Recent Items

Why is the SEC Willing to Get Aggressive and Creative With Big Names Only on Insider Trading Cases?

Posted on by

I suppose we poor suffering ordinary citizens should be pleased to see any prosecutions directed at those at the top of the food chain. The Wall Street Journal reports that the former head of McKinsey, Rajat Gupta, is facing criminal charges in the Galleon insider trading case. It’s such a rare event for a business figure of the stature of Gutpa to be charged (he was on the boards of Goldman and the Gates Foundation) that it is now the lead story on the New York Times front page.

But that is what is wrong with this picture. Given the level of criminality in the top echelons in the US, we should see a lot more in the way of prosecutions. And the Wall Street Journal contends that the case against Gupta would break new ground, since he did not profit in any direct manner from his tips:

The expected charges against Mr. Gupta are likely to reveal that the government believes that insider trading doesn’t always involve swapping information for money. Mr. Gupta isn’t alleged to have received any money or direct benefits from Mr. Rajaratnam in exchange for corporate secrets, a potential weakness in the prosecutors’ case Mr. Gupta’s lawyer is likely to seize on.

The government is expected, however, to argue that the relationship between the two men, who socialized and invested together, is emblematic of the back-scratching that pervades the corporate world and can sometimes veer into insider trading.

Note the New York Times differs a tad:

While there has been no indication yet that Mr. Gupta profited directly from the information he passed to Mr. Rajaratnam, securities laws prohibit company insiders from divulging corporate secrets to those who then profit from them.

Regardless of whether the legal argument is a bit aggressive or not, notice that the SEC is moving boldly on these cases when it has sorely neglected other beats. Let’s face it: insider trading cases are comparatively easy to prove, and the SEC likes to go after low hanging fruit.

Many people, including your humble blogger, have criticized the SEC for doing close to nothing as far as attacking abuses in mortgage securitizations and CDOs. We’ve also argued that they dropped a promising avenue for getting criminal (stress criminal) prosecutions of Wall Street executives by an apparent misreading of a ruling in their case against Angelo Mozilo.

But as much as the SEC’s timidity and learned incompetence is frustrating, it is not entirely the agency’s fault. It has been repeatedly hounded by Congress at least as early as the Clinton era, when the agency was interested merely in protecting consumers. How exactly do you think Congresscritters would react if SEC actions regularly implicated the banks that are among their biggest meal tickets? Since Congress controls the SEC’s budget, it can and has hamstrung the SEC. An occasional action to preserve the agency’s image might be tolerated, but anything beyond that is certain to lead to retaliation.

I don’t know if the SEC can ever be restored to being the respected and feared body it was in the 1970s and early 1980s. I’d have said impossible, but recall that the Commie-bashing 1950s were followed by the big social changes of the 1960s. We may be in the early stages of a similar large change in the zeitgeist, which means major changes in institutional behavior could occur down the road.

Update 3:10 PM: Aargh, the perils of AM drafting when I am a little too keen to turn in. Reader LucyLulu correctly points out that I failed to mention that only the DOJ can file criminal cases. As I stated in comments I should have included material from the older post I linked to that that there is a VERY clear path under Sarbanes Oxley from civil to criminal cases. If you win certain types of civil Sarbox cases, the criminal case follows virtually directly. And the area in which Wall Street is vulnerable is that Sarbox requires certain executives to certify the adequacy of internal controls, which for Wall Street can easily be argued to include risk management. We’ve written as to how obviously defective and politically compromised risk management is at major banks. You have further issues at some firms. For instance I’ve been told that Lehman didn’t even know how many open derivatives positions it had at the time of its collapse. They ran on multiple systems (with “multiple” being a large number, not two or three) with no effective structure over them for aggregation. If this is true, it’s a stunning lapse. It would be easy, indeed, predictable, for large mistakes to occur.

So the bit of the argument omitted was that the SEC could have filed more Sarbox cases and then relied their visibility to pave the way for the related criminal case. The SEC seems to have started down that path, and in the post we linked to, it appears to have been deterred by a ruling (with no explanation) from the judge, which we read as having far more narrow implication that the SEC appears to think it had.

