Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, September 30, 2010

Second Circuit Finds Judge Rakoff Exceeded Discretion in Galleon Insider Trading Case

In a setback for the SEC, the Second Circuit, in SEC v. Rajaratnam (Download Secvgalleon2Cir ), reversed Judge Rakoff's discovery order that compelled defendants to disclose to the SEC wiretapped conversations provided to defendants by the federal prosecutor in a related criminal action for use in the civil enforcement action.  The Second Circuit held that, while federal law did not absolutely prohibit the disclosure of the wiretap conversations, the trial court must balance the right of access to the materials against the privacy interests at stake.  The court determined that the district court clearly exceeded its discretion in ordering disclosure of thousands of conversations involving hundreds of parties, prior to any ruling on the legality of the wiretaps and without limiting the disclosure to relevant conversations.

Both the criminal action and the SEC enforcement action (which are before different judges in the S.D.N.Y.) revolve around the same allegations: that defendants engaged in widespread and repeated insider trading at several hedge funds.  The criminal investigation included court-ordered wiretapping of conversations which were turned over to the defendants as part of criminal discovery.  The federal prosecutor did not share the information with the SEC; the agency instead sought access through discovery in the SEC enforcement action.

The appellate court made clear that where the civil defendant has properly received the materials from the government, the SEC has a presumptive right to discovery of the materials based on the civil discovery principle of equal information.  It went on, however, to state that the right of access does not outweigh any and all privacy interests at issue.  A balancing is required for a district court reasonably to exercise its discretion.  The court found that the SEC's right of access is significant, but the privacy interests in this case were real, since the disclosure order implicated thousands of conversations with hundreds of individuals.  Accordingly, the district court exceeded its discretion because (1) disclosure was ordered prior to any ruling on the legality of the wiretaps, and (2) disclosure was not limited to relevant conversations.

In particular, the appellate court noted that "the more prudent course in the instant case may have been to adjourn the civil trial until after the criminal trial."  In that case, the most relevant wiretapped conversations might have been publicly disclosed at trial, and the SEC would be able to use the materials in the civil proceeding without implicating any privacy concerns.  "Apparently, all the parties agreed to such a request, yet the district court declined to grant it."

Judge Rakoff is known as a take-charge kind of judge -- remember his disapproval of the first proposed settlement in SEC v. Bank of America.  Here the Second Circuit clearly felt he had gone too far and did not take into account the complexities presented by concurrent civil and criminal proceedings.

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