Under What Circumstances Does the SEC Typically Refer Insider Trading Cases to the Department of Justice for Criminal Investigation?

It depends.  There are no hard and fast rules governing when a SEC investigation is referred to the Department of Justice (DOJ) for criminal investigation and, potentially, prosecution.  There are, however, a number of factors the SEC considers in its decision-making process.  As I am routinely asked this question by my clients under SEC investigation for possible insider trading, and given that I approach the defense of SEC insider trading investigations with these factors in mind, I thought it made sense to address this topic.

It should be made clear at the outset that a majority of SEC insider trading investigations never get referred to the DOJ, whether settled or even litigated.  There are, though, exceptions.  Usually, those cases share some or all of the characteristics identified below.

What Factors Does the SEC Consider in Referring an Insider Trading Investigation to DOJ?

• Fiduciaries and Gate Keepers: 

The DOJ takes the breach of fiduciary duty extremely seriously.  This applies to corporate insiders (CEOs, etc.) who owe a fiduciary duty to the corporation and its shareholders not to disclose, trade upon or tip others concerning, the material nonpublic information (MNPI) (like earnings results or a merger or acquisition).  This equally applies to professionals who are entrusted with MNPI (like lawyers, accountants and investment bankers) who owe a fiduciary duty to their client (the publicly traded corporation) and who cannot use this information for personal gain.  Given the tremendous trust shareholders and the financial markets place in these actors to uphold their fiduciary duties, and the critical importance of them doing so to ensure market integrity, a breach is considered a serious violation that will often attract the DOJ’s interest.  Such prosecutions are driven by the Government’s need to create deterrence, to punish the offending actors, and to ensure individual accountability.

By way of example, in a criminal insider trading indictment of a publicly traded health care corporation CEO, the U.S. Attorney for the Central District of California publicly stated: “Mr. Peizer is accused of using his insider knowledge as CEO of a publicly traded company to line his own pockets in violation of his duty to his company and its shareholders.” “Mr. Peizer allegedly exploited material nonpublic information and tried to shield himself with a rule designed to ensure a fair and level playing field for all investors. With this indictment, we again affirm that the law applies equally to all and that corporate executives who unlawfully denigrate the integrity of our financial markets will be held accountable.”

• Compelling, Persuasive and Clear Evidence of Guilt: 

In situations where the evidence proving illegal insider trading is compelling, persuasive, and clear, there is a heightened risk that the DOJ will intervene.  Such evidence may consist of tape recordings, utilization of short-term, substantially out-of-the money options, incriminating emails or text messages, and/or testimony of cooperating witnesses who were involved in the illegal trading. The DOJ needs such evidence to prove its case, particularly the elements of intent and willfulness, as its burden of proof is beyond a reasonable doubt, a much higher evidentiary standard than the SEC’s burden in a civil insider trading action, which is by a preponderance of the evidence.  It is the lack of clear and compelling evidence of guilt that often impedes an SEC referral, as many SEC insider trading cases rest exclusively upon mere circumstantial evidence.

• A Pattern of Repeated Insider Trading Over Time: 

Where there exists a demonstrable pattern of repeated instances of illegal insider trades over a period of time, this significantly increases the risk of a referral by the SEC to the DOJ.  This is true for three reasons.  First, it evidences, from the Government’s perspective, an abuse of the market, where an individual, either alone or in concert with others, is systemically taking advantage of those traders who do not possess MNPI and thus are being defrauded by trading with the counterparty that does.  Second, it may indicate that the target trader is not acting alone and may be working with others, like a ring, where there is a sophisticated, coordinated effort to obtain MNPI, disseminate it, trade upon it and then profit from it, with the spoils divided amongst the operators after-the-fact.  Third, from an evidentiary proof standpoint, it is much harder for a defendant to try to credibly explain away multiple, highly suspicious and circumstantial trades, as opposed to a one-off trade where a plausibly innocent, legitimate reason can be offered for the transaction.

