Three Notorious (Recent) Cases of Wire Fraud

Wire fraud is the act of fraud used in electronic communication. That’s simple. Easy to understand.

The American Supreme Court mucked things up — for the laymen — when they “several times observed the wire fraud statute has a long arm.,” Pasquantino v. United States.

Despite the Court’s statement, the truth is the wire fraud statute has been used in a broad range of activities in addition to having been applied in linking to other criminal statutes.

To put the code, 18 USC Section 1343 simply:

Wire crime-fraud is a crime for a person who has devised or intends to design a scheme to:

Defraud

• Obtain money using false pretenses
• Transmit by wire, radio or television communication any writings, signals, pictures or sounds for the purpose of executing a fraudulent scheme.
• To put it even simpler, wire fraud consists of coming up with a scheme to defraud and then using the country’s telecommunications networks to carry that plan out.
• A violation can be punished by a fine, imprisonment of not over twenty years or both.

Willie D

William “Willie D” Dennis, was sentenced to a year and a day on wire fraud charges.

According to the press release from the U.S. Attorney, Dennis was selling iPhones — and other electronics on eBay to overseas customers. When the money was sent to Dennis’ bank account through electronic transfers, Dennis would then provide the customer with a fake shipment tracking number and wouldn’t ship the phone.

Dennis, who gained fame as part of the Geto Boys recently spoke to a Houston TV station and tried to explain the issue.

“Someone did me wrong; someone stole my phone, so I did the same to someone else. I got the cash and didn’t send the orders. I felt vindicated in doing it at the time. Of course, I realize now I was wrong.”

Three Guys and a Hotel in Boston

A federal grand jury indicted three men Thursday on charges they attempted to hide a mob associate’s ownership in land near Boston where Wynn Resorts has planned to build a $1.5 billion casino.

So what got Charles Lightbody, Dustin DeNunzio and Anthony Gattineri in trouble? Prosecutors claim the three lied and forged documents to hide the fact that Lightbody, a well-known Mafia associate, was part owner of the undeveloped property in Everette — just north of Boston.

Arrested and charged with wire fraud, they were looking at up to 20 years in prison according to the Carmen Ortiz, U.S. Attorney. When it was over, all three were acquitted.

Real Housewife Star

When Teresa Giudice reported for her 15-month prison sentence, being a “Real Housewife” didn’t mean much.

Often a stigma is attached to prison terms by celebrities for committing white-collar crimes. Many people believe a celebrity spends their incarceration in “Club Fed.”

For Giudice, sentenced for her part in mail and wire fraud crimes, the general population made up her bunkmates. No tennis courts and golf courses for her.

Not only was Giudice stripped of her furs and jewelry, but she also gave up her $650,000 seasonal paycheck on the show. She was paid the whopping total of 40-cents an hour for working at various jobs while behind bars.

Teresa and her husband Joe pleaded guilty to bankruptcy fraud and conspiracy to commit wire fraud.  The pair hid assets and income when they filed for bankruptcy in 2009. They didn’t stop there. They also created fake W2s and tax returns so they could get millions in mortgages and constructions financing.

Teresa was released after serving 11-months in prison. Now, Joe is chipping away at his 41-month sentence.He faces deportation when he’s released.

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Employees of investment firms and professionals throughout New York City need to take note of a new possible threat: the Justice Department has announced new policies prioritizing the prosecution of employees for corporate wrongdoing. The Department of Justice (DOJ) is taking action to become more aggressive in prosecuting individual employees after years of criticism that it went “too soft” on Wall Street following the financial collapse. Part of the DOJ’s new policies focuses on encouraging companies to turn over evidence against executives, while there will also be a shift in how investigations are structured to focus on employees from the beginning.

The problem with these new policies is they are driven largely by politics, and they can encourage scapegoating of people with only tangential involvement in criminal acts or even with no knowledge they were participating in lawbreaking.

Defendants who are charged with white collar crimes like financial fraud, Sarbanes-Oxley violations, insider trading, and other related offenses can face lengthy prison terms and a ruined career. As the DOJ goes on a witch hunt to satisfy a vocal group crying out for prosecution of financial professionals, it is essential for those accused of wrongdoing to get appropriate legal help from a NY criminal defense firm with knowledge of how to handle complex financial crimes cases.

