Thursday, February 7, 2008

What's the Difference Between Criminal and Civil Insider Trading Cases?

That's an easy question: with one you pay out money (and take an injunction prohibiting future violations) while the other sends you to jail.  But two insider trading cases this week raise the issue of why some go criminal while others remain only as civil enforcement actions.  The SEC announced on February 5, 2008, the filing of a settled insider trading complaint against a former director of Dow Jones, David Li, who tipped a close friend about a potential offer by News Corp. for the owner of the Wall Street Journal and other publications.  According to the Commission's Litigation Release (here):

On May 8, 2007, the Commission filed an emergency action in the United States District Court for the Southern District of New York against Kan King Wong ("K.K. Wong") and Charlotte Ka On Wong Leung ("Charlotte Wong"), alleging that the husband-wife couple traded Dow Jones securities based on inside information. Specifically, the Wongs purchased approximately $15 million worth of Dow Jones securities in their account at Merrill Lynch and, after the Offer became public, made approximately $8.1 million in trading profits. The court entered a Temporary Restraining Order freezing those assets and imposing other relief. See LR-20106 (May 8, 2007). Today the Commission filed an amended complaint alleging that Dow Jones board member David Li tipped his close friend, Michael Leung Kai Hung ("Michael Leung"), before the Offer's public disclosure, and Michael Leung, with the Wongs' assistance, traded Dow Jones stock in their Merrill Lynch account. The Commission further alleged that K.K. Wong bought 2,000 Dow Jones shares in his TD-Ameritrade account and made approximately $40,000 in profits. Charlotte Wong is Michael Leung's daughter, and K.K. Wong is his son-in-law.

Li is quite prominent in the Hong Kong business community, serving as the CEO of Bank of East Asia and as a member of Hong Kong's Legislative Counsel and Executive Committee.  This was not a small case as Mr. Li paid a civil penalty of $8.1 million and Michael Leung, the main trader, disgorged $8.1 million and paid a one-time penalty of the same amount, so that total from the case was over $24 million.  There is no indication that any criminal charges will be brought because of the trading, which involved the purchase of over 400,000 Dow Jones shares through a third party's account to hide the identity of the actual purchaser.  Of course, there is a chance that a sealed indictment was returned and prosecutors could be seeking to arrest either David Li or Michael Leung if they return to the United States, but it does not sound like that's the case given the civil settlement.

Meanwhile, on February 4, 2008, the U.S. Attorney's Office for the Southern District of New York announced that a jury convicted Hafiz Naseem of twenty-eight counts of insider trading and one count of conspiracy based on tipping a Pakistani banker, Ajaz Rahim, about impending deals that he learned about while working at J.P. Morgan and then Credit Suisse.  According to a press release (here):

Credit Suisse was engaged to advise either the target company or the acquiring entity in connection with business combination transactions involving the Issuers (the "Subject Transactions"). NASEEM, who was not assigned to work on any of the Subject Transactions, repeatedly searched Credit Suisseā€™s internal computer databases for confidential documents relating to the Subject Transactions, opened and read these documents, and passed the material non-public information concerning the Subject Transactions in these documents to RAHIM (the "Credit Suisse Inside Information"). NASEEM also was observed rummaging through papers on the desks of several analysts when the analysts were not present.

Naseem is not a U.S. citizen, and after the conviction the court revoked his bail and he was remanded into custody, most likely because he was a flight risk.  The total profits realized from the various tips was $7.9 million, the bulk of it from trading in TXU call options.   Under the Federal Sentencing Guidelines, Naseem is looking at a sentencing range of at least 78-97 months based only on the gain before any other enhancements that could easily take him up to a ten-year prison term.

While there are some differences between the two cases, there are many similarities, so it's not clear to me why one is criminal and the other only civil.  The loss amount is the roughly the same in each, and the violation of a fiduciary duty is clear for both tippers.  Each involved trading overseas, a particular problem that can threaten the integrity of the U.S. securities markets.  While Naseem was involved in a systematic course of conduct, Li was a director of a major corporation tipping a close friend.  The trading by the tippees was similar in the sense that each tried to hide his true identity, and substantial profits were made. 

Could it be that the decision was influenced by the fact that Li and Leung are prominent businessmen while Naseem is a lower-level investment bank employee who tipped a less-prominent Pakistani banker?  While it may be a consideration that Li and Leung might not be extraditable to the U.S., the U.S. Attorney's Office did indict Rahim despite the fact that it has not yet been able to get him into this country yet to face charges.  It may just have been the timing of the discovery, because Naseem was nabbed around the same time that the U.S. Attorney's Office was cracking down on others on Wall Street engaged in insider trading -- he was in the wrong place at the wrong time.  There may also be considerations about the strength of the government's evidence relating to Li and Leung that influenced the decision not to pursue criminal charges.  While the SEC complaint (here) presents the case in stark terms that makes it appear to be a straightforward insider trading case, the Commission does not have to test its evidence in court, and may only have a circumstantial case that the defendants were willing to settle so long as no criminal charges were filed.  But from the outside, at least, it is difficult to distinguish between them, and raises the question about what the appropriate criteria are for determining whether a criminal prosecution is used in addition to the civil enforcement mechanism.  That it could just be who wins or loses the criminal prosecution lottery is not very comforting. (ph) 

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Civil Enforcement, Insider Trading, Prosecutions | Permalink

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Comments

Very interesting.

Certainly seems like there is favoritism involved, as you suggest. Or maybe it is as simple as one guy being "in the wrong place at the wrong time."

Thanks for writing such a well-thought-out post.

Posted by: A.J. Option Trading | Oct 11, 2008 8:50:25 AM

I am going to jail for insider trading. Did I lose a lottery? Was my crime worse than any one elses? Why not a big fine and an industry ban. Please don't tell me its just luck. I cant live with that!

Posted by: anon | Oct 16, 2008 6:18:21 PM

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