|
SEC Loses Insider-Trading Case:
Court “Distressed” by Counsel’s Conduct
By Richard A. Levan and Conor L. Mullan
The Securities and Exchange
Commission was recently handed a significant defeat in SEC v.
Heartland Advisors, Inc., when a U.S. District Judge dismissed
civil insider-trading charges levied against an adviser and his
client. While the decision was itself a damaging setback to the
SEC’s ongoing efforts to deter insider-trading, the court added
insult to injury in an opinion riddled with jabs at the SEC
counsel’s professional conduct.
The case involved Heartland
Advisor Inc., client William Krueger's sale of $25,000 in shares of the
Heartland Short Duration Fund (SDF), which Krueger sold immediately
after a lunch meeting with Heartland president William Nasgovitz. In its complaint, the SEC alleged
that Nasgovitz must have tipped Krueger about
the upcoming devaluation of the SDF, based largely on the timing of the
sale and the lunch date, which occurred shortly after Nasgovitz obtained information concerning SDF’s devaluation.
Despite the existence of several
key uncontested facts that implied the existence of an insider-trading
scheme, the SEC’s counsel apparently could not resist finessing
their allegations in what they likely believed to be an exercise in
persuasion. The court described the SEC’s actions –
the most egregious of which are discussed below – as
“playing fast and loose with the facts” and stated that
counsel’s “pattern of misquoting an opponent and misrepresenting
facts and law is especially distressing.”
First, the court admonished the
SEC for misquoting Krueger’s testimony regarding his post-lunch
visit to Heartland’s offices, where Krueger admittedly instructed
Nasgovitz’s assistant to liquidate his
SDF holdings. The SEC claimed that Krueger testified to returning
to the Heartland offices after lunch for a tour of the new complex, and
placed the word “tour” in quotes in their proposed findings
of fact. Upon reviewing Krueger’s testimony and Wells
submission, the court found that the word “tour” was never
used by Krueger and, therefore, characterized the SEC’s use of
quotes as “a misleading indication, at best.”
Furthermore, the court pressed the issue in stating, “Perhaps the
SEC is not unlike Britney Spears in its ability to use quotation marks
correctly,” referring to the pop star’s improper use of air
quotes in a recent NBC Dateline interview.
Next, the court addressed the
SEC’s position that Nasgovitz’s
assistant’s preparation of a summary of Krueger’s holdings
prior to the lunch meeting supported an inference of an illegal
disclosure. The court criticized the SEC for failing to mention
that the assistant had prepared similar summaries in the past for other
clients, and further stated, “There is nothing unusual or
sinister about preparing a summary of a client’s holdings before
the client’s business lunch with her boss.”
Furthermore, the SEC represented
to the court that Krueger’s Wells submission explained the sale
of his SDF shares as “part of a predetermined plan to sell
one-third of his holdings each year for three years.”
However, upon reviewing Krueger’s Wells submission, the court
found that there was no discussion of a “predetermined plan.”
Rather, Krueger’s Wells submission stated that he had established
a “prior pattern” of SDF liquidation. (As discussed
in Heartland, a prior pattern of trades may in fact negate an
inference of insider-trading.)
Finally, the court found that
the SEC misquoted Krueger’s testimony regarding Nasgovitz’s role as his account
representative. The SEC stated that Krueger testified that he did
not know that Nasgovitz was his account
representative, but upon reviewing the record, the court found that
Krueger merely stated that he did not know what the term
“representative” meant.
In addition to being criticized
for “playing fast and loose with the facts,” the court
censured the SEC for citing an incomplete case holding.
Specifically, the court found that the SEC – in citing Freeman
v. Decio for the proposition that
evidence of suspicious timing of trades relative to contact with an
insider gives rise to an inference of insider trading – failed to
state that, under Freeman, such an inference may be negated by
demonstrating a prior pattern of trades. In reminding the
SEC’s attorneys that they are “obligated to quote
authorities accurately,” the court instructed them to review the
Wisconsin Rule of Professional Responsibility regarding the duty of
candor toward the tribunal. The court further urged the SEC to
“remember that a suit by the SEC is akin to a criminal
prosecution in that it is accusing a private individual of
wrong-doing.” Therefore, the SEC’s duty in such a
case is to act as the representative of “a sovereignty whose
obligation to govern impartially is as compelling as its obligation to
govern at all; and whose interest, therefore, in a criminal prosecution
is not that it shall win a case, but that justice shall be
done.”
The Heartland
court’s harsh criticism of the SEC’s attorneys is something
that is not often captured in a judicial opinion. However, this
is far from the first time the SEC has been rebuked by a court.
In U.S. v. Stringer, the SEC’s counsel was accused of
“deceit and trickery” by a federal judge for improperly
colluding with the U.S. Attorney’s Office and misleading three
former executives into believing they were not the targets of a
criminal investigation. In In
re Brandt, Kelly & Simmons, LLC, an administrative law judge
found the SEC had “mistakenly exalted form over substance”
in charging an investment adviser and its co-founder with
misappropriating client funds. The respondents had actually
reimbursed the clients by giving them credit – in excess of the
amount allegedly misappropriated – against their management
fees.
The court in SEC v. Siebel
Systems, Inc., criticized the SEC for “scrutiniz[ing] at an extremely heightened level, every
particular word [in private statements by a company’s CFO] . . .
including the tense of verbs and the general syntax of each
sentence.” In WHX Corporation v. SEC, the court
found that the SEC had failed to provide a “rational
explanation” for the sanction it had imposed on a corporate
defendant.
All of these cases have something
in common beyond the tribunal’s harsh words for the positions or
tactics taken by the SEC. The SEC lost every one of these cases,
and these are far from the only losses sustained by the agency in
recent years. For an agency that carefully reviews the cases it
selects for prosecution, such results can be disastrous.
One clear message arises from
this spate of Commission losses: Challenging the SEC can pay
off. Of course, only those defendants with the necessary funds
may be able to exonerate themselves, a troubling fact in itself.
Despite the SEC’s setbacks
in Heartland Advisors and beyond, the SEC can be expected to
vigorously pursue its enforcement agenda. Indeed, while the Heartland
court dismissed the insider-trading charges in that case, other
securities fraud charges remain against Nasgovitz,
Heartland Advisors, and seven current and former Heartland Advisors
officers and employees. Presumably, those charges will receive
careful scrutiny from a judge already troubled by the Commission’s
tactics. Regardless of the outcome in Heartland Advisors, however,
litigants should be emboldened by the SEC’s courtroom
missteps.
[Note: The full citation for the Heartland case is SEC v.
Heartland Advisors, Inc., et al., No. 03-cv-1427, 2006 WL 2547090 (E.D.Wis. Aug.
31, 2006).]
RICHARD A. LEVAN is a partner at Levan
Friedman LLP and can be reached at rlevan@rlevan.com. Mr. Levan
formerly served as a senior official in the SEC’s Philadelphia
Office and as an Assistant U.S. Attorney in the Department of Justice
in Washington, D.C.
CONOR L. MULLAN joined Levan
Friedman LLP in 2005 as an associate, where he concentrates on
Securities Regulation and Litigation and White Collar Defense.
This article is reprinted with
permission from the December 4, 2006, issue of The Legal Intelligencer. ©
2006 ALM Properties Inc. Further duplication without permission
is prohibited. All rights reserved.
|