Justice Department Going After White Collar Crime

 The NY Times reported that the Justice Department is going to be taking a stronger stance in going after employees of corporations that commit crimes in part because of criticism that the DOJ has “punished few executives involved in the housing crisis, the financial meltdown and corporate scandals.”

A copy of the DOJ’s memo was provided to the New York Times and it describes several different policy shifts that are now going into effect.  For example, while investigations previously turned to individuals only after a settlement was negotiated with corporations, now investigations will focus on the people who allegedly commit crimes from day one when wrongdoing is identified.

During settlement negotiations, companies will also no longer receive credit for any cooperation with government authorities unless they identify employees who were involved in the alleged wrongful acts and turn over evidence against those employees.  Getting credit for cooperation can make the difference between being charged criminally and facing only civil penalties and getting this credit can save companies billions of dollars in fines. There will now be a strong incentive for businesses to turn on executives and other workers who they can point fingers at. While a spokesperson for the DOJ said they would not allow companies to put the blame onto “low-level officials,” the problem is, companies could still have incentive to turn over scapegoats to save their own business interests.

The DOJ’s new policies outlined in its memo are guidelines, and no new laws have been passed. The rules take effect immediately and it is expected that politicians campaigning for president will be invoking the new policies as a talking point on the campaign trail.  The fact that the policy change is likely politically motivated means that the DOJ may be focusing more on the optics of its actions and less on actually making sure that justice is done.

No defendant in a criminal case should be prosecuted to show a politician is tough on crime, but this is exactly what could end up happening. Anyone who is accused of wrongdoing in connection with any white collar crimes needs to understand his or her rights and build an aggressive defense quickly to avoid being made an example of.  A New York criminal defense lawyer can provide invaluable assistance to those who are accused of wrongdoing or who are under investigation by the DOJ and who need help protecting their future.  Even an accusation of wrongdoing can end a professional career, so don’t wait to call a lawyer who can help.  Contact Bukh Law Firm, PLLC today to get advice and representation from a lawyer you can trust.

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In response to allegations uncomfortably similar to those against former New York celebrity lawyer and arch Ponzi-schemer Marc Dreier, Fort Lauderdale attorney Scott Rothstein, head of Rothstein, Rosenfeldt and Adler, P.A., appeared in response to a criminal information in the U.S. District Court for the Southern District of Florida on Tuesday. The information charges Rothstein with one count of Racketeering Conspiracy, in violation of 18 U.S.C. § 1962(d); one count of Money Laundering Conspiracy, in violation of 18 U.S.C. § 1956(h); one count of Mail and Wire Fraud Conspiracy, in violation of 18 U.S.C. § 1349; and two counts of Wire Fraud, in violation of 18 U.S.C. § 1343, as well as criminal forfeiture, U.S. v. Rothstein, 0:09-cr-60331-JIC.

According to the criminal information, available here, from about 2005 through November 2009, Rothstein, and other “known and unknown” unnamed co-conspirators, allegedly unlawfully obtained approximately $1.2 billion from investors through a Ponzi scheme (outdoing even Dreier’s scheme). The Government alleges that Rothstein used false statements, documents and computer records to induce investors to loan money to alleged borrowers based upon fraudulent and fictitious promissory notes and bridge loans. Rothstein allegedly falsely informed investors that his law firm, Rothstein, Rosenfeldt and Adler, P.A.’s, clients requested short-term financing for undisclosed business deals and that the clients were willing to pay high rates of return for loans negotiated by Rothstein.

