Monday, February 24, 2014 9.42 PM / By Dr. Olumide Kolawole Obayemi, LL.M.; SJD**
THE FULL AMOUNT TO BE DISGORGED BASED ON INSIDER TRADING LIABILITY: ANOTHER LOOK AT SECURITIES AND EXCHANGE COMMISSION, — v. — JOSEPH CONTORINIS, Docket No. 12‐1723‐cv, UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT, Decided: February 18, 2014
In the area of civil insider-trading cases, prior to February 2014, it was unclear if an individual engaged in insider trading would be liable not only for the personal profits but also for the illegal profits generated for and acquired by his employers as well. On February 18, 2014, the UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT, expanded the scope and meaning of “disgorgement of unlawful profits” by an inside trader in SECURITIES AND EXCHANGE COMMISSION, — v. — JOSEPH CONTORINIS, Docket No. 12‐1723‐cv.
The Court of Appeal applied the “Tipper/Tippee Rule”. Under the law, a tipper is a person in possession of inside information who seeks to confer a benefit on a friend or to curry favor with someone (a tippee) who can confer reciprocal benefits in the future can do so either by trading on this information himself and passing the profit on to the intended beneficiary, or by passing the information to the beneficiary and thus allowing the tippee to realize the profit himself.
Therein, the court held that the illegal profits would cover those profits that the insider personally received as well as those gains received by employer.
In SEC v Contorinis, Joseph Contorinis was the Managing Director at Jeffries & Company, Inc. and the primary issue presented in the appeal, was whether an insider trader who trades on behalf of another person or entity using funds he does not own, and thus produces illegal profits that he does not personally realize, can nevertheless be required to disgorge the full amount of illicit profit he generates from his illegal and fraudulent actions. Because United states Securities Laws and Practice and case laws have established that tippers can be required to disgorge profits realized by their tippees’ illegal insider trading, and this case is distinguishable only insofar as Contorinis himself executed the fraudulent trades rather than leave that task to a tippee, the Court of Appeals concluded that the district court was empowered to enter the disgorgement order, and did not abuse its discretion in doing so. Additionally, the appellate court found no abuse of discretion in the district court’s imposition of an injunction on Contorinis or in its order that Contorinis pay prejudgment interest on the disgorgement amount.
Earlier on, Joseph Contorinis had been convicted at a criminal trial of securities fraud and conspiracy to commit securities fraud, based on his use of inside information, as the Managing Director at Jeffries & Company, Inc., to trade on behalf of Jeffries (an investment fund --Contorinis’ employers) of which he was Managing Director.
Subsequently, in this civil enforcement action, Hon. Richard J. Sullivan of the United States District Court for the Southern District of New York ordered Contorinis to disgorge all profits generated by insider trading ($7,260,604 in profits from illegal insider trading), enjoined him from future violations of the securities laws, and ordered him to pay prejudgment interest on the disgorgement amount.
Hon Sullivan, while granting United States Securities and Exchange Commission (SEC)’s motion for summary judgment and, among other forms of relief, ordered Contorinis to disgorge all profits made by the insider trades, including those profits that accrued to Jeffries & Company, Inc. (Contorinis’ employers) rather than to Contorinis personally.
The Court of Appeal applied the “Tipper/Tippee Liability Rule”:
Thus, because a tipper can be required to disgorge all gains obtained by his tippees through illegal insider trading even without direct economic benefit to the tipper, and because defendant gave the fund the benefit of his inside information just as does a tipper, we hold the district court did not abuse its discretion by ordering the defendant to disgorge all profits.
II. The Facts in SEC v. Contorinis
Joseph Contorinis, a Managing Director at Jeffries & Company, Inc. (“Jeffries”), executed several illegal insider trades involving the stock of the supermarket chain Albertson’s, Inc. (“Albertson’s”), using material nonpublic information received from Nicos Stephanou, an employee of UBS Investment Bank (“UBS”). The offense had its origins in September 2005, when Stephanou informed Contorinis that UBS would be advising on a major financial acquisition involving Albertson’s.
As a UBS employee involved in the transaction, Stephanou was privy to confidential material information regarding the acquisition, and Contorinis asked Stephanou to keep him apprised of developments. In January 2006, as negotiations involving the acquisition of Albertson’s unfolded, Stephanou on several occasions disclosed material inside information regarding the acquisition to Contorinis before the information became public.
