By Stuart Gittleman
NEW YORK, June 26 (Thomson Reuters Accelus) – Two court rulings last week may raise the enforcement burden for the financial services industry and its regulators.
A Brooklyn federal judge suggested that for regulatory targets of the Securities and Exchange Commission, forcing the agency to take them to court could end up costing less than settling before litigation is begun, depending on legal fees and other considerations, because its ability to seek compensation in court is limited.And a Supreme Court ruling may make investigating potential violations more expensive and time-consuming for prosecutors and agency lawyers as well as criminal and regulatory defense counsel and may also cut the number of jury trials.
Federal judge “reluctantly” inks SEC settlement with fund managers
In Brooklyn Judge Frederic Block approved a settlement between the SEC and Ralph Cioffi and Matthew Tannin, two former Bear Stearns hedge fund managers.
Cioffi and Tannin were previously acquitted of related criminal charges in connection with the funds’ failure, which occurred the year before the bank itself collapsed.
Without admitting or denying the SEC’s allegations that they defrauded the funds’ investors, Cioffi and Tannin respectively agreed to pay $800,000 and $250,000.
Block has called $1.05 million “chump change,” compared to the $1.6 billion in losses to the funds’ investors. He also said the failure of the funds, which invested in residential mortgage backed securities, weakened both Bear Stearns and the RMBS market, resulting the distressed sale of the bank in March 2007 and the collapse of the global credit market six months later.
But the federal securities laws only let the SEC order parties to disgorge ill-gotten gains – in this case, the compensation the men received after allegedly violating the anti-fraud laws – rather than the damages caused by the alleged violations, Block said.
This offended Block’s sense of fairness, a key standard for his approving the deal, but he said he was constrained by the law and urged Congress to strengthen investor protections.
Block noted that Congress authorized the Commodity Futures Trading Commission “to assess ‘actual damages’ … and in cases of ‘willful and intentional’ violations, punitive damages ‘equal to no more than two times the amount of such actual damages.’
“Given the obvious parallels between commodities trading and securities trading, Congress could easily grant the SEC the same authority,” Block said. “For now, however, the court must accept the SEC’s enforcement authority.”
SEC Chairman Mary Schapiro has also asked Congress to expand the agency’s remedial authority, but no legislation to this effect is expected to pass any time soon.
Moreover, the SEC has limited litigation resources and it would be unlikely to squander them trying a civil case in a district where a criminal jury drawn from the same pool had acquitted Cioffi and Tannin on essentially the same allegations of securities fraud.
In deciding to approve the $1.05 million settlement, Block balanced the amount against $5.5 million, which he said is the most the SEC could obtain after a successful trial.
Throughout the investigation a potential target’s defense litigation strategy will require doing similar computations, for which there is no proven formula, and also considering the value of avoiding the reputational risk of a verdict of liability.
Proving the violations and adding them up, one by one
The Supreme Court ruled that a federal judge could not fine Southern Union, an energy company, for environmental pollution unless the jury, which had found general liability, also found the factors the judge used to calculate the fine.
The high court ruled that if a claim for fines or other monetary damages over the statutory minimum is tried before a jury only the jurors – not the judge – may determine the basis for the amount awarded.
The court extended to corporate fines its 2000 ruling in Apprendi vs. New Jersey that a judge may not impose a longer criminal sentence unless the jury, if there was one, made the inculpatory findings on which the longer sentence is based.
Most alleged violations of the federal securities laws, including the Foreign Corrupt Practices Act (FCPA), are resolved by settling with the SEC or entering into a deferred- or non-prosecution agreement with the Justice Department.
Although there is still an incentive for a firm to use one of the agreements to avoid a felony conviction, the ruling will make it more costly for authorities to investigate and prosecute these cases, Brandon Garrett, a law professor at the University of Virginia, told Thomson Reuters Accelus.
“Prosecutors will need to be more specific about potential monetary damages – illicit gains and potential losses illegally avoided – earlier on in the investigation and must develop evidence to prove these damages,” Garrett said.
Much of the evidence in an FCPA case is in the hands of the corporate defendant or the individual defendant’s employer or principal, and prosecutors will need these records to be produced in order to negotiate what they consider a fair DPA or NPA, Garrett said.
Trials, when they are held, will be more technical and complex, and potentially more difficult for the jury to follow, Garrett said. Entities and individuals will have to think more strategically by balancing the benefit of a lower penalty with the business costs of a felony conviction, but the expected result will be more expensive investigations by or on behalf of the entity, not more trials.