Fairness, and the appearance of fairness, is critical for regulators and law enforcement officials. This helps foster respect for the law which in turn encourages cooperation with enforcement officials and compliance. In contrast, actions which are unfair, or appear to be, can seriously undermine the effectiveness of law enforcement officials.
The question of fundamental fairness is at the center of the recent decision by Judge Rakoff to deny a motion to dismiss filed by the SEC in Gupta v. SEC, Civil Action No. 11 Civ 1900 (S.D.N.Y. Ruling dated July 11, 2011). The court concluded that Mr. Gupta had raised an issue of equal protection under the Constitution which states a viable claim.
The suit was brought by Rajat Gupta, the former Goldman Sachs director who is a Respondent in a Commission administrative proceeding accusing him of insider trading. He was also a witness at the trial of Raji Rajaarathnam. In the Matter of Rajart Gupta, Adm. Proc. File No. 3-14279 (March 1, 2011). In his complaint Mr. Gupta claims, among other things, that he has been denied his right to equal protection under the law as guaranteed by the U.S. Constitution. The claim has two key facets. First, every other Galleon related defendant accused of insider trading has been named as a defendant in a case filed in Federal District Court. He is the only person named as a Respondent in an SEC administrative proceeding. Second, the SEC wants to retroactively apply the provisions of Dodd-Frank, passed after the acts alleged in the complaint, to impose a civil penalty which could not have been ordered at the time of the alleged wrongful conduct.
As Judge Rakoff takes pains to point out in his opinion, normally claims for selective prosecution or bad faith prosecution are dismissed. It is clear that law enforcement agencies such as the SEC have broad prosecutorial discretion which vests them with the right to configure the charges and select an appropriate forum. Typically that discretion will not be second guessed by the courts. This is as it should be.
Nice legal arguments were made by the SEC suggesting the case should be dismissed. Those center on claims related to procedure, immunity or wrong forum. None have anything to do with the merits. Judge Rakoff carefully analyzed each. In his opinion he rejected each one. The court did narrow the claims to center on one involving equal protection.
Whether the Commission ultimately prevails in this case is a question for another day. Even if the SEC ultimately wins it will not erase the tinge of unfairness here. As the Court points out in its opinion, 28 other persons and entities accused of Galleon related insider trading have had actions brought against them in Federal Court. The allegations in those cases are substantially similar to those asserted in the administrative proceeding against Mr. Gjupta. These facts alone raise questions about the Gupta administrative proceeding.
The suggestion of unfairness is only enhanced by consideration of the types of actions typically brought in administrative proceedings and the procedural difference between that forum and Federal Court. Rarely has the SEC brought an insider trading case as an administrative proceeding. The forum of choice is, as the Galleon related cases demonstrate, Federal Court, not an SEC administrative proceeding.
The procedural differences are also significant. In Federal Court all parties can develop the pertinent facts using the extensive discovery tools available. In an administrative proceeding, in contrast, there is virtually no discovery. The SEC staff, however, will have had ample opportunity to fully develop the facts through the Commission’s extensive investigative powers prior to filing the proceeding. The Respondent has no such right or opportunity. In Federal Court the Federal Rules of Evidence carefully sift the evidence to ensure its trustworthiness and reliability. Those Rules do not apply in administrative proceedings meaning a Respondent in such a proceeding does not have the same safeguards as a defendant in Federal Court.
The request for a civil penalty against Mr. Gupta amplifies the odor of unfairness. Prior to the passage of Dodd-Frank the Commission could not seek to impose a civil penalty on a person such as Mr. Gupta in an administrative forum. Nothing in the Dodd-Frank provision indicates it was intended to be retroactive. Indeed, provisions which enhance punishment typically can not be given retroactive effect. There is no doubt that the conduct at issue in the case against Mr. Gupta occurred prior to Dodd- Frank and that applying the new penalty provision in his case increases punishment. Again the SEC may be able to make nice legal arguments to support its claim, but it appears unfair.
Overall, by bringing the insider trading case against Mr. Gupta as an administrative proceeding the Commission looks like the gambling house that puts it thumb on the roulette wheel, tilting the role to its advantage. Good, effective law enforcement can ill afford such an appearance. This is particularly true for an agency that has struggled in recent years to restore its lost luster in the wake of a string of high profile errors and gaffs. Regardless of the outcome of the suit before Judge Rakoff, the SEC has already lost. More importantly, effective law enforcement has lost.