Monday, July 29, 2013

SAC Capital: Rotting From the Top

    Nearly one-fourth of 250 finance industry professionals surveyed by a New York City law firm recently said they would likely engage in illegal insider trading to make $10 million if they could get away with it. It is not known whether billionaire hedge fund owner Steven A. Cohen was one of those questioned, but if he was — and if he answered honestly — then surely he was one of those willing to break the law for a good-sized profit.
     Not only would Cohen trade on illegal inside information, but he actually did — often and at a substantial profit, according to the criminal indictment unsealed in federal court in Manhattan on Thursday [July 25] against his hedge fund, SAC Capital Advisors. The 41-page indictment depicts SAC Capital as an insider trading machine, whose outsize profits depended on “widespread solicitation and use of illegal inside information” and “an institutional indifference” to violations “on a scale without known precedent in the hedge fund industry.”
    Cohen himself was not indicted — he was identified only as “SAC Owner” — but the indictment puts him and his $15 billion fund in the government’s crosshairs for the second time in a little over a week. The Securities and Exchange Commission (SEC) filed an administrative proceeding against Cohen on July 19, charging him with failing to investigate suspicious trading activity at SAC or to take steps to prevent illegal conduct.
    Together, the government actions, if successful, could bar Cohen from managing investor funds and force SAC Capital to disgorge profits linked to illegal insider trading. SAC pleaded not guilty to the indictment on Friday; Cohen’s attorneys have vowed to contest the administrative proceeding. In the meantime, however, some investors are reportedly voting with their wallets by withdrawing money from the fund.
     Far from being the clueless head of a company rotting from the bottom, Cohen is depicted in the indictment as the rot at the very top. SAC Capital’s hiring policies, trading operations, compliance systems, and compensation practices combined to make insider trading a way of life at the fund, according to the indictment.
     To start, SAC sought to hire portfolio managers and research analysts “with proven access to public company contacts likely to possess inside information.” One new hire came with the recommendation that he had a house share with the chief financial officer of a Fortune 500 company and was “tight with management.” Richard Lee was hired at Cohen’s insistence in April 2009, over the objections of SAC’s legal department, despite information that he had been part of an “insider trading group” at the hedge fund where he had been working. Lee pleaded guilty to federal conspiracy and securities fraud earlier last week [July 23].
     Employees were “financially incentivized,” according to the indictment, to recommend to Cohen “high conviction” trading ideas in which SAC would have an “edge” over other investors. As one example, research analyst Jon Horvath recommended selling Dell stock on Aug. 26, 2008, because of a “second hand read” from contacts inside the company about an upcoming unfavorable earnings report. Cohen liquidated his $12 million holding within 10 minutes after receiving the recommendation. Horvath pleaded guilty to conspiracy and securities fraud in connection with Dell trades in September.
     In another example, Cohen liquidated $700 million in holdings in two drug companies, Elan and Wyeth, on July 20, 2008, after health care analyst Matthew Martoma passed along inside information about the soon-to-be-announced negative results of clinical trials of a new drug. By selling and shorting the stock, Cohen realized $276 million in profits or avoided losses. Martoma was indicted in December in connection with the trades. Cohen allegedly knew Martoma was paying a doctor involved in the drug trials for the tips.
     SAC’s compliance systems reflected what the indictment calls “a lack of commitment” to address the insider trading issues. The indictment notes that up until 2009 the compliance department did not do keyword searches of employees’ e-mails for terms suggestive of insider trading. In the only insider trading violation uncovered internally, two portfolio managers were found to have used inside information to trade on a health company stock in July 2009. They were fined, but allowed to keep their jobs; no report was made to regulatory authorities.
     Cohen and SAC Capital are Exhibit Number One of the ethics gap in the financial services industry identified by the survey released in mid-July by the law firm of Labaton Sucharow, which specializes in representing plaintiffs and whistleblowers in securities fraud litigation. More than half of the financial industry professionals surveyed — 52 percent — thought their competitors probably engaged in unethical or illegal behavior. Nearly one-fourth — 24 percent —  thought some of their co-workers had done so. Substantial numbers viewed compensation systems as encouraging unethical conduct (26 percent) and top officials as likely to turn a blind eye to improper conduct by a “top performer” (17 percent).
     Back in baseball’s steroid era, true fans knew the home run records were too good to be true. Financial experts know that some of the returns posted by hedge funds and individual investors are similarly too good to be true. Baseball can at least claim to be trying to clean house; the government's moves against SAC are one step in cleaning up the ethical rot on Wall Street.

