March 21, 2011, 3:06 pm Legal/Regulatory | White Collar Watch
Behind Galleon Figure’s Court Challenge to S.E.C.
By PETER J. HENNING
Eric Piermont/Agence France-Presse — Getty Images
Rajat K. Gupta.It is extraordinary that someone would sue the Securities and Exchange Commission, contending that he should have been accused of insider trading in federal court. But that is exactly what Rajat K. Gupta, a former board member at Goldman Sachs and Procter & Gamble, has done in seeking to stop an S.E.C. administrative case that alleges he tipped off Raj Rajaratnam about inside information at both companies.
Mr. Gupta filed a lawsuit in Federal District Court in Manhattan on Friday, asking for an injunction preventing the S.E.C. from pursuing insider trading charges before an administrative law judge. The case against Mr. Gupta is the first in which the S.E.C. took advantage of a provision in the Dodd-Frank Act that allows for civil penalties and disgorgement for a securities violation in an administrative proceeding. Those remedies previously were available only in federal court cases unless the defendant was a broker or investment adviser.
The issue is whether Congress intended to limit the S.E.C.’s use of this new avenue for imposing penalties to securities violations occurring after the Dodd-Frank Act went into effect on July 22, 2010, or whether prior misconduct could be the basis of an administrative filing so long as the case started after that date.
Ex-Goldman Director Sues S.E.C. Over Galleon Case
.The only statement in the law on the timing of its effectiveness is that it “shall take effect after the date of enactment of this act.” Not surprisingly, judicial decisions on retroactive application of civil statutes are not entirely clear, so the outcome of Mr. Gupta’s claim is up in the air.
An interesting potential wrinkle in the case is which federal judge will be assigned the matter. Under the court’s rules, the lawsuit will first be reviewed by the judge assigned to the S.E.C.’s civil insider trading case against Mr. Rajaratnam to determine whether it is “related” to those cases. That is none other than Judge Jed S. Rakoff, who has proven to be a bit of a thorn in the side of the S.E.C. in other cases, like the settlement with Bank of America over the Merrill Lynch acquisition.
Judge Rakoff is not required to accept the case, but up to this point all of the civil insider trading cases filed in connection with trading by Mr. Rajaratnam and his hedge fund, the Galleon Group, have been designated as related and assigned to the judge. At a recent hearing in another insider trading case connected to the Galleon Group, Judge Rakoff said the decision to pursue the charges against Mr. Gupta before an administrative judge struck him as “sort of bizarre,” according to Bloomberg News. That may be an ominous sign for the S.E.C. if the challenge ends up in his courtroom.
Fred R. Conrad/The New York Times
Judge Jed S. RakoffIf the case against Mr. Gupta had involved criminal charges, then the ex post facto clause of the Constitution would prevent retroactive application of a law that imposed new rules after the conduct at issue occurred. But the S.E.C.’s case is clearly civil, even though it seeks a monetary penalty.
Courts generally look to the label applied to any liability imposed by the statute in determining whether it is a criminal punishment or just a civil remedy. Insider trading penalties and disgorgement are viewed as civil, so Mr. Gupta must rely on more general principles of statutory construction and due process that limit the application of new laws to prior conduct unless Congress makes clear that the new rule should be applied retroactively.
The leading case in this area is Landgraf v. USI Film Products, a sexual harassment suit that involved the issue of whether a change in the law authorizing a jury trial in such cases should be applied even though the violation occurred before enactment of the provision. The Supreme Court referred to the general presumption against retroactive application of laws unless Congress clearly wants the new rule applied to earlier cases. There is nothing in the Dodd-Frank Act about allowing the S.E.C. to pursue administrative cases for conduct prior to July 22, 2010, which works in Mr. Gupta’s favor.
But the Supreme Court also noted this presumption would not necessarily apply to every change in the law, so that “the court must ask whether the new provision attaches new legal consequences to events completed before its enactment.”
Exactly what impact the Dodd-Frank Act had on Mr. Gupta’s rights will be the key to the retroactivity issue. The S.E.C. can point to language in the Landgraf opinion in which the Supreme Court explained that “changes in procedural rules may often be applied in suits arising before their enactment without raising concerns about retroactivity.”
The S.E.C. is likely to argue that expanding its authority to pursue a civil penalty and disgorgement before an administrative judge is merely a “procedural” change that does not affect the substance of the securities laws. In addition, even before the Dodd-Frank Act, it could have sought a cease-and-desist order against Mr. Gupta in an administrative proceeding for violating the securities laws, even though it could not obtain any penalty, so adding to the available remedies did not alter any rights he might have had.
Mr. Gupta’s lawsuit points out the significant changes affected by the Dodd-Frank Act’s authorization to pursue securities violations in administrative proceedings, perhaps most importantly denying him the right to have a jury decide his liability for the suspected insider trading violations if the case had been filed in federal court. The presumption is against retroactive application of a new law, so having the case decided by an administrative judge and then reviewed by the S.E.C. itself could be viewed as impairing “rights a party possessed when he acted.”
Not surprisingly, the law in this area is murky at best. Each side can point to language in Landgraf that support the conclusion that the provision should, or should not, be read to allow the S.E.C. to pursue an administrative hearing on whether Mr. Gupta’s tipped off Mr. Rajaratnam.
If Judge Rakoff accepts the case, we can certainly expect him to demand an expeditious resolution of the issue, much as he has done in the past when overseeing S.E.C. litigation by setting short deadlines and quick trial dates. Regardless of the outcome, Mr. Gupta’s lawsuit highlights how aggressively he intends to fight the S.E.C.’s charges.