Relying on that information, Contorinis made several opportune trades in Albertson’s stock. Contorinis did not execute these trades with his personal assets, but rather did so on behalf of the Jeffries Paragon Fund (the “Paragon Fund”), of which Contorinis was a co‐manager and over which he had investment control. As a result of these insider trades the Paragon Fund realized
profits of $7,304,738, and avoided losses of $5,345,700.
In February 2009, Contorinis was indicted on one count of conspiracy to commit securities fraud and nine counts of securities fraud. A jury found him guilty of the conspiracy and of seven counts of securities fraud, and on October 6, 2010, he was sentenced to six years of imprisonment and ordered to pay $12,650,438 (the combined value of the Paragon Fund’s realized profits and avoided losses) in criminal forfeiture penalties.
On appeal, this Court affirmed Contorinis’s conviction but vacated the forfeiture order, remanding to the district court to redetermine the proper amount. United States v. Contorinis, 692 F.3d 136, 148 (2d Cir. 2012).
III. Whether An Insider Trader Who Trades On Behalf Of Another Person or Entity Using Funds That He Does Not Own, Producing Illegal Profits That He Does Not Personally Realize, Can Nevertheless Be Required To Disgorge The Full Amount Of Illicit Profit That He Had Generated From His Illegal And Fraudulent Actions.
Under the Securities Laws, neither the language of the criminal forfeiture statute nor case law supported the proposition that a defendant must forfeit proceeds that “go directly to an innocent third party and are never possessed by the defendant.” Rather, criminal forfeiture penalties are “usually based on the defendant’s actual gain.”
In SEC v Contorinis, the district court’s initial forfeiture calculation reflected the total benefit to the Paragon Fund, not the gains accruing to Contorinis himself. On remand, the district court found that Contorinis’ personal profit, in the form of linked compensation from the trades, amounted to $427,875, and ordered forfeiture of that amount.
However, following the filing of the criminal indictment, the Securities and Exchange Commission (“SEC”) brought a civil action against Contorinis in the United States District Court for the Southern District of New York, seeking disgorgement of $7,260,604 in unlawful profits obtained by the Paragon Fund (equivalent to the total profit from insider trading less trading commission costs), as well as additional civil monetary penalties and an injunction against future securities law violations.
After Contorinis was convicted at his criminal trial, the SEC moved for summary judgment, and Contorinis, without admitting to the underlying offense, acknowledged that the jury verdict had a preclusive effect requiring a finding of civil liability. On February 3, 2012, the district court granted the SEC’s summary judgment motion against Contorinis and granted relief in the forms requested by the SEC, permanently enjoining Contorinis from violating the securities laws in the future, ordering Contorinis to disgorge $7,260,604 (less any amount paid pursuant to the criminal forfeiture), and imposing a civil penalty of $1,000,000.
Further, in a superseding judgment of February 29, 2012, the district court reaffirmed those penalties, and furthermore ordered Contorinis to pay $2,485,205 in prejudgment interest on the disgorgement amount.
In a related development, on September 24, 2013, the SEC informed the Court that the parties had agreed to adjust the prejudgment interest amount to reflect the fact that, after the sentence was imposed, Contorinis had posted $3,000,000 as bail, of which the government, and not Contorinis, had the use between October 7, 2010 and March 29, 2011. That adjustment reduces the prejudgment interest award from $2,485,205 to $2,417,940. The agreement did not resolve any of the other issues in dispute between the parties, including Contorinis’s contention that he should not be required to pay prejudgment interest at all. September 24, 2013 Letter, SEC v. Contorinis, No. 12‐1723, ECF No. 122.
Contorinis timely brought an appeal, challenging the judgment insofar as it required him to disgorge the entire amount obtained by the Paragon Fund through insider trading and to pay prejudgment interest on the disgorgement amount, and permanently enjoined him from violating the securities laws.
a. Disgorgement of Illegal Profits
In the United States, Disgorgement serves to remedy securities law violations by depriving violators of the fruits of their illegal conduct. See SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997); see also SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987)
“The paramount purpose of enforcing the prohibition against insider trading by ordering disgorgement is to make sure that wrongdoers will not profit from their wrongdoing.”
