Second Circuit Affirms $92.8 Million Civil Penalty for Insider Trading Violations

Case Name: SEC v. Raj Rajaratnam, et al.

Date of Opinion: March 5, 2019

Opinion by: Judge Lynch

Summary:

In 2011, Raj Rajaratnam, former hedge fund manager of Galleon Management, LP, was indicted in the Southern District of New York on nine counts of securities fraud under Section 17(a) of the federal Securities Act and Section 10(b) and Rule 10b-5 of the Exchange Act. Rajaratnam’s criminal indictment was based on his insider trading of the stock of five different companies, in addition to five counts of conspiracy to commit insider trading.

On the day of his arrest, the Securities and Exchange Commission (“SEC”) filed a related civil action against Rajaratnam in the Southern District of New York. The SEC based its civil allegations on the same insider trading conduct charged in the criminal case, as well as additional violations of the Securities and Exchange Acts stemming from Rajaratnam’s alleged purchases and sales of stock in certain companies based on material nonpublic information. In the civil action, the SEC sought an injunction against further securities violations, disgorgement of Rajaratnam’s gains from the alleged violations, and a civil monetary penalty under Section 21A of the Exchange Act.

Following an eight-week trial in the criminal case, a jury found Rajaratnam guilty on all counts, and he was sentenced to 132 months’ imprisonment and ordered to pay a $10 million criminal fine and a court-imposed forfeiture of $53.8 million. Following Rajaratnam’s conviction and sentencing, the SEC moved for partial summary judgment on the civil insider trading claims that formed the basis of Rajaratnam’s criminal conviction. Rajaratnam conceded liability based on principles of equitable estoppel, leaving the amount of the civil penalty as the sole issue for the district court to decide on summary judgment. The district court accepted Rajaratnam’s calculation that the “total profit gained and loss avoided” from the insider trades was $30,935,235, and that he personally gained approximately $4.7 million.  It then determined that the language of Section 21A imposing a penalty of “three times the profit gained or loss avoided” was not limited to a penalty equal to three times Rajaratnam’s personal gains of $4.7 million. Rather, the court held, the penalty extended to the total profit of nearly $31 million from the illegal trades he secured. Based on this reading of the statute, and considerations of Rajaratnam’s “egregious” violations, the district court imposed the maximum civil penalty of $92,805,705.

On appeal before the Second Circuit, Rajaratnam made two main arguments. First, he argued, as he did in the district court, that Section 21A penalties are not permitted to exceed three times of his personal profit gained or loss avoided. Second, Rajaratnam argued that the district court abused its discretion in imposing the maximum penalty because it impermissibly relied on his wealth and ability to pay and ignored the criminal penalties previously imposed on him.

In analyzing the permissible extent of a Section 21A penalty, the Second Circuit relied on the plain meaning of the statute and case law, and agreed with the district court that Section 21A “permits a civil penalty to be based on the total profit resulting from the violation.” The Court also found that the district court’s interpretation of Section 21A was consistent with the congressional intent of federal securities laws to allow civil penalties based on the total profit resulting from a violation, rather than merely the profit earned by the defendant. Moreover, the Court determined that the lower court’s penalty effectuated the purpose of Section 21A to deter the exact conduct that Rajaratnam had been found liable for (both criminally and civilly).

As to Rajaratnam’s abuse of discretion argument, the Second Circuit relied on its own precedent, as well as the precedent of other circuits, in determining that the district court permissibly considered Rajaratnam’s wealth and ability to pay in imposing the civil penalty. Specifically, the Court found that the district court had undertaken “a careful and thoughtful analysis of the factors bearing on the appropriate penalty.” Moreover, the Court determined that the district court properly considered Rajaratnam’s criminal penalty in calculating his civil penalty, and Section 21A contemplates and permits the imposition of civil penalties in addition to criminal penalties.

Accordingly, the Second Circuit affirmed the district court’s imposition of a $92,805,705 civil penalty against Rajaratnam.

To read the full opinion, visit http://www.ca2.uscourts.gov/decisions/isysquery/d872ecd2-6641-4f7b-aeed-672dd427c454/6/doc/11-5124_op.pdf#xml=http://www.ca2.uscourts.gov/decisions/isysquery/d872ecd2-6641-4f7b-aeed-672dd427c454/6/hilite/

Summary by: Amy O’Brien​

 

 

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