• Big Trading Profits: 

While the SEC routinely pursues insider trading inquiries involving minimal profits or losses avoided (in some cases a few thousand dollars), that is not the norm for the DOJ.  While no firm rule exists, the DOJ is usually interested in those cases involving significant trading profits in at least the high six figures and more often in excess of $1 million.  Why?  The answer is limited resources.  The DOJ simply does not have the manpower to pursue every insider trading lead referred to it and thus must adhere to certain internal benchmarks when assessing whether, and how, to utilize its assets.  All factors being equal, a case that involves millions in profits will get the resources as opposed to a minimal gain, which will typically be handled exclusively by the SEC.

• Sophisticated Means: 

Insider trading that involves sophisticated and complex means often catches the DOJ’s eye.  Examples include, but are not limited to: (1) computer hacking to either access MNPI from company databases and/or to hijack retail securities customer accounts to trade, (2) use of encrypted digital communications or burner phones, (3) utilization of multiple offshore, opaque brokerage accounts, or accounts in the name of others, and (4) communications using code words or hard to decipher messages.  These facts, which are often seen in big dollar profit insider trading cases, will heighten the risk of a DOJ referral, and will also potentially increase the criminal exposure of the trader if convicted.

A good example is U.S. v. Rajaratnam, which involved the criminal prosecution of a major hedge fund owner who perpetrated one of the single largest insider trading frauds in U.S. history.  In that case the sophisticated means included a network of insiders at several publicly traded corporations who provided a consistent stream of MNPI, efforts to conceal (like coded emails and fabricated documents), and global interconnected players, which made the investigation and prosecution of the crimes more difficult to detect.

• Cover Up After-the-Fact: 

As it is said, “the cover-up is worse than the crime.”  That holds equally true for potential DOJ interest in an insider trading case.  Recall that Martha Stewart did not go to prison for engaging in illegal insider trading but rather did five months in the slammer for conspiracy, obstruction of justice and making false statements to federal agents about her trading in ImClone Systems stock after-the-fact.  The DOJ, as is true with the SEC, does not take well to those under investigation who try to stymie their efforts, obstruct the administration of justice, or lie to its investigators.  This is a cautionary tale to those who are under SEC investigation to avoid taking steps that could even potentially be viewed as obstructive or designed to conceal, lest they unwittingly invite DOJ scrutiny.

• High-Profile/Celebrity Targets: 

While it should not be the case, it is true that the involvement of high-profile individuals, including celebrities, may increase the odds the DOJ will join the investigatory party.  The reasons may range from a prosecutor that seeks to make a name for himself, to the fact the press has already picked up the story and pressure is thus placed on the DOJ to act, to there exists credible and persuasive evidence that the high-profile target, in fact, engaged in illegal insider trading.  While not set in stone, and armed with this practical knowledge, I am always extra cautious when representing high-profile, well known clients.

• Recidivists:

Finally, the SEC loves to refer those who previously violated the federal securities laws to the DOJ for investigation and, if appropriate, prosecution.  The SEC’s reasoning: they violated the federal securities laws once before and, apparently undeterred by the prior SEC civil action and its attendant penalties, repeated their  fraudulent conduct again.  It is all about deterrence and sending the strong message that if you show no respect for the law, and in particular the SEC injunction prohibiting you from future securities laws violations, you deserve to be criminally prosecuted and incarcerated.  It need not be a second insider trading violation to generate the referral, but if it is, there is thus more reason for concern.

Why Hire David Chase as SEC defense counsel if you are under investigation for insider trading?

David Chase is a former SEC Enforcement Attorney who investigated and prosecuted insider trading cases.  He therefore understands how the SEC identifies, investigates and prosecutes insider trading.  Using this insider perspective, he strategically defends his clients with the objective of avoiding charges.  David is also an Adjunct Professor of Law at the University of Miami School of Law where he teaches a course on SEC investigations, including insider trading.  He has been recognized as an outstanding securities lawyer in his field by Chambers & Partners and Super Lawyers, has numerous, highly positive reviews from his former clients, has been widely quoted in the media, including the Wall Street Journal, interviewed on Bloomberg Television on SEC matters and has extensively written on insider trading.

Contact SEC Insider Trading Defense Lawyer David Chase

If you have just been contacted by the SEC or received a subpoena, contact David now for a confidential, no cost consultation at: 800-760-0912 or e-mail him at: david@davidchaselaw.com.  To read about David’s SEC defense experience, and the firm’s recent successful insider trading results, please visit the firm’s website at: www.securitiesfrauddefense.net.