The Gupta insider trading case is a significant,
high profile action by an SEC Enforcement program which is working hard to
restore its lost luster. Mr. Gupta is a former Goldman Sachs director, a firm
which is an icon of Wall Street. He is a current director of Proctor and
Gamble, a company with a long and storied tradition. Previously, he was a
senior official of McKinsey and Company, a highly respected consulting company.
He is also a long time friend and business associate of Raja Rajaratnam, the
founder of the multi-billion dollar Galleon hedge funds. The SEC's new case
accusing Mr. Gupta of illegally tipping his friend has been long rumored but
not filed until the eve of Mr. Rajaratnam's criminal insider trading case.
The charges against Mr. Gupta are built on a classic
insider trading model of alleged illegal tips followed by trading. The charges
are set-forth in exquisite detail. Four separate instances of illegal tipping
are claimed (here). Repeatedly
the papers specify the date and time of a board meeting or telephone call at
which Mr. Gupta obtained information about Goldman's plans or earnings or those
of P&G. Repeatedly the date and time of the telephone calls to Mr.
Rajaratnam are specified. In some instances the time laps between the end of
the board meeting and the initiation of the call to Mr. Rajaratnam is noted.
Repeatedly the trades at Galleon in Goldman or P&G securities are detailed.
This is far more detail than appears in many SEC enforcement actions.
In bringing insider trading charges against Mr. Gupta the
SEC has clearly gone to great lengths to craft a convincing - some might say
over whelming - portrait of illegal conduct. A critical ingredient is missing
however. Virtually all SEC insider trading cases are brought in federal
district court. Not here. In bringing the action against Mr. Gupta the SEC
chose to file it as an administrative proceeding which will be heard by an
Administrative Law Judge. Why the SEC elected to deviate from its standard
practice when bringing what appears to be a significant and very strong insider
trading case is not revealed in any of the court papers, press releases or
comments of SEC officials.
Filing Gupta as an administrative proceeding raises
significant questions and may make a an important statement. All of the Galleon
related insider trading cases brought by the SEC to date have been filed in
federal court. That is the forum in which the agency can obtain its strongest
remedies, a federal court injunction and appropriate orders to implement any
other necessary relief. In contrast in an administrative proceeding the primary
remedy is a cease and desist order and directives by an ALJ. Those orders are
not "self-executing," meaning that to enforce them the administrative order
must be filed in a federal court and the Commission must ask the court to then
order the directive enforced. Accordingly, the federal court action has
traditionally been viewed as the Commission's primary forum for bringing
One possible explanation for bringing the case as an
administrative proceeding is that the evidence is not as strong as it appears.
When all the detail is parsed it is clear there is no "smoking gun" here. The
SEC does not have wire tap tapes or wired informants as in the Galleon criminal
cases. Rather, the passing of inside information in each instance is being
inferred from the surrounding facts and circumstances.
Since the allegations offer only snippets and fragments
of events it will be important for the tried of fact to view them in context
before determining if the inferences of wrongful conduct on which the
Commission's case rests can be drawn. That process might begin by analyzing all
the telephone calls between the two men. In view of the relationship between
Mr. Gupta and Mr. Rarajartman it is not hard to imagine that they spoke on the
telephone frequently and often multiple times per day, not just in the isolated
instances specified by the SEC. The link between the so-called tip - assuming
it is actually material inside information which will be another question - and
the trades as well as all the trading will have to be carefully evaluated.
Galleon employed multiple traders who bought and sold millions of shares of
securities every day. Just what evidence links whatever Mr. Rajataman learned
to the trades will be a key point to determine.
Similarly, the isolated trades detailed in the papers the
SEC filed will also have to be viewed in the contest of other trades in
Goldman, P&G and perhaps other securities made by Galleon. Likewise the
public information and rumors then available about each event as well as the
quality of the information possessed by the trader will have to be added to the
mix. And, the evidence about the credibility of the two witnesses referenced in
the Commission's papers to whom Mr. Rajaratman supposedly confirmed he had
inside information will have to be ascertained. All of this and other
information which might shed light on what if any motive a man of Mr. Gupta's
position and reputation would have for engaging in such conduct will all have
to be developed to fill out the portrait the SEC has begun to paint.
Developing these fact and others will be critical to
determining the outcome of the case. In federal court broad discovery tools
would be available to ensure the development of all the essential evidence. The
Federal Rules of Evidence would govern the admissibility of the facts so that
only trustworthy information is used as the predicate for the final judgment.
In an administrative proceeding however, discovery is
severely limited and the rules of evidence are not as rigorous as in federal
court. This means Mr. Gupta may have difficulty developing all the necessary factual
information. The SEC Enforcement Division, in contrast, will not suffer from
this limitation. It has had years to use the Commission's vast investigative
authority to develop all of the evidence needed before filing the action. If
the administrative forum was selected for its limitations in contrast to
federal court it would raise significant questions about the exercise of
prosecutorial discretion here.
At the same time the Commission may have been mindful of
some significant losses it has suffered in recent insider trading cases. Last
year it lost the high profile first ever swaps based insider trading case
following a trial in federal court in Manhattan where the Gupta case would have
been brought. In detailed and lengthy findings the court in SEC v. Rorech
(here) rejected the SEC's
efforts to draw an inference of illegal tipping from the cell phone calls,
trading and the surrounding circumstances. Likewise the in SEC v. Zachariah
(here) a Federal Judge refused
to draw an inference of illegal trading in an insider trading case after
listening to the evidence. In reaching its conclusions the court pointed to one
instance where the Commission failed to offer any facts to support its argument
and another where it misinterpreted the trading records in an effort to win a
point. These losses however should suggest the difficulty of proving insider
trading and the care which must be taken in marshalling the evidence, not that
a more favorable forum should be selected.
Finally, the new Dodd-Frank provisions permitting the SEC
to obtain civil penalties in any administrative action may have influenced the
forum selection. Prior to the passage of the Wall Street Reform Act last year
the SEC's ability to obtain a civil penalty from a Respondent in an
administrative proceeding was limited primarily to regulated entities. Under
the Act a civil monetary penalty can be imposed on any respondent in an
If Gupta signals a shift in enforcement policy under
which significant actions will now be brought as administrative proceedings
rather than in federal court it would raise even more profound questions while
making an important statement. For two years the Commission has repeatedly told
Congress and the public that the enforcement program is being retooled in the
wake of recent scandals. Repeatedly press releases have touted the "largest
reorganization" of the division in its history and the new tools being added to
its arsenal of weapons. All of this, Congress and the public have been told,
will restore the enforcement program to its glory days when it was considered
one of the most effective in government. If the outcome of all this rejuvenation
is a program which avoids bringing cases in federal court for fear of a loss or
to gain a procedural advantage in the development of the evidence, that choice
will speak volumes about those claims. It will also make a clear statement
about the future direction of SEC Enforcement.
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a
blog by Thomas Gorman.
trading is discussed in greater detail in 6 A.A. Sommer
Jr., Securities Law Techniques, Ch. 80 (Matthew Bender Rev. Ed.), "
Insider Trading Under Section 10(b) of the Securities Exchange Act," which
can be accessed online by subscribers of lexis.com. This
treatise is also available in the LexisNexis online store.
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