Christopher L. Garcia and Amanda Burns Shulak ()
By most measures, the government’s recent multi-year crackdown on insider trading has been an unqualified success. The U.S. Department of Justice (DOJ) and the U.S. Securities and Exchange Commission (SEC) have scored high profile trial victories, including against Raj Rajaratnam and Rajat Gupta, and won substantial resolutions, including $1.8 billion in settlements with SAC Capital Advisers and its affiliates CR Intrinsic Investors and Sigma Capital.
Recently, however, the SEC has had some missteps, most notably at trial. While during the three-year period ending November 2013, the SEC’s success at trial was approximately 80 percent,1 that rate dropped to below 60 percent from October 2013 through March 2014, due in part to a string of losses in insider trading cases. Specifically, of the 12 cases the SEC tried overall during that period, it won three, had mixed verdicts in four, and lost five outright.2 To some, the losses in three of the insider trading cases—SEC v. Steffes, SEC v. Schvacho, and SEC v. Cuban—have raised questions about the ability of the SEC to try cases effectively, an important issue if the SEC’s recent decision to seek admissions more frequently in settlements results in more trials.
But more likely, the losses in those cases were the result of the SEC having brought enforcement actions for conduct that was not provable based on the available evidence. Each of the cases suffered from proof issues that made them difficult cases to win. This article will briefly examine those losses and discuss at least one way that the SEC is trying to address them.
‘SEC v. Steffes’
While insider trading cases are rarely won or lost on materiality, Steffes3 may be the exception. In Steffes, the SEC brought insider trading claims against railway workers Gary Griffiths and Cliff Steffes, alleging that they traded on material nonpublic information about the acquisition of the railway company where they worked and also tipped relatives who traded on the information. The information that Griffiths and Steffes allegedly traded on and shared, however, was not direct information that their company was a target of acquisition but rather observations of, and speculation about, activity they witnessed at the railway yard where they worked. The SEC alleged that Steffes observed “an unusual number of daytime tours of [Rail] Yard involving a tour bus and people dressed in business attire” and that other employees who observed the tours began expressing concern that the company was being sold.4 The SEC claimed that Griffiths’ supervisor asked him to prepare a list of locomotives and other equipment owned by the company and their corresponding valuations; Griffiths observed an unusual number of tours and “believed [the people on the tours] were investment bankers who were considering buying or investing in the railway company”; and Griffiths was asked by other yard employees whether the company was being sold.5 As charged, these pieces of information hardly seemed material, although the district court denied defendant’s motion for summary judgment, finding that a jury could find otherwise.6 The jury was less generous in returning a verdict against the SEC.7
On a technical level, it seems likely that the jury found that the information was not material. More broadly, it appears likely that the facts simply did not provide a compelling moral reason to hold Griffiths and Steffes liable. Finding that someone has violated the law is serious business, and most jurors want to feel compelled to do so. There is at least a possibility with respect to Steffes that the jury just did not think that Griffiths and Steffes should be held liable for trading on and sharing information that they incidentally or fortuitously observed at work, as opposed to the insider who predatorily obtains information to gain an edge over others in the market or who sells that information for personal profit.
‘SEC v. Schvacho’
In Schvacho,8 the issue did not appear to be the quality of the evidence as much as the quantity of it. In its complaint, the SEC alleged that Ladislav “Larry” Schvacho traded on material, nonpublic information about an impending merger from the CEO of the target company, Larry L. Enterline, who was a close personal friend.9 The evidence against Schvacho was based almost entirely on records of telephone calls and text messages and other trips and meetings between Schvacho and Enterline around the times of Schvacho’s stock purchases (which spanned several years). The SEC did not present any evidence about the content of any of the calls or texts or any testimony establishing that Schvacho received or overheard confidential information from Enterline. Both Schvacho and Enterline testified at trial that they never discussed confidential information about the company or its acquisition. The court found both witnesses credible, leaving the SEC with a largely circumstantial case that the court concluded did not add up. The case was dismissed after a bench trial.10
In Schvacho, it seems likely that the SEC overestimated the strength of inferences that could be drawn from the chronology of events surrounding the purportedly problematic trading and underestimated the impact of Schvacho’s and Enterline’s testimony. Pursuing a purely circumstantial case is always challenging, but mounting one when the defendant and the alleged source of the information will deny the allegations credibly under oath is virtually impossible.
