Back when former Goldman Sachs director Rajat Gupta's most
pressing problem was the Securities and Exchange Commission's
civil case against him, his defense scored a small victory when
the SEC agreed to drop an administrative proceeding against him
and brought civil charges in federal court instead. Gupta's
lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, had
fought to have Gupta's case heard by a federal judge, rather
than an SEC administrative law judge, because the rules of
evidence in administrative proceedings favor the agency. Among
other things, the SEC can admit hearsay evidence, and
defendants don't have the same rights to depose opposing
witnesses. Although the SEC can't seek the same penalties in
administrative proceedings as it can in federal court, they can
be an effective way for the agency to make a statement about
Except when the defendants win.
On Friday, the SEC's chief administrative law judge, Brenda
Murray, entered a painstaking 58-page decision that cleared
former State Street executives John Flannery and James Hopkins
on all of the SEC's sprawling allegations that they misled investors about the mortgage-backed securities holdings in
State Street bond funds. Murray found that the agency failed to
show at trial that Flannery and Hopkins violated any securities
laws in communicating with investors about the funds' subprime
MBS holdings. She went out of her way to describe the former
State Street execs as candid, believable witnesses who were
frustrated to be on trial.
Murray's ruling is yet another courtroom rebuke to the SEC,
which in the last few years has seen several high-profile trials end in victory for defendants. Most notably, in 2009 a
San Francisco federal judge dismissed stock options backdating charges against Broadcom executives; and in 2010 a Manhattan
federal judge exonerated two traders in a landmark SEC case
alleging insider trading in credit default swaps. The State
Street loss is perhaps an even bigger black eye for the SEC,
given that the loss came in an administrative proceeding, the
agency's home turf.
"This is a case where the SEC should never have proceeded
against my client," said Mark Pearlstein of McDermott Will &
Emery, who represented former State Street Americas chief
investment officer Flannery. "We felt all along that if we
received a fair hearing we would prevail. Chief judge Murray
gave us a very fair hearing."
Hopkins, who was a former head of project engineering for
State Street, was represented by John Sylvia of Mintz Levin.
"We and our client are thrilled," Sylvia said. "We've
maintained from the outset that this is a case that never
should have been brought."
The ruling may be a setback for the SEC in another way as
well. Agency lawyers urged the chief ALJ to adopt a narrow
interpretation of the U.S. Supreme Court's June 2011 ruling in
Janus Capital v. First Derivative Traders. In Janus, the court
ruled that a mutual fund adviser isn't liable for the fund's
allegedly false statements in a prospectus because the adviser
did not make the statements at issue. The SEC argued that the
Janus decision should apply only to private securities fraud
cases, and not to its causes of action. The administrative law
judge, citing a ruling by U.S. district judge Colleen McMahon
in Securities and Exchange Commission v. Kelly, said Janus
extends to the SEC's allegations.
In the end that didn't matter in the case against Flannery
and Hopkins, because Murray found that the SEC's allegations of
misstatements fell short. But the agency may want to think
twice about asking the full commission to review the chief
ALJ's reasoning on Janus. The SEC, which told Reuters that it
is reviewing the ruling, has three weeks to decide whether to
appeal Murray's initial determination to the full commission.
(Reporting by Alison Frankel)
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