Disgorgement is an equitable remedy, imposed to “forc[e] a defendant to give up the amount by which he was unjustly enriched.” FTC v. Bronson Partners, 654 F.3d 359, 372 (2d Cir. 2011), quoting SEC v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978).
By forcing wrongdoers to give back the fruits of their illegal conduct, disgorgement also “has the effect of deterring subsequent fraud.” SEC v. Cavanagh, 445 F.3d 105, 117 (2d Cir. 2006) (“Cavanagh II”).
However, because disgorgement does not serve a punitive function, the disgorgement amount may not exceed the amount obtained through the wrongdoing. At the same time, however, as it operates to make the illicit action unprofitable for the wrongdoer, disgorgement need not serve to compensate the victims of the wrongdoing. Because disgorgement is not compensatory, it “forces a defendant to account for all profits reaped through his securities law violations and to transfer all such money to the court, even if it exceeds actual damages to the victim.”
Further, because disgorgement’s underlying purpose is to make lawbreaking unprofitable for the law‐breaker, it satisfies its design when the lawbreaker returns the fruits of his misdeeds, regardless of any other ends it may or may not accomplish.
b. Liability: Tipper/Tippee Rule
Contorinis argued that because he illegally traded not for his own account with his own funds, but rather on behalf of an investment fund that he managed and whose assets belonged to third‐party investors, he did not personally enjoy the proceeds of the resulting gain (beyond the increase in his compensation linked to the performance of the Paragon Fund).
On the other hand, although Contorinis did not pocket the profits from his trades, it was he who utilized the inside information, executed the trades, and secured the resulting profit for the benefit of his clients. The question is thus posed whether an insider trader can be required to disgorge not only the profit that he personally enjoyed from his exploitation of inside information, but also the profits of such exploitation that he channeled to friends, family, or clients.
Contorinis argued, in effect, that one can only “disgorge” what one has personally “swallowed”
While the SEC argued that a fraudster should be compelled to return not only those profits from the fraud that he has reserved for his own use, but also those that he has bestowed on others.
Let us examine the Tipper/Tippee rule that makes perfect sense that the dishonest trader should be made to disgorge all profits—even to his employers.
As stated above, under the law, a potential tipper is a person in possession of inside information who seeks to confer a benefit on a friend or to curry favor with someone (a tippee) who can confer reciprocal benefits in the future can do so either by trading on this information himself and passing the profit on to the intended beneficiary, or by passing the information to the beneficiary and thus allowing the tippee to realize the profit himself.
In the former case, the insider would unquestionably be liable to disgorge the profit; disgorgement is required whether the insider trader has put his profits into a bank account, dissipated them on transient pleasures, or given them away to others.
Therefore, with the above scenario, it would make little sense to allow the insider to escape disgorgement when he gives away not the proceeds of a trade predicated on his insider knowledge, but rather the knowledge itself to others who he knows will spin the information into gold by trading on it themselves.
Using the Tipper/Tippee rule, it must follow that the insider who, rather than passing the tip along to another, directly trades for that other’s account must equally disgorge the benefit he obtains for his favored beneficiary.
For instance, in SEC v. Warde, 151 F.3d 42, 49 (2d Cir. 1998), the defendant utilized an account belonging to his wife, over which he had control, to make trades based on material nonpublic information. The court held that whether he traded on his own account and gave the profit to his wife, gave the information to his wife to enable her to trade on it, or executed the trades on his own authority using his wife’s account such that the proceeds accrued to her, the wrong committed by the defendant would be the same, as would the economic result.
Thus, under the Tipper/Tippee rule, whether the dishonest trader’s motive is direct economic profit, selfaggrandizement, psychic satisfaction from benefitting a loved one, or future profits by enhancing one’s reputation as a successful fund manager, the insider trader who trades for another’s account has engaged in a fraud, secured a benefit thereby, and directed the profits of the fraud where he has chosen them to go.
Thus, establishing that tippers may be held liable to disgorge the gains of their tippees, it would be inconsistent to deny the discretion to impose equivalent liability for conduct such as Contorinis’s.