Monday, July 22, 2013

Reporter May Be Bound for Jail Over Subpoena

   James Risen may need to start packing a toothbrush and overnight bag because the Pulitzer Prize-winning reporter and author is headed to jail barring an unlikely change of heart by either the government or the federal judiciary.
   Risen, who covers national security for the New York Times, got the bad news on Friday [July 20] that the federal appeals court in Richmond, Va., had upheld the government’s effort to force him to testify in the prosecution of an alleged CIA leaker. The government believes that ex-CIA agent Jeffrey Sterling leaked classified materials to Risen to use in his book State of War to recount a botched CIA operation a decade ago aimed at disrupting Iran’s nuclear program.
  Risen has fought the subpoena, claiming a reporter’s privilege to protect confidential sources. Judge Leonie Brinkema, who is presiding over Sterling’s now-held-in-abeyance trial in federal district court in Alexandria, Va., ruled in July 2011 that Risen did not have to testify about any confidential sources. On Friday, however, the Fourth U.S. Circuit Court of Appeals reversed Brinkema’s ruling in a split decision by a three-judge panel.
   For the majority, Chief Judge William Traxler found no reporter’s privilege under either the First Amendment or federal common law. In a sharp dissent, Judge Roger Gregory argued that the government does not actually need Risen’s testimony and that forcing him to testify would undermine freedom of the press in general and the ability of the press in particular to hold the government accountable on national security issues.
   The ruling against Risen reflects the confluence of three unfavorable trends for reporters. Federal courts, starting with the Supreme Court in 1972, have been unreceptive to claims of a journalist privilege to refuse to disclose confidential sources. States have passed reporter shield laws, but they have been only partly effective and Congress has not acted on a federal shield law at all. And, most recently, the Obama administration has aggressively gone after government leakers, charging 11 people so far, including Sterling, with violating the federal Espionage Act and facing the risk of long prison sentences.
   The Supreme Court started things going downhill for reporters with its 1972 decision in Branzburg v. Hayes that rejected a reporter’s privilege to protect confidential sources in three consolidated cases that involved reporting on marijuana users and black militants. Writing for the 5-4 majority, Justice Byron R. White, no fan of the press, said courts were entitled to testimony from reporters just like from anyone else. White disregarded such common law privileges as husband-wife, attorney-client, doctor-patient, and priest-penitent. Justice Lewis F. Powell Jr. added what has been labeled an “enigmatic” concurrence that seemed to recognize a limited privilege even while joining White’s majority opinion.
   The Supreme Court has not revisited the issue. But Congress in 1975 approved a new provision for the Federal Rules of Evidence, Rule 501, that explicitly gives federal courts the authority to create new privileges. In 1996 the Supreme Court cited that provision in recognizing for the first time a psychotherapist privilege in federal courts (Jaffee v. Redmond).
   Free press advocates use that precedent to argue for a federal common law privilege for journalists. But the argument failed before the D.C. Circuit in the case eight years ago that led to the jailing of New York Times reporter Judith Miller. And the Fourth Circuit panel rejected it as well in last week’s decision in Risen’s case. “[N]either Rule 501 nor Jaffee overrules Branzburg or undermines its reasoning,” Traxler wrote for the majority.
   Risen’s case illustrates the heightened danger for reporters when the government decides to prosecute leakers themselves. In Branzburg, the reporters argued in part that the government did not need their testimony to prosecute the drug users or black militants for any crimes they may have committed. In the leak cases, however, the leak is the crime itself and the reporter may very well be a direct eyewitness.
  As Traxler wrote, Risen “can provide the only first-hand account of the commission of a serious crime. . . .” (Risen has been granted immunity, so he cannot claim the Fifth Amendment privilege against self-incrimination.) In his dissent, Gregory disagreed, noting the circumstantial evidence the government has against Sterling, including records of telephone calls and e-mails between him and Risen. But Traxler says the government is entitled to the best evidence available: Risen’s own testimony about his sources.
  The Obama administration is quite serious about going after government leakers, as documented in a thorough story in the Times on Sunday by reporter Sharon LaFraniere. “It is good to hang an admiral once in a while,” Dennis Blair, Obama’s first national director of intelligence and a former Navy man, is quoted as saying. He and Attorney General Eric Holder fashioned an anti-leak crackdown that filtered down to courtroom prosecutors.
  Obama has turned aside criticism that the crackdown goes against his campaign promises for greater transparency. New Justice Department guidelines issued this month in response to media criticism seem to offer little help to Risen or others in like circumstances.
  Risen and his lawyers are promising to appeal up to the Supreme Court if necessary. And Risen has indicated he will go to jail rather than comply with the subpoena. In his dissent, Gregory said the newsworthiness of Risen’s reporting outweighs any benefit to law enforcement from his testimony. Traxler brushed the argument aside, apparently willing to take the risk that reporters will find it that much more difficult to tell the public what the government does not want it to know about U.S. intelligence agencies.