Print Friendly
Twitter14DiggReddit0StumbleUpon0Facebook2LinkedIn1Google+0bufferEmail

30 comments

  1. LucyLulu

    Just want to clarify for readers that the SEC can not themselves bring criminal charges, only civil. They can however team up with either state or federal prosecutors to bring a criminal case.

    1. Yves Smith Post author

      Whoops, that is a key omission. I should have included material from my older post that there is a VERY clear path under Sarbanes Oxley from civil to criminal cases. If you win certain types of civil Sarbox cases, the criminal case follows virtually directly. And the area in which Wall Street is vulnerable is that Sarbox requires the CEO and IIRC the CFO to certify the adequacy of internal controls, which for Wall Street included risk management. We’ve written as to how obviously defective and politically compromised risk management is at major banks. You have further issues at some firms. For instance I’ve been told that Lehman didn’t even know how many open derivatives positions it had at the time of its collapse. They ran on multiple systems (with “multiple” being a large number, not two or three) with no effective structure over them for aggregation. If this is true, it’s a stunning lapse. It would be easy, indeed, predictable, for large mistakes to occur.

      So the bit of the argument omitted was that the SEC could have filed more Sarbox cases and then relied their visibility to pave the way for the related criminal case. The SEC seems to have started down that path, and in the post we linked to, it appears to have been deterred by a ruling (with no explanation) from the judge, which we read as having far more narrow implication that the SEC appears to think it had.

      1. LucyLulu

        Let me see if I understand this? Can the SEC file the criminal Sarbanes-Oxley charges themselves or must they still rely on judicial to file them? My understanding was that the SEC as a regulatory agency had no standing to file criminal charges.

        My understanding is that even in the case of fraud, there is no difference between civil and criminal other than the burden of proof required (which I may have read on your blog).

        Lulu, qui m’aime aime mon chien.

  2. sleeper

    I’m gonna say it -

    What better poster boy for financial duplicity than a dark skinned foriegner ?

    Did he do it ? Who knows ? But this stinks !!!

    1. skippy

      And well you should! Oldest trick in the book, chuck out the cabana boy into the crowd and point fingers.

      Hell just to make it fair…they should pick out one *poster boy* from each ethnicity and flay them proper to the_crowds_delight.

      Skippy…you just can find club boys that will_fall on the sword_like you used too…whats this world coming too…eh.

      1. tyaresun

        To be fair, this thing started with the FBI suspecting Rajaratnam for giving money to the Tamil tigers in Sri Lanka. Hence the dark skinned folks.

        1. skippy

          Oh boy! If you send a letter home with birthday money in it, your supplying one side in a ethnic / tribal conflict…snicker.

          Skippy… Tamils were getting rubbed out, even in their own back yard, in the end both sides commuted atrocities.

    2. bluntobj

      I vote this. When it comes to determining the sacrificial victim to chuck to the hounds, it’s easier to toss a consultant with less power and influence.

      1. Yves Smith Post author

        Gupta is very high profile and connected. I never met him, but McKinsey had a mafia of Indian Institute of Technology grads (it’s their Harvard and MIT rolled into one) who had then gotten graduate degrees in the US (usually Harvard MBAs).

        The McKinsey crowd was very classy. They usually had upper case Commonwealth accents, which to American ears sounded British. A British accent is worth 20 attributed IQ points. And many did the mandarin/guru routine (think an intellectual version of Ricardo Mantalban) which is particularly seductive.

        But not only is Gupta not of the iconic WASP-y CEO mold, he is also currently NOT heading a big organization, and even when he was in his prime of power, not a TBTF bank. Goldman in this case was a victim, not a perp.

  3. rjs

    Why is the SEC Willing to Get Aggressive and Creative With Big Names Only on Insider Trading Cases?

    seems i’ve read a about their budget getting cut, or not funded, post dodd-frank…so with limited resouces, it’s logical to after high profile cases…

  4. Tom

    What this guy did was nothing compared to the other stuff Goldman and the rest of the big banks did. The biggest crime is how they all got propped up by the federal reserve and now, they are earning big salaries and bonuses as usual.