Rothstein also allegedly told investors that they could purchase at a discount confidential settlement agreements in sexual harassment and whistleblower cases in amounts ranging from hundreds of thousands of dollars to millions of dollars. Rothstein allegedly falsely represented that the settlement agreements would be repaid to the investors at face value over time. Rothstein allegedly represented to investors that the settlements were highly confidential in order to protect the reputations of the companies and executives involved; that the plaintiffs preferred to settle the claims rather than purse them in a public forum; that Rothstein, Rosenfeldt and Adler, P.A., would disburse the investors’ funds to the plaintiffs; that the firm would make payments to the investors pursuant to the payment schedules in the alleged settlement agreements; that the funds were maintained in designated trust accounts for the investors in accordance with the rules and regulations of the Florida Bar and were verified by independent sources, as well as numerous other alleged false statements regarding the settlement agreements, investment funds and the firm.

To effect the fraud, Rothstein allegedly established numerous trust accounts in Rothstein, Rosenfeldt and Adler, P.A.’s name; falsified statements from financial institutions and manufactured online banking information allegedly showing investors’ monies; created false and fictitious settlement agreements and other documents. Among the alleged false and fictitious documents was a court order in a case, purportedly signed by a Federal District Judge, which falsely alleged that Rothstein, Rosenfeldt and Adler, P.A.’s clients had prevailed in a lawsuit and were owed $23 million, when in fact the firm had settled the case without the clients’ knowledge and had obligated them to pay $500,000 to the defendant.

The information also alleges that Rothstein allegedly falsely told clients that, in order to recover funds, they had to post bonds to be held in Rothstein, Rosenfeldt and Adler, P.A.’s trust account. Over several years, clients wired approximately $57 million to a trust account controlled by Rothstein. Rothstein allegedly created another false Federal court order to conceal the scheme, providing that the funds were to be returned to the clients by a later date.

Rothstein used the funds acquired through the alleged scheme to fund the operations of Rothstein, Rosenfeldt and Adler, P.A., and to expand the firm. The firm grew to employ approximately 70 attorneys. Rothstein is alleged to have laundered the funds from the scheme through corporations, contributions and large bonuses and gifts to employees. The information alleges that Rothstein used the funds to make contributions to Federal, State and local political candidates in a manner designed to conceal the source of the funds and to circumvent Federal and State limits on campaign contributions; for charitable donations; to purchase controlling interests in restaurants in South Florida; and to hire members of local law enforcement to provide security for Rothstein, Rosenfeldt and Adler, P.A., and for Rothstein personally.

The enormous wealth amassed by Rothstein through the alleged scheme is apparent in the Governement’s forfeiture allegations, which seek forfeiture not only of a sum of $1.2 billion, but also of 24 properties in Fort Lauderdale, Lauderdale by the Sea, Boca Raton, Hollywood and Plantation, Florida; New York City and Narragansett, Rhode Island, including Rothstein’s 10% ownership in the Miami Beach mansion of late fashion mogul Gianni Versace, “Casa Casuarina.” Forfeiture is also sought of numerous business interests, bank accounts and jewelry, as well as 24 vessels and vehicles purchased by Rothstein, including a 55 foot yacht.

The Government also lists millions in political and charitable contributions by Rothstein which it seeks forfeiture of, including contributions to the Republican Party of Florida; Florida Governor Charlie Crist; Democratic Chief Financial Officer Alex Sink, who is running for governor; and two hospitals.

As reported in the Miami Herald here, and here, Rothstein started Rothstein, Rosenfeldt and Adler, P.A., in 2002 as an obscure attorney practicing employment law. Over the next six years, his net worth grew from about $160,000 to tens of millions. Rothstein used flashy wealth and connections in the Broward County social and business communities to lure wealthy persons to invest in his schemes. He befriended the rich and famous, including NFL Hall of Famer Dan Marino

George G. Levin, a wealthy Fort Lauderdale resident and hedge fund manager, gave $656 million to Rothstein to invest in settlements purportedly worth $1.1 billion. Levin helped Rothstein market investments in employment and sexual harassment lawsuits to investors, although he is not alleged to have been complicit in Rothstein’s crimes. Another of Rothstein’s clients, car-dealership mogul Ed Morse, claims that Rothstein defrauded him of $57 million, arising from the settlement of a contract dispute with an interior decorator.

