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 significant actions.
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 administrative proceeding.
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.