  5. mark

    The SEC has been timid, to be sure. But the primary responsibility for criminal prosecutions lies with the Justice Department, which has been spectacularly silent. The only thing that white collar criminals fear is criminal prosecution. A proper investigation would have elicited very powerful evidence. That responsibity lies with Eric Holder. He has betrayed his oath of office and his country by ignoring these crimes

  6. Fraud Guy- Also

    Does the SEC have a self-narrative about what it probably characterizes as “cautiousness” in pursuing strong penalties? If so, I wonder if that narrative encompasses the story of Arthur Anderson, which suffered the “corporate death penalty”. Though I think that a “corporate death penalty” needs to be served up to deserving firms from time to time to keep the system honest, many people felt that the result was fundamentally unfair because thousands of Arthur Anderson employees who had not done anything wrong lost their jobs. Being convicted corporately in wrong-doing will result in almost any financial firm going out of business. I suspect that the SEC is trying to avoid that result. Consequently, we get situations like the one a few days ago, where a dark pool trading firm paid a puny million dollar fine for front-running its clients, when it seems obvious that the appropriate penalty for such behavior should be the corporate death penalty.

  7. patrick

    The “didn’t make any money argument” didn’t work in the related case of Bob Moffat, the IBM exec caught up in the case. He apparently never made a dime, All he was apparently guilty of was passing on info during “pillow talk” with the femme fatale of this particular case. Never the less he was charged with conspiracy and plead out to save the family, etc.

    Gutpa will have deeper pockets than Moffat so he’ll give the feds a run for their money. But the impression is that the SEC/DoJ are content to hunt down the 7-11 bandits of insider trading while the bank robbers, literally, get a free pass.

  8. commiebasher

    recall that the Commie-bashing 1950s were followed by the big social changes of the 1960s…

    And what, pray tell, is wrong with commie-bashing?

  9. skinla

    This is the case of feed the barking dog something. I would say, it is once against orchestrated by crooked bankers and Obama administration just to fool public by claiming that they are cracking down on wall street crimes. The fact is real criminals are sitting around Obama and laughing. For example, if SEC, FBI or whoever else is serious they should be prosecuting Goldman Sach and people like Blankfein and fund manger John Paulson. I think it was Paulson who made billions by providing a list of bad securities to Goldman Sachs who in turn packaged and sold it to investors. On the other hand, Paulson and Goldman Sach shorted the same securities and made billions while investors lost. That is an obvious insider knowledge and a crime but it is being neglected. Instead, they are using that Indian named U.S. Attorney Preet Bharara, to destroy Indian sounding names like Raj Rajaratnam and Rajat Gupta for something that looks trivial and does not even seem to harm anyone else, certainly nowhere at the scale of damage done by bankers. Real crooks like Jamie Demon, Blankfein and others are roaming free because of their clout with corrupt Obama administration and others in the government.

  10. Ben Brandt

    Yes, how was the SEC unable to find and prosecute any ‘white’ men who have been doing this for centuries, and yet find two Indian/Indian-Americans and prosecute them very hard. This stinks. Glad I was not the only person sickened by this. I am certain that Indian/Indian-Americans noticed and will take note. The game is not over, for sure.

  11. David Rockefeller

    I too noticed the WSJ’s claiming that Gupta’s not having made money from his tips represented a weakness in the govt’s case.

    WSJ quoted Gupta’s lawyer making this claim. My first thought was if that’s Gupta’s best defense, he’s in trouble. As if helping rob a bank but not sharing in the loot means you get to skate.

  12. sgt_doom

    “..it is not entirely the agency’s fault.”

    This is soooo true, especially given the continuity of Mary Shapiro’s rule there (Clinton, and now again in Obama’s), plus how G.W. Bush (#2) reduced the Office of Risk Managment within the SEC from 100 employees to only 1.

    (Just as Bush #2 dissolved the “high roller” division of the IRS, which went after and recovered the most revenue from extremely wealthy individual and corporate tax evaders.)