Sunday, July 14, 2013

No Answers From a No-Surprise Verdict

   The not-guilty verdict in the George Zimmerman case came as no surprise to those who had carefully followed the three-week trial. Nor to those who had predicted from the first that no Florida jury would convict the white/Hispanic wannabe-cop in the shooting death of the innocent and unarmed black teenager Trayvon Martin in a gated community in Sanford, Florida. Nor to the criminal justice experts who explained, also from the start, that a self-defense defense is hard for the prosecution to rebut, especially if the victim is dead.
   The six jurors — all women, none of them African American — surprised some observers by deliberating for 16 hours and 20 minutes before returning their verdict late Saturday night [July 13]. With so much attention to the prosecution’s shortcomings and the defense team’s skillful playing of the reasonable-doubt card, some expected a verdict within a couple of hours.
  The anonymous jurors have exercised their right to confidentiality, so the course of their deliberations remains for now unknown. Suffice it to say that the reports that the jury “believed” Zimmerman’s claim of self-defense may be an overstatement. It was enough for an acquittal that none of them found him “guilty” beyond a reasonable doubt of either second-degree murder or manslaughter.
  The televised trial tested the patience of some observers, who thought Americans should be paying more attention to events in Egypt or the debate over electronic surveillance. But the Zimmerman case raised profound issues: race, crime, guns. The availability of gavel-to-gavel coverage prepared Americans for a verdict that might otherwise have been a jarring and disorder-producing shock.
  Despite their importance, those issues were not argued in the courtroom. Judge Debra Nelson prohibited the prosecution from saying that Zimmerman had “racially”: profiled Martin on that rainy night in February 2012. Florida’s “Stand Your Ground” law — so much the focus in the weeks after the killing — was in the background but not front and center: Zimmerman declined the chance to use the law to get the case dismissed without a full trial.
  Instead, the trial turned into, of all things, a trial: with testimony from eyewitnesses, earwitnesses, investigators, experts, and friends and family of victim and defendant. Those who hoped for a conviction began complaining about the prosecution’s case by the time the trial reached the halfway point. They saw miscues, mistakes, and missed opportunities that doomed the case.
  The judgment is too harsh. For one thing, the defense often has the advantage in a high-profile trial. The prosecutors are typically career civil servants: underpaid, overworked, underresourced. The defense lawyers — whether paid or pro bono — are often in a better position to pull out all stops for this one case, with a payoff in the form of national publicity and a possible book deal. The O.J. Simpson trial is an example, and not an isolated one.
  In any event, the Zimmerman prosecution team had to play the hand it was dealt — and it was not a good one. Martin was not alive to give his version of the fight that ensued after Zimmerman exited his car and the two of them — a burly adult and a wiry teen — struggled on the ground. Rachel Jeantel, the cellphone friend speaking with Martin in the moments before his death, was a witness with an unhelpful attitude. And the police investigators, including lead detective Chris Serino, very unhelpfully said they believed Zimmerman’s version, his inconsistencies notwithstanding.
  Prosecutors perhaps could have done more with those inconsistencies and more with the logical inferences from some of the uncontradicted evidence. In the end, however, the trial came down to two highly disputed questions of fact: who was on top on the struggle and who was heard to scream in the final moments. The eyewitnesses from the neighborhood supported the defense version that it was Zimmerman on the ground, pummeled by Martin atop him. And the earwitnesses too — except for Martin’s mother — indicated it was Zimmerman, not Martin, heard to scream on the 911 tape.
  The prosecution team responded to the verdict with as much dignity as they could muster. “I am disappointed with the verdict,” said chief prosecutor Bernie de la Rionda. “We accept it.” Co-counsel John Guy commended the Martin family. “They’ve been dignified, they’ve shown class,” he said.
  The same cannot be said for Zimmerman’s family or his chief counsel, Mark O’Mara. Zimmerman’s brother, Robert Zimmerman, said on CNN that the family fears people “that would want to take the law into their own hands” — apparently unaware of the irony. And O’Mara went so far as to say that if Zimmerman had been black, he would never have been charged. As refutation, bloggers dug up a 2007 case from New York in which a black homeowner was convicted of manslaughter for the shooting death of a white punk making trouble in his front yard.
  Was justice done? The Martin family had their day in court, however unsatisfying. Zimmerman goes free, not guilty but also not innocent. But true justice would require that Martin have found his way home that night, unimpeded. Do we know the truth of what happened that night? No. A nation still divided by race and ideology has to live with two versions of truth, never to meet.

