By Moshe Silver
New York district judge Jed Rakoff continues to annoy folks by insisting that government do its job. In his famous rant about a proposed settlement between the SEC and Citigroup over allegations of billion-dollar fraud, Rakoff said “you’re asking me to exercise my authority, without exercising my judgment,” pushing back against the age-old practice where the SEC reaches a settlement with an accused party and a court rubber stamps it. The standard outcome is, the accused pays a lot of money to the SEC, the SEC doesn’t identify accused individuals, no one has to admit to anything, and the firm or individuals who paid the settlement resume Business As Usual.
If, like us, you get your daily dose of rage by watching the ongoing blatant collusion between the worst of Wall Street and government’s “brightest and best,” you may recall that Rakoff held firm on not approving the Citi/SEC settlement without knowing the details. Finally, the SEC and Citibank got together and sued in appeals court to force Rakoff to sign off. We think this looks like the sheriff and the burglars getting together to poison the watchdog, but the courts are generally not interested in our opinion.
Now, Judge Rakoff is giving the SEC the go-ahead to proceed with a civil insider trading case against two stockbrokers, even though federal prosecutors have dropped the case.
Prosecutors are treading gingerly after an appeals court threw out the insider trading convictions of Anthony Chiasson and Todd Newman, respectively of Level Global Investors and Diamondback Capital. This was a mega-high-profile case – complete with FBI raids of hedge fund offices in broad daylight – and was considered a major win for the government. Until another arm of that same government ruled that – in the absence of clearly defined insider trading laws – prosecutors had to meet an increasingly heavy burden of evidence, the further the insider tip was from its source. In the Newman case, the fund managers were found to have benefited from tips that originated three or four degrees of separation away from them and their firms – hardly the same as handing the CFO a bag full of unmarked $100 dollar bills to get him to tell you what next week’s earnings report will be.
Judge Rakoff found that, while prosecutors may not have been comfortable bringing a criminal case, the charges meet the lower standards of evidence for civil cases, and the SEC could proceed with its independent case.
But Judge Rakoff also wrote that “difficulties” arise from the current scenario, where courts and regulators are forced to make insider trading law case by case. “The tensions thereby created cannot always be resolved in satisfactory fashion,” he wrote, “thus reinforcing the need for Congressional action.”
Late last year Supreme Court justices Scalia and Thomas wrote that it is not up to appointed members of government agencies (the SEC, the Justice Department) to decide what constitutes a federal crime. The court has declined to hear insider trading appeals, indicating a general discomfort with letting the SEC call the shots on a case-by-case basis, in the absence of actual legislation.
Judge Rakoff suggests that Congress should make black-letter laws defining insider trading, thereby telling prosecutors when they can bring future cases. These laws would clarify categories requiring punishment for wrongdoing – which, unlike the current practice of settling with the Commission, would require identifying wrongdoers by name and maybe even putting them in prison.
Following up on our favorite legal doctrine, the Law of Unintended Consequences, we note that, the minute Congress sets out to write laws defining securities fraud in such a way that people run a real risk of going to prison, there will be a massive shift in campaign funding.
According to the website OpenSecrets.org, the financial and securities sector comes in as far and away the largest donor to Congressional races – nearly twice the amount given by the next-largest donor group: lawyers (who get paid to represent guys on Wall Street… are you beginning to see where this is going?)
We applaud Judge Rakoff for telling Congress it’s time they actually do their job.
A man can dream, can’t he?
Moshe Silver is a Managing Director at Hedgeye Risk Management and author of Fixing a Broken Wall Street.