When it comes to insider trading, the Securities and Exchange Commission is very clear: Everyone must play by the same rules. But the government agency charged with enforcing a level playing field does not play itself on one that is fair and level.
In the fiscal year that ended Sept. 30, the SEC brought an increasing number of insider trading enforcement actions — 235 cases, representing a 10 percent increase from the previous year — in front of its own “in-house” judges, instead of in federal district courts with their accompanying jury system. These in-house proceedings, which provide far less discovery than does litigation in federal courts and do not operate under the traditional rules of evidence, provide an undeniable “insider” advantage to the SEC.
How big is the SEC’s home-court advantage? The agency won 100 percent of the cases brought before in-house courts over the last year. Compare that record with the SEC’s win rate of 61 percent for cases brought in federal court, and it’s obvious why the SEC prefers its own version of “insider trading.”
Federal courts provide more than just the common sense of a jury. They provide independent federal judges tasked with interpreting the relevant statutes and developing the common law. The SEC’s in-house courts, on the other hand, provide judges on the SEC payroll. No one can seriously argue that they will be as balanced as independent federal judges.
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Nobody knows this better than we do. The SEC spent seven years litigating an insider trading case against one of us — Mark Cuban — that it ultimately lost in front of a jury. As the rules of discovery in federal court revealed, this was a case that should never have been brought.
Some of the key evidence in our case was testimony by the chief executive of Mamma.com, whose company stock the SEC alleged was traded on insider information. Being able to take his deposition and explore potential inconsistencies in his testimony, including apparent changes in his story after the SEC dropped an investigation against his company, was critical to our defense. In an SEC home-court proceeding, we wouldn’t have had the right to take the deposition and to discover inconsistent testimony. And would a judge on the SEC payroll have been as convinced as the jury was that the testimony was tainted by undue SEC influence? That hardly seems likely.
Our case is hardly unique. Nelson Obus, founder of a small investment fund, Wynnefield Capital, spent 12 years fighting a similar battle with the SEC. He and his colleagues were exonerated in May, but only after all the facts were brought before a jury. At the end of the case, Obus criticized the SEC for engaging in a “12-year campaign of regulatory overreach.”
Some media have noted that the SEC’s maneuvering to decide more cases in-house coincided with the agency losing a number of high-profile insider trading cases in federal court, beginning with our case in October 2013. In November, federal Judge Jed Rakoff, a frequent SEC critic, called the SEC to task for its “chutzpah” in taking this approach.
But the critiques are not merely verbal ones. In October, two targets of SEC in-house proceedings challenged the practice in court, arguing that administrative proceedings violate their constitutional due process rights. Other insider trading cases challenging the practice are pending in the appellate courts.
It is highly unlikely, however, that these challenges will succeed. The law, as developed by the very federal judges the SEC seeks to avoid with its in-house filings, is very deferential to agency decisions on how to enforce the laws under its jurisdiction. That is why it’s essential for Congress to step in.
There is no reason for investors accused of insider trading to be deprived of the ability to have the allegations against them decided by a judge and jury. The powers given to the SEC in the 2010 Dodd-Frank legislation should be amended to prohibit the SEC’s use of in-house courts for that purpose.