff Lawyer It Fired, N.Y. Times June 30, 2010

“The settlement appears to be the largest disclosed by the Merit Systems Protection Board, the federal agency that oversees such cases.”

Whistleblower protections

No employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower—

a) providing information to the SEC pursuant to WB statute;

b) participating in the process; or

c) making disclosures that under the Sarbanes-Oxley Act and any other law, rule, or regulation subject to the jurisdiction of the SEC.

Remedies where reprisal

Whistleblower may bring an action in the US District Court for” (i) reinstatement with the same seniority status

   (ii) 2 times the amount of back pay with interest; and  (iii) litigation costs, expert witness fees, and reasonable attorneys' fees.

Confidentiality Agreements

“We caution employers that, as adopted, Rule 21F-17(a) provides that no person may take any action to impede a whistleblower from communicating directly with the Commission about a possible securities law violation, including by enforcing or threatening to enforce a confidentiality agreement.”

SEC Final Whistleblower Rules, p. 33

12

“GOD-GIVEN MARKETS”

Manipulation of the markets was not merely the source of immediate stock-market profit, but the indispensable means to innumerable tortuous schemes and devices.

Ferdinand Pecora, Wall Street Under Oath: The Story Of Our Modern Money Changers, at 258.

It all looks alike on the ticker

“The Public was always in the dark. It could not tell whether sales were due merely to the ‘free play of supply and demand,’ or whether they were the product of manipulated activities…It all looks alike on the ticker (emphasis added).”

Ferdinand Pecora, Wall Street Under Oath: The Story Of Our Modern Money Changers, at 267.

In Goldman, Sachs We Trust

“The virtue of the investment trust was that it brought about an almost complete divorce of the volume of corporate securities outstanding from the volume of corporate assets in existence. The former could be twice, thrice, or any multiple of the latter.”

John Kenneth Galbraith, The Great Crash 1929, at p. 47.