In a ruling laced with tough questions about a key US government enforcement tool in financial crime cases, a federal judge grudgingly approved a $602 million settlement between the Securities and Exchange Commission and hedge fund giant SAC Capital – with one big caveat.
Issued by US District Judge Victor Marrero in a Manhattan courtroom last week, the order consented to the largest-ever settlement related to insider trading, but said final approval is contingent on a pending ruling from the US Court of Appeals for the Second Circuit. That Second Circuit case hinges on the SEC’s use of settlement agreements that allow defendants to “neither admit nor deny guilt” in securities fraud and other financial crime cases.
Likewise, Marrero’s order contained serious misgivings about the SEC’s decision to allow SAC Capital to “neither admit nor deny guilt” in the record-setting settlement.
Marrero stated he was “troubled” by the provision, and called it “counterintuitive and incongruous” given the size of the penalty and the severity of SAC Capital’s alleged wrongdoing in the case. The SEC is charging SAC Capital and one of its portfolio managers, Mathew Martoma, with perpetrating a huge insider trading scheme in violation of Rule 10(b) of the Securities Exchange Act. The hedge fund, which has been under investigation since 2010, allegedly relied on insider information to earn $276 million on trades of pharmaceutical stocks.
Major financial crimes cannot be blamed on ‘mischief of leprechauns,’ judge says
Provisions allowing companies to settle charges without conceding to wrongdoing have become standard practice in many financial crime enforcement actions brought by the SEC and US Justice Department. The SEC has used the “admit or deny” provision for decades in securities fraud settlements.
More recently, the US Justice Department has adopted it as a settlement practice in a variety of financial crime cases, such as the “deferred prosecution agreements” typically used to settle US Foreign Corrupt Practices Act cases. Nevertheless, the practice has come under scrutiny by several federal judges over the past two years, and Marrero’s order may be one of the strongest salvos yet.
“In the real world, and in the eyes of the public whose perceptions pass judgment on official actions, harmful conduct on the scale of the contemporary models ordinarily does not occur absent some form of wrongdoing,” Marrero said. “The damage the victims suffer cannot always be blamed on acts of God or the mischief of leprechauns.”
Judge questions validity of dodging guilt in age of ‘too big to jail’
The bulk of Marrero’s 34-page order focused on the “neither admit nor deny guilt” issue, thoroughly outlining the arguments in favor and against using such a settlement provision. Marrero stated that there were valid “financial, practical, and public policy grounds” for allowing defendants to settle without admitting guilt in “run-of-the-mill cases,” such as when the costs of litigation would outweigh any penalties collected by the SEC.
The judge also acknowledged that the settlement practice had become a key negotiating tool in cases against large corporations and financial institutions. Forcing companies to admit guilt would leave them more vulnerable to private suits from shareholders or others, and may give companies little incentive to accept large penalties and settle cases quickly, Marrero wrote.
“In many, if not most, cases, ‘neither admit nor deny’ provisions are essential to bring corporate defendants, which are frequently also facing private civil actions, to the bargaining table,” the order stated.
‘New era’ of financial crimes may call for greater judicial oversight, judge says
At the same time, Marrero voiced reservations about the validity of the provision in large-scale cases like SAC Capital. His order questions if the new reality of multi-million dollar financial crimes, and their accompanying multi-million dollar penalties, calls for enhanced judicial scrutiny of settlement practices.
Federal judges are required to examine and approve proposed SEC settlements to determine if they are “fair, reasonable and adequate within the limitations Congress has imposed on the SEC to recover investor losses.” Until recently, judges have rarely objected to settlements in their reviews.
“Perhaps we live in a different era,” Marrero stated in his order.” “In this age when the notion labeled ‘too big to fail’ (or jail, as the case may be) has gained currency throughout commercial markets, some cynics read the concept as code words… encourag(ing)… a free pass to evade or ignore the rules, a wink and a nod as cover for grand fraud, a license to deceive unsuspecting customers.”
“Perhaps, too, in these modern times, new financial, industrial, and legal patterns… call for enhanced regulatory and, as appropriate, judicial oversight to counter these sinister attitudes,” he continued.
Case now hinges on appellate review of rejected Citigroup settlement
Marrero is not the first judge to cast doubt on the use of the “admit or deny” provision in SEC settlements. His order cites three other cases in which judges have questioned the settlement practice. Two years ago, US District Judge Jed S. Rakoff, in Manhattan, rejected a $285 million SEC settlement with Citigroup over charges the global banking giant defrauded investors in a $1 billion portfolio of mortgage-backed securities.
Rakoff blasted the proposed settlement as “pocket change” and called it “neither fair, nor reasonable, nor adequate, nor in the public interest.” He stated that allowing Citigroup to neither admit nor deny guilt left him with no way to determine if the settlement was appropriate.
“When a public agency asks a court to become its partner in enforcement… the court, and the public, need some knowledge of what the underlying facts are,” Rakoff wrote in a November 2011 ruling. “Otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.”
The SEC and Citigroup have appealed Rakoff’s rejection, and the case is currently being considered by the Second Circuit Court of Appeals in New York. In hearings last year, a three-judge panel of the Court rebuked Rakoff for overstepping his bounds, saying “it was not… the proper function of federal courts to dictate policy to executive administrative agencies.”
A final ruling is still pending in the Citigroup appeal. The SEC’s settlement with SAC Capital will not be finalized until the Second Circuit’s decision.
SAC settlement comes amid ongoing insider trading crackdown
The $602 million settlement that now hangs in the balance is only the latest chapter in the wider and long-running SAC Capital insider trading saga. Besides Martoma, eight other current or former SAC employees have been charged with insider trading violations. Four have pled guilty. The latest arrest of a SAC Capital employee came just three weeks ago, when a senior portfolio manager was taken into FBI custody in Manhattan.
The SAC Capital case is part of an interagency crackdown on insider trading that began in late 2009 with an FBI initiative known as “Operation Perfect Hedge.”
Since then, the FBI, SEC and US Attorney’s Office for the Southern District of New York have focused resources on bringing insider trading cases, making more than 75 arrests in the past two and a half years. Last year, the FBI stated that informants have provided enough evidence for the agency to continue prosecutions for the next five years.