Jeffrey Plotkin is a partner at Day Pitney LLP in New York and Lorraine Bellard is an associate with the firm. The guest column below is the Introduction to a NY Litigator article that can be read in its entirety here.
The Securities and Exchange Commission (“SEC”), a civil agency, has statutory authority to bring suit against inside traders (tippers and tippees) in federal district court to obtain injunctive relief, disgorgement of profits gained or losses avoided plus interest, civil penalties of up to three times the amount of profits gained or losses avoided, and individual bars from acting as officers or directors of public companies. The SEC may also bring administrative proceedings to secure individual bars from association with entities regulated by the SEC.
But the trials of the inside trader do not always end with the SEC. The SEC can and often does advise the Department of Justice (“DOJ”) of its insider trading investigations, and the SEC and DOJ may conduct parallel investigations. It is not unusual for the SEC to file suit against an inside trader in federal district court on the same day the DOJ announces that it has obtained an indictment against that inside trader. The criminal penalties for insider trading may be severe depending on the circumstances of the case, including fines of up to $5,000,000 and prison sentences of up to 20 years.
Robert Khuzami, the SEC’s Director of Enforcement, at the recent joint DOJ/SEC press conference announcing the filing of parallel civil and criminal insider trading actions related to the Galleon hedge fund, stated: “Our law enforcement agencies are together much more than the sum of our parts. That is why coordination, of which today’s actions are a prime example, is critically important to the goal of rooting out fraud and misconduct in our markets.”
In determining whether to bring parallel criminal actions to SEC civil insider trading actions, Assistant United States Attorneys (“AUSAs”) are guided by the prosecution principles outlined in the DOJ’s United States Attorneys’ Manual (“Manual”). In short, it is the responsibility of the DOJ prosecutor to make “certain that the general purposes of the criminal law…are adequately [met.]” (Manual at 9-27. 110.) Under the Manual, even though a AUSA may believe that a person’s conduct constitutes a Federal offense, and the admissible evidence will probably be sufficient to obtain and sustain a conviction, the AUSA should decline prosecution of such person if: (1) “No substantial Federal interest would be served by prosecution” (Manual at 9-27.230; (2) “The person is subject to effective prosecution in another jurisdiction;” or (3) “There exists an adequate non-criminal alternative to prosecution” (Manual at 9-27.220).
In light of these considerations, AUSAs routinely exercise their discretion to decline criminal prosecution of inside traders sued by the SEC. In fact, as more fully described below, the DOJ pursued criminal cases with respect to only 65 of the 159 individuals sued by the SEC in the New York federal courts over a recent six year period. This statistic raises the question, Why? Why does the DOJ bring criminal insider trading charges against certain individuals sued by the SEC, but not others? What factors determine which civil investigations become criminal ones?
To answer this question, we analyzed the DOJ’s prosecution or non-prosecution of defendants named in SEC insider trading complaints filed in the New York federal district courts during SEC fiscal years 2004 to 2009. The analysis revealed the following, all of which should be of interest to lawyers practicing in this area: Licensed professionals (e.g., investment bankers, brokers, traders, investment advisers, attorneys, and accountants) face a very high likelihood of prosecution by the DOJ. During the relevant time period, the SEC brought insider trading cases against 69 licensed professionals, and the DOJ pursued criminal charges against 42, or sixty-one percent of these SEC defendants. The analysis also suggests that licensed professionals are substantially more likely to face criminal prosecution than officers and directors of public companies who conduct insider trading in the stocks of their companies. Our analysis showed that the DOJ brought criminal insider trading charges against only one out of every three officers or directors of public companies sued by the SEC.
The analysis also suggests that tippers face a far higher risk of criminal prosecution than do tippees or sole actors. Fifty-eight percent of the SEC defendants selected by the DOJ for prosecution tipped inside information to others, whereas thirty-six percent of defendants were mere tippees, and six percent of defendants were sole actors who did not tip anyone.
Especially large trading gains or losses avoided by the defendant do not result in criminal prosecution as frequently as one might expect. The DOJ prosecuted only slightly more than half of the defendants accused by the SEC of earning profits or avoiding losses of more than $100,000. On the other hand, defendants accused of pocketing smaller gains or avoiding smaller (between $25,000 and $100,000) appear statistically less likely to be prosecuted.
On the other hand, the analysis suggests that certain aggravating factors have an impact on the DOJ’s exercise of discretion, such as the defendant’s criminal misconduct during the investigation (e.g., obstructing justice and making false statements to the SEC), and the defendant’s commission of substantive crimes in addition to insider trading (e.g., falsifying books and records, bribery and violating grand jury secrecy laws). The analysis also suggests that certain mitigating factors, such as the defendants’ age, and marital relationship to other defendants or relevant parties, had an impact on the DOJ’s charging decisions. And the analysis shows that individuals who consent to settlements with the SEC prior to the filing of the SEC’s complaints are, on a statistical basis, rarely the subjects of a parallel criminal prosecution.
While the empirical analysis does not (and likely cannot) account for the array of factors that influence the DOJ to prosecute or not prosecute any particular defendant, the findings set forth in this article should be useful to practitioners representing clients in insider trading investigations, particularly in the current environment of increased coordination between the SEC and federal prosecutors.
 For a discussion of the considerations and processes for referral of SEC matters to the DOJ, see SEC Division of Enforcement Manual, Section 5.2.1 at 108-111, and Section 5.6.1 at 115-118 (Jan. 13, 2010).
 Remarks by Robert Khuzami at SEC v. Galleon Management, LP Press Conference (Oct. 16, 2009), available at http://www.sec.gov/news/speech/2009/ spch101609rk.htm
 Analysis reflects prosecutions by the DOJ as of April 13, 2010 against insider trading defendants who were charged by the SEC during fiscal years 2004-2009.
 The SEC’s fiscal year begins on October 1st of the previous calendar year. For example, fiscal year 2009 began on October 1, 2008 and ended on September 30, 2009. The SEC’s annual report for fiscal year 2008 noted that fiscal year 2008 saw the highest number of insider trading cases brought by the SEC in the agency’s history. See SEC 2008 Performance and Accountability Report (Nov. 14, 2008), available at http://www.sec.gov/about/secpar/secpar2008.pdf.