‘SEC v. Cuban’
Cuban was undoubtedly the most high profile of the SEC’s losses. In Cuban, the SEC alleged that Dallas Mavericks owner Mark Cuban sold his ownership stake in the company Mamma.com based on material nonpublic information about a potential Private Investment in Public Equity (PIPE) transaction that would have diluted the value of his shares.11 The SEC claimed that Cuban misappropriated confidential information about the transaction from Guy Fauré, the former CEO of Mamma.com.
Notably absent from the trial was Fauré, who lives in Canada, beyond the reach of the SEC’s subpoena power. The SEC played video from a deposition of Fauré, in which Fauré testified that he told Cuban about the PIPE transaction, and Cuban replied, “Now I’m screwed, I can’t sell.” Cuban testified in person that he could not recall any details of the conversation with Fauré but also that he did not agree to keep the information confidential or not to trade on the information. For the SEC to prevail, the jury had to credit the video deposition of Fauré over the live testimony of Cuban, which it did not. The jury rejected each of the SEC’s substantive allegations.12
While we cannot be sure why the jury returned a verdict in favor of Cuban, it is likely that the failure of the SEC’s star witness to testify in person had an effect on the verdict. As stated above, juries want to feel compelled to hold someone responsible for violating the law, and it likely was not compelling to the jury that the principal witness against Cuban did not appear in court. At a minimum, the jury may have felt more comfortable assessing and affirming Cuban’s credibility than that of the witness who did not appear before them.
SEC’s Efforts to Address Losses
Steffes, Schvacho and Cuban were each beset by significant proof issues that ultimately made it impossible for the SEC to prevail. Some of the proof issues in these cases were of a type that the SEC commonly confronts. As Mary Jo White, the current Chairwoman of the Commission, has noted, the SEC faces unique challenges in taking cases to trial: “[u]nlike our colleagues at the DOJ, we most often proceed without the benefit of cooperators, wiretaps, surveillance evidence, and many of the other tools at the disposal of prosecutors … [and] often must rely heavily on circumstantial evidence, hostile witnesses, or on the cross-examination of the defendant in order to prove our case.” These challenges, and the SEC’s losses in Steffes, Schvacho and Cuban, necessarily raise the question: What should the SEC do to ensure that only provable cases are charged and tried?
The SEC has recently instituted structural changes in the Enforcement Division that should help achieve this goal. Unlike at the DOJ where cases are investigated by the prosecutors who try them, the SEC historically has had divided investigation and trial functions. Staff attorneys with the Enforcement Division have been charged with identifying potential securities laws violations, investigating whether such violations have occurred through the collection and review of documents and deposition testimony, and proposing charges. When cases are charged, the matter is handed off to attorneys from the trial unit, who litigate the case, including through to trial. Under Chairwoman White, however, the SEC has reportedly reorganized its trial unit into groups that more closely correspond with how investigating staff attorneys are organized and is pairing investigators and trial attorneys together earlier in the investigative process.13 This is a move in the right direction for several reasons.
Involving trial attorneys at the investigation stage will likely pay substantial dividends. First, attorneys from the trial unit will be able to help staff attorneys optimize the evidentiary record for trial. Among other things, attorneys from the trial unit should enable staff attorneys to better identify opportunities to use discovery, including deposition testimony, to stave off meritless trial defenses. They will also be able to help the staff identify small pieces of evidence that may be critical at trial even though their significance may not be obvious to someone who has not had the benefit of trying cases.
Second, trial attorneys will help the staff make better assessments of whether cases are provable. Their experience at trial will help the staff make accurate assessments of how much circumstantial evidence is enough to prevail at trial, whether important evidence is likely to be admitted at trial, and whether witnesses are likely to be deemed credible by judges and juries.
Alternatively, trial attorneys under this reorganized system should be able to develop a deeper knowledge about the cases they are tasked with trying, including knowledge of nuances concerning evidence and witnesses that can only be developed by participating in the investigation and that cannot be transmitted through a case file.
Indeed, by making efforts to better integrate the staff and the trial unit, the SEC seems to be looking to capture some of the benefits of the trial-lawyer-as-investigator model operative at the DOJ, a model with which Chairwoman White is obviously familiar from her time as a prosecutor. That model recognizes the value that the experience of trial has for an investigator. Indeed, you will be hard pressed to find an FBI agent who will tell you that he or she did not become a better investigator after sitting through his or her first trial. Nor will you find a prosecutor who will deny that he or she became considerably better at assembling a case after having conducted trials. The SEC has taken important first steps to integrate its enforcement and trial units, and still may benefit further from additional integration efforts.