    A question for Ms. Smith (or anyone else who knows):

    The American monolithic myth-media keeps claiming that Galleon was the world’s largest hedge fund, yet I have read many various reports and other articles which suggest any number of others filled that category.

    I realize the opaque nature of hedge funds (not having to register with the SEC, etc.) but how accurate is that, after all?

  13. Jmd

    When I saw the headline in the NYT I was so excited, I figured it was Stevie Cohen. Just a matter of time folks…

  14. Lyle

    ON the criminal issue and Sarb Ox, The law has not yet been interpreted by the courts, so justice would have to feel very confident that they could prove their case beyond a reasonable doubt to go with it. Say on the issue of inadequate internal controls: The execs would have a statement by their independent (??) auditor saying that the controls were ok, so you would have to show that the execs pulled the wool over the auditors eyes as a part of the case.
    But the bigger issues is how does one define inadequate? As with many laws the terms need to be made air tight and it takes court decisions to do that which take time. On insider trading there has been 80 years of court decisions defining the terms involved, thus it is easier to prosecute.

  15. Fiver

    Hoops (above) and a couple others have it correct. This is the tried-and-true “bad apple” approach wherein the public is tossed a bone or two, but NEVER someone with real clout. These guys’ antics pale into trifles relative to the heavy criminal lifting/looting of the likes of Blankfein, Dimon, Friedman, Dudley, Geithner, Bernanke, both Paulsons, Dodd, his Rep opposite numbers, and so many, many more who are able to trade on both private and public “priveleged access” information. One thing that could be done by this Admin right now, while Wall Street is front and centre, is to rescind the right of anyone in Congress to own stocks or other financial instruments in companies or other entities he/she either has oversight for or are subject to legislation pending.

    Inside trading is so rampant, so blatant that many sites now post charts showing exactly where and when odiferous trades took place with a given stock. Several routinely forward info to SEC, OTCC and others, but never, ever hear back.

  16. Yata

    The whole affair is a non-starter and brings to mind Lloyd Blankfein’s testimony in the Rajaratnam trial, where he remains essentially blasé during testimony until he is asked about a wiretap conversation and then states: “He broke the rules”…Striking, isn’t it? when juxtaposed to the ease with which the large financial firms can have rules tailored to suit any current market endeavor, Raj on the other hand was clearly not under any illusions as to how the market was played, only the odd man out when it came time to break out the wiretap and investigative gear, you know, just to make sure the stuff still worked.

    Through the whole affair the pronouncement during sentencing by Danielle Chiesi “I brought disrepute to what is an honorable profession.” brings about an over-the-top respite to the mind numbing regulatory capture.

  17. AndyC

    Another Raj, another nobody in the greater scheme of things, another fall guy.

    A connection at Goldman may make him a somebody to the rest of us but if he’s a nobody at Goldman he’s still a nobody

    1. Lyle

      Except that this guy used to be the head of McKinsey the Uber consultant of the world, on how to run a corporation. This sort of shows that the ethics at that organization are no better than anywhere else.

  18. vlade

    A year or so ago, I was present at a talk by an ex Rep. Kennedy. One of the questions he was asked was why no-one was prosecuted, and what was his views on it. His response was “we cannot prosecute, there’s no law we could use”.

    I couldn’t help but to point out to Sarbox, which seemed to take him entirely by surprise (hey, how can CEO/CFO of Lehman sign accounts only to find short time after 100+bln is missing? Isn’t that on par with Enron at least?)

    There should have been a number of Sarbox prosecutions (indeed, there should have been indicements under Sarbox even for non-US banks listed in US, RBS comes to mind straight away – and, given the previous record/precedent of extradiction of UK businessmen to US for non-UK crimes, I wonder how that would work with the UK govt…), and to this moment no-one explained to me why there are none.
    What is the statue of limitation for Sarbox?

    If Obama wanted to show OWS & co he’s at least semi serious, he would instruct GA to at least start looking at whether anyone could be prosecuted under Sarbox.

Comments are closed.