Indeed, to the extent that this case can be distinguished from the tipper‐tippee situation, the case for disgorgement is stronger here. The tipper in possession of material nonpublic information who passes that inside information to another, even with full knowledge that the tippee will use the information to trade, has no control over, and likely no knowledge of, the extent to which the
tippee will trade. The tippee may make a modest wager or take a deep plunge; she may act at the ideal moment, or sacrifice some potential profit by trading prematurely or delaying too long. The tipper is liable for the tippee’s gains, whatever they may be.
US courts have long applied that principle in the tipper‐tippee context. Thus, in SEC v. Warde, the could held that, in the determination of a disgorgement amount, “[a] tippee’s gains are attributable to the tipper, regardless whether benefit accrues to the tipper.”
It is to be noted that the Tipper/Tippee principle has deep roots in parallel civil remedial structures. Thus, in Elkind v. Ligget & Myers, Inc., 635 F.2d 156, 165 (2d Cir. 1980), the court concluded that “[t]rades by tippees are attributed to the tipper” in determining liability for damages, and in SEC v. Texas Gulf Sulphur Co., 446 F.2d 1301, 1308 (2d Cir. 1971), the foundational case for insider trading liability, the court required a tipper to make common‐law civil restitution “for the profits derived by his tippees.”
IV. Applicability to Nigeria
Assuming the following factual scenario, in December 2013, Mr Wazobia was working as a stockbroker for Wayoman Securities, Ltd at Kakawa Street in Lagos. Between 1980 and 1985, Wazobia had attended Eko Boys High School with Mr Ado John Sule. Sule now works for Arthur Andersen (“AA”) in Ikoyi. AA was retained fir First Bank, Nigeria Plc (FBN) in a major takeover of Isale-Eko Finance Company (IEFC)—a deal that would make the shares of IEFC, presently trading for NGN1.00 to rise to NGN100.00 within a week. Sule passes the information to Wazobia. Wazobia then purchases 1,000,000 shares for himself along with another set of 2,000,000 shares for Wayoman Securities Ltd
As foretold, FBN acquired IEFC in February 2014, and, instantly, Wazobia gained almost NGN100,000,000 while his employers—Wayoman also gained NGN200,000,000. Of course, Wazobia paid a kickback of NGN50,000,000 to Sule.
Assuming they were all caught, it used to be the law that both Wazobia and Sule would each cough up their individual illegal gain of NGN500,000 each. But, with SEC v. Contorinis, even, Wayoman securities, Ltd would also disgorge its improper NGN200,000,000 gains.
There is a similar case pending which may take a cue from the decision in SEC v Contorinis-- the case of Mathew Martoma, the former SAC Capital Advisors LP portfolio manager convicted of insider trading in February 2014. Against Martoma, prosecutors and regulators alleged that Martoma had earned a $9.3 million bonus as the result of illegal trades SAC made based on inside information he received. With SEC v Contorinis, Martoma could now also be liable for the $275 million in profits SAC earned as a result of the trades, legal experts said. A related SEC civil suit against Martoma now seeks all ill-gotten gains received as a result of the illegal trades, "including [his] ill-gotten gains, and the illicit trading profits, other ill-gotten gains, and/or losses avoided."
Further, according to Tamar Frankel, a professor at Boston University School of Law, the SEC v Contorini decision could become a deterrent to insider trading as well as a greater incentive to cooperate because of heftier financial consequences, and "This is a punishment that hits the pocket."
In another view, Bradley J. Bondi, leader of the securities-enforcement and investigations practice at Cadwalader, Wickersham & Taft LLP, said:
"While this decision will give the SEC a large hammer to apply in insider-trading cases, there is a question whether other circuits will follow this decision."
We must note, as Christopher M. Matthews, had stated in Wall Street Journal, that the Contorini issue may not be completely settled as Contorinis could ask for a hearing (Petition for Hearing En Banc) before the Second Circuit Court of Appeals following the panel's split decision.
It is also unclear whether other appeals court circuits in the United States will follow the decision.
Finally, the U.S. Supreme Court could also decide to weigh in, legal experts said.
**Dr. Olumide Kolawole Obayemi, LL.M. (Alberta Canada); LL.M. in Taxation Law; SJD in International Legal Studies, is of the Bars of the Federal Republic of Nigeria and State of California.