Only time will tell whether such steps will lead to more provable cases being charged and tried, but there can be no doubt that such an outcome is vital. On the one hand, the SEC’s centrally important mission of protecting the investing public through the specific and general deterrence of violators is substantially undermined if the SEC loses cases that are not provable at trial. Equally important are the consequences for anyone who is caught in the crosshairs of an SEC investigation. Those who fight the SEC and win do so at considerable expense, both personal and financial. But in truth, many do not have the wherewithal to fight the SEC and ultimately settle the cases brought against them, regardless of the merits. When cases that are not provable are settled, there is a risk that real unfairness results, threatening the integrity of enforcement. For example, various relatives of Griffiths and Steffes who were allegedly tipped by them were charged by the SEC but settled without going to trial.14 While it is unclear whether financial resources played a factor in their decisions to settle, it would be troubling if they settled on the basis of such considerations when the SEC was unable to prove those who were the alleged to be the primary violators liable.
Christopher L. Garcia is a partner at Weil, Gotshal & Manges in the securities litigation and white-collar defense and investigations practices. Amanda Burns Shulak is an associate in the securities litigation practice.
1. Mary Jo White, “The Importance of Trials to the Law and Public Accountability,” 5th Annual Judge Thomas A. Flannery Lecture, Washington, D.C., Nov. 14, 2013, available at http://www.sec.gov/News/Speech/Detail/Speech/1370540374908#.U1QKn_ldWSo.
2. N. Lynch & Aruna Viswanatha, “Weak trial witnesses hinder a more aggressive SEC,” Reuters, http://www.reuters.com/article/2014/03/10/us-usa-sec-court-insight-idUSBREA2907A20140310 (reporting SEC trial success rate of 58 percent from Oct. 1, 2013 through March 20, 2014); Jean Eaglesham, “SEC Takes Steps to Stem Courtroom Defeats,” Wall Street Journal, http://online.wsj.com/news/articles/SB10001424052702304703804579381310253258646 (reporting SEC trial success rate of 55 percent from Oct. 1, 2013 through Feb. 13, 2014);
3. SEC v. Steffes, 10-cv-06266 (N.D. Ill.).
4. Id. (Complaint, Sept. 30, 2010, Dk. No. 1, at ¶¶ 37).
5. Id. at ¶¶ 34.
6. Id., Transcript, Dec. 6, 2013, Dk. No. 241 at 17:23- 18:8 (“Taking isolated facts which on their face and in isolation may seem innocuous doesn’t change the fact that piecing together a variety of innocuous facts to come to a conclusion that a company is going to be sold when you’re an employee of that company and you’re bound to keep information derived from the company confidential could make that information material and can also result, if you disclose that information, in a violation of the confidentiality agreement. A reasonable jury could find that such circumstances were material to deciding whether to buy FECI stock if the jury found that Griffiths disclosed this information to the defendants and defendants, in fact, purchased the stock on the basis of this information.”).
7. SEC v. Steffes, Judgment, Jan. 27, 2014, Dk. No. 295.
8. SEC v. Schvacho, 12-cv-02557 (N.D. Ga.).
9. SEC v. Schvacho, Complaint, July 24, 2012, Dk. No. 1, at ¶1.
10. SEC v. Schvacho, Findings of Fact and Conclusions of Law, Jan. 7, 2014, Dk. No. 62 (entering verdict and judgment in favor or Schvacho).
11. SEC v. Cuban, 08-cv-02050 (N.D. Tex.), Complaint, Nov. 11, 2008, Dk. No. 1.
12. See SEC v. Cuban, jury verdict form, Oct. 16, 2013, Dkt. No. 278.
13. Jean Eaglesham, “SEC Takes Steps to Stem Courtroom Defeats,” Wall Street Journal, http://online.wsj.com/news/articles/SB10001424052702304703804579381310253258646; Sarah N. Lynch & Aruna Viswanatha, supra note 2.
14. W. Gary Griffiths, Rex C. Steffes’ brother-in-law, agreed to pay a civil penalty of $120,000 to settle the SEC’s claims that he tipped Rex C. Steffes, and Robert J. Steffes agreed to pay $104,981 in disgorgement plus interest and a penalty of $104,981 to settle claims against him. SEC Litigation Release No. 21678, Sept. 30, 2010, available at http://www.sec.gov/litigation/litreleases/2010/lr21678.htm.