Rothstein would allegedly give large bonuses to employees of Rothstein, Rosenfeldt and Adler, P.A. on the condition that they make campaign contributions to political candidates who Rothstein would specify. The Government has stated that the recipients of the political contributions have returned the contributions. The Florida Democratic Party has returned $200,000 and the Florida Republican Party has given back $150,000. After Crist won the Governor’s race in 2006, he appointed Rothstein to a panel which nominates Broward County judicial candidates. The Florida Democratic Party has called for an investigation of Crist. Rothstein also allegedly paid gratuities to local law enforcement officers to avoid scrutiny.

Rothstein’s scheme began to unravel over Halloween weekend, when investors began calling the firm for overdue payments and discovered the fraud. Rothstein fled to Morocco in October, taking $400,000 to $500,000 in cash with him and wiring $16 million to Casablanca. Rothstein reportedly sent e-mails to members of his firm that he was contemplating suicide, but he returned to the U.S. on a private jet in early November. He met with Federal authorities and provided details regarding his Ponzi scheme. FBI and IRS agents raided Rothstein, Rosenfeldt and Adler, P.A.’s law offices, and seized Rothstein’s real and personal property. Rothstein agreed to waive indictment, an indication that he is cooperating with the Government, although Rothstein’s counsel has denied that he has any deal with the Government.

The Government’s information does not name Rothstein’s alleged co-conspirators, however news reports suggest members of Rothstein’s inner circle at the law firm, and officers at Toronto Dominion Bank, where the investor trust accounts were held.

Rothstein’s alleged Ponzi scheme has been called the largest in the history of South Florida by Federal officials. The Florida Bar has disbarred Rothstein for stealing from the firm’s trust account. Rothstein, Levin and TD Bank are also being sued by a group of investors for more than $100 million.

Rothstein appeared in court on Tuesday in casual attire with a confident demeanor and pled not guilty to the information. U.S. Magistrate Judge Robin Rosenbaum ordered Rothstein jailed pending trial based on Rothstein’s flight to Morocco. Rothstein is represented by attorney Marc Nurik, oddly of Rothstein, Rosenfeldt and Adler, P.A. He faces up to 100 imprisonment if convicted.

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Investors who fall victim to investment fraud could face significant financial loss. Litigation provides recourse to investment fraud victims, but often shareholders and investors do not detect problems with the company they have invested in until the company is bankrupt or in serious financial trouble. A bankrupt company has limited or no assets to pay out to compensate shareholders for investor fraud.

Detecting red flags early on when a company is committing investor fraud is key to preserving and protecting financial investments. Unfortunately, News Wise reports that the majority of investors who are vigilant about looking for signs of corporate fraud track the wrong metrics. Those who are looking for fraud indicators may identify warning signs only after it is already too late to protect an investment and avoid loss.  As soon as warning signs are detected and possible investment fraud identified, those who stand to face losses should contact a NY investment fraud litigation lawyer for assistance in using the civil justice system to seek compensation.

Recognizing Investment Fraud

Researchers conducted a survey if 194 experienced non-professional investors who lived across 38 states in the U.S.  These investors were asked about their investment activities, the research they do, and the manner in which they work to identify fraud.  Specifically, investors were asked if they look for any warning signs and what specific red flags they watch for when seeking to identify fraud in an investment.

Factors that investors look for include things like SEC investigations and shareholder lawsuits.  However, by the time the SEC becomes involved or a suit has already occurred, the majority of more sophisticated investors will have caught earlier warning signs and sold their shares.

Some of the different red flags that more sophisticated investors tend to look for when trying to recognize investment fraud include high manager turnover; abnormally high revenue growth, and a change in the auditor of the company’s finances. Investors who track early warning signs were found to have higher returns on their investment portfolios than others in the study who focused on later warnings like SEC investigations or litigation.

As many as 25 percent of all respondents in the survey had experienced problems and lost money in the past as a result of investment fraud committed by companies they held shares in.  These investors who had experienced previous fraud-related losses were found to be no more likely than the other experienced non-professional investors to recognize early warning signs of a possible problem with a company that has been invested in.

