The guilty plea hearing last week in the Justice Department’s prosecution of SAC Capital Advisors raised an interesting question about the law of insider trading: Just who are the victims of a violation? A provision of the federal securities laws gives those who traded at the same time as the insider a right to sue for a violation, but the Justice Department said they are not victims of the crime.
At the hearing, the firm’s general counsel, Peter Nussbaum, expressed “our deep remorse for the misconduct of each individual who broke the law while employed at SAC.” But even though SAC admitted guilt, the plea agreement has not been approved yet by Judge Laura Taylor Swain of the Federal District Court in Manhattan.
Under the terms of the agreement, the judge must decide whether to approve without change the penalties provided, which include a $900 million fine, termination of SAC’s investment advisory business and five years of probation that includes appointment of an outside monitor to oversee the firm’s compliance with insider trading regulations. If Judge Swain does not go along, SAC will have the opportunity to withdraw its guilty plea, or it can choose to accept whatever punishment the judge deems appropriate. The firm will return to court in March after the preparation of a presentence report, at which point it will learn whether the case has been resolved.
The hearing also included a brief diversion when a lawyer for investors who have sued SAC asked the court to reject the plea agreement because it does not include a specific acknowledgment of a violation for trades in Elan and Wyeth based on information about a drug trial. That trading makes up the bulk of the government’s case, involving losses avoided and gains totaling approximately $276 million, far more than the amount seen in other transactions.
Judge Swain permitted the lawyer to speak because of Federal Rule of Criminal Procedure 60(a)(3), which gives victims of a crime the right to be heard in a proceeding about accepting a guilty plea. Her decision to postpone that decision means that she could still make a broader admission of guilt by SAC a condition of acceptance.
Although the Justice Department did not oppose the request, it argued that the investors in Elan and Wyeth did not qualify as victims of SAC’s crimes, a term defined in the Crime Victims Rights Act as one who was “directly and proximately harmed” by the violation. A letter filed by the prosecutors stated that “an individual who happens to buy or sell securities at the same time as an insider trading defendant is not considered a ‘victim’ under the C.V.R.A. because that individual was denied the opportunity to make the same illegal profits obtained by the defendant.”
Instead, the focus in insider trading prosecutions is on protection of the markets, and the broader economy, as the true victim of the violation. In sentencing Raj Rajaratnam to 11 years in prison after his conviction, Federal District Court Judge Richard J. Holwell said that “insider trading is an assault on the free markets” and the “crimes reflect a virus in our business culture that needs to be eradicated.”
Yet the federal securities law sends a different message by authorizing those who traded at the time of the insider transactions to pursue a private lawsuit. The case filed by the Elan and Wyeth investors against SAC is under a little used provision, Section 20A of the Securities Exchange Act of 1934, that gives “contemporaneous traders” a right to sue those trading on inside information.
The law was adopted in 1988 as part of the Insider Trading and Securities Fraud Enforcement Act in response to the scandals involving Ivan Boesky and others, an era epitomized by the movie “Wall Street.” A report by the House of Representatives said that the law would “provide greater deterrence, detection and punishment of violations of insider trading.”
The act authorizes the Securities and Exchange Commission to seek triple penalties for insider trading while allowing individual investors to pursue a claim as a backup. But the private plaintiffs can recover only the gains or losses avoided by the defendant, and any award is reduced by payments made to settle a government case over the trading.
That creates an odd situation because investors on the opposite side of the transactions are provided a right to enforce the law but are not considered victims of the crime for purposes of whether to accept a plea agreement involving the same trades.
The problem with calling a contemporaneous trader a victim is that securities trading is largely anonymous, with orders placed electronically involving no real interaction between buyers and sellers. Whether someone might be acting on inside information in making a trade is largely irrelevant to the counterparty who engages in a transaction for his or her own purposes.
That is particularly true now with the prevalence of high-frequency trading systems that give no consideration to the fundamentals of a company, only looking at whether there is a pricing anomaly that can generate profitable trading. Giving contemporaneous traders a right to pursue a case is similar to the federal False Claims Act that authorizes individuals to sue on behalf of the government for claims that it was defrauded.
Insider trading is more about the unfairness of someone realizing benefits from unauthorized trading on confidential information than about identifying victims of the violation. Although it is a misnomer to describe it as a “victimless crime,” it is a type of securities fraud in which no one will have an identifiable loss like the victim of a Ponzi scheme.
As I noted in a previous post , the plea agreement with SAC was carefully drafted to avoid having the firm admit to a violation for any particular trades, so it can still deny that the transactions in Elan and Wyeth constituted insider trading. But even if it were forced to make such an admission, that would not have much effect on the investor lawsuit. SAC has already paid the S.E.C. approximately $275 million in forfeited profits for its illegal gains for that trading as part of a settlement in March, so the investors look to be precluded from any additional recovery from the firm.
Although federal law grants rights to victims in criminal prosecutions, when the case involves insider trading it looks like no one can claim that status.