Monday, July 8, 2013

Making Lemonade Out of Voting Rights Decision

   The Voting Rights Act was not broken, but now, thanks to the Supreme Court, Congress and the Justice Department have to try to fix it. It is a daunting challenge, but perhaps not impossible.
   The court’s 5-4 decision in Shelby County v. Holder [June 25] to strike down a key provision of the 1965 law is long in praising the act’s historic accomplishments and short in documenting its supposed present-day harms. Chief Justice John G. Roberts cites with statistics the dramatic improvements in voter registration and turnout among African Americans in the Deep South. “There is no doubt,” Roberts writes for the majority, “that these improvements are in large part because of the Voting Rights Act.”
   One might take that as an endorsement of the law and justification for Congress’s decision in 2006 to extend the law for another 25 years, including the proven-to-be-effective enforcement mechanism: the preclearance provision in section 5 that applies to nine states and parts of six others. Instead, Roberts and his four conservative colleagues threw out the formula used to determine the states that have to preclear voting changes with the Justice Department or a federal court.
   The harm from this provision, according to the majority, is its “drastic departure from federalism” and “from the principle that all States enjoy equal sovereignty.” The Constitution supposedly forbids Congress from treating one state or group of states differently from others without very good reasons. 
   This may sound right in theory, but, as Justice Ruth Bader Ginsburg shows in a well documented dissent, it is not correct in practice. Congress routinely treats states differently, for reasons far less compelling than protecting the right to vote. Sports-related gambling is prohibited nationwide except for any state that allowed it in 1976 (read: Nevada). Appropriation measures often include obscurely phrased funding formulas designed to favor individual states or groups of states.
   No less a figure than Michael McConnell, a conservative law professor and former federal judge, says the Court’s supposed principle is just “made up.” “There’s no requirement in the Constitution to treat all the states the same,” McConnell remarked in an interview with NPR’s Nina Totenberg. “It might be an attractive principle, but it doesn’t seem to be in the Constitution.”
   Roberts says the other harm from the Voting Rights Act is that states and localities covered by the preclearance requirement are delayed or preventing from adopting “validly enacted laws.” But the voting changes may or may not be validly enacted. The unchallenged Voting Rights Act section 2 makes it illegal for any jurisdiction, nationwide, to enact a voting change that has the intent or the effect of discriminating against a racial or language minority.
    The Justice Department or federal court applied essentially the same standard in reviewing proposed changes. So, any changes that were disallowed —  a vanishingly small fraction —  had been found by an official body to be, in fact, illegal under federal law. A proper view of the preclearance requirement is that it prevented the enactment of invalid laws — a benefit in protecting voting rights, not a harm, as the Supreme Court conservatives believed.
   The Court made its decision, however, and Congress and the Justice Department now have to live with it. Roberts stressed that the preclearance requirement remains on the books and Congress is free to craft a new coverage formula.
  Without a coverage formula, the preclearance requirement is — as Ginsburg wrote in her dissent — “immobilized.” Political realities make it unlikely that Congress can enact a formula that recognizably identifies the worst of the bad actors in voting rights for preclearance coverage. But the possibility of salvaging something of the preclearance requirement is less remote than pessimistic lawmakers and realistic Capitol Hill observers depicted immediately after the ruling.
  A New York Times editorial a few days later [June 29] pointed to some of the ways that Congress or the Justice Department can respond to blunt the impact of the Corut’s decision. For starters, the Times noted that the act’s “bail-in” procedure in section 3, untouched by the decision, allows the Justice Department to ask a court to extend the preclearance requirement to a designated jurisdiction upon proof of intentional racial discrimination in voting.
  The Times notes that intentional discrimination is hard to prove, but it is not impossible. The state of Texas, as one example, was found to have intentionally discriminated against Latino voters in redrawing congressional lines in 2003. And minority group plaintiffs filed a federal court action after the latest ruling seeking to invoke section 3 to block Texas from implementing its voter ID law.
  The Times suggests that Congress could make section 5 usable again by requiring preclearance for any state to have violated a federal election law in the last few years. Such an objective requirement would meet the Supreme Court’s criterion that preclearance be based on “current conditions.” It would impose preclearance again on most of the southern states and on others, but recidivist voting rights violators would have a hard time complaining about being unfairly singled out.
  The Supreme Court won little praise for its decision to gut the Voting Rights Act. The only poll conducted so far found a majority of Americans opposed to the ruling, The Court has given a lemon to Congress and the Justice Department; their job now is to make lemonade out of it.