Every shareholder needs to be watchful for possible signs of investment fraud to protect their financial interests.  In the eyes of the law, however, it is ultimately a corporations responsibility not to engage in dishonest behavior. A corporation or other business entity that publishes misleading disclosures or financial statements or that otherwise defrauds shareholders can find itself the defendant in an investment fraud or shareholder lawsuit.

Research revealed that most sophisticated non-professional investors have shares of stock in only five to 10 companies at a time. This means that investors who have a lot of money to invest could face significant financial losses if they have put a large chunk of their funds into a company engaging in fraudulent behavior.  These investors can seek to recover damages if they can prove fraud occurred.

Investment fraud cases can be complicated and shareholders/ investors as well as organizations accused of fraud should both be represented by a qualified and experienced New York litigation lawyer. Call today to schedule a consultation with an attorney who can provide assistance with litigation arising from allegations of investment fraud.

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A Ponzi scheme is a scheme in which unrealistically high rates of return are promised to investors. When new investors are lured by these promises and provide their funds to a money manager or financial advisor, money that the new investors pay in is used to enrich the person orchestrating the fraud scheme as well as to pay the existing investors. The scheme can continue until no new investors can be found and the money runs out.
Ponzi schemes are illegal and can result in federal securities fraud charges. Just recently, the Washington Post reported on a former worker from Fannie Mae who was sentenced to 13-years imprisonment for allegedly running a Ponzi scheme. The defendant will also be forced to repay $28.6 million to more than 170 different investors.

Ponzi Schemes Can Lead to Federal Criminal Charges

According to the Washington Post, the defendant who used to work for Fannie Mae operated an investment fund from 2006 through 2010.  He marketed his investments by claiming that he was using a “sophisticated trading strategy that protected against loss.”  He promised high rates of returns but allegedly made high risk trades that led to a string of losses. He was also accused of withdrawing as much as $2.5 million of investor funds for his own personal use.

The defendant claimed that he was innocent of the charges and that the investments he made for clients suffered losses as a result of the financial crisis.  The Securities and Exchange Commission and federal prosecutors did not believe the defendant’s claims and pursued both a criminal and a civil action.  The SEC obtained a civil judgment against the defendant.

When the defendant was represented by a public defender service, he entered a guilty plea in March of 2014.  A U.S. District Judge sentenced him to 13-years of prison in May of this year. The defendant has since filed a motion to withdraw the guilty plea.  The defendant is now claiming that it was market forces and not fraud that resulted in the string of losses.

The case is a clear illustration of the significant penalties that could follow investment fraud charges. The SEC and federal regulators have become aggressive in pursuing legal action against people who are believed to have violated securities laws.

The push towards aggressive prosecution and harsh sentences follow high-profile investment fraud cases like Bernie Madoff. These are cases in which investors lost significant sums of money. The stories about these alleged instances of fraud always feature sympathetic victims, like a children’s charity that invested with the defendant in this most recent case.  What the stories often ignore, however, is the complexity of investment markets and financial transactions that occur within those markets.

Defendants could be accused of participation in a Ponzi scheme if authorities believe that their intentions were to mislead investors, but there may be a fine line between a legitimate investment fund that suffers losses and a scam that is in violation of the law.

Those who are accused of any type of investment fraud offense need to ensure they are represented by a legal professional who understands the complexities of the securities and commodities markets and who is prepared to help make the best possible arguments to try to avoid conviction.

An attorney with experience in investment fraud should also be consulted for assistance before a plea deal is negotiated or before a defendant in a securities fraud case decides how to plead. With the potential for decades of imprisonment and the push for tough prosecution of financial crimes, the stakes are too high not to have a good lawyer.

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The Ninth Circuit Court of Appeals, sitting en banc, recently decided a fraud case holding that a person may commit federal fraud and face imprisonment for breaching a broadly-defined fiduciary duty to a contractual business partner. This holding arises under the “honest services” fraud statute, presuming the breaching party also has a specific intent to defraud. See United States v. Milovanovic, 2012 WL 1398647 (9th Cir., April 24, 2012). The Court explained that the honest services fraud statute is not limited to formal “fiduciary” relationships that are well-known in law, but also extends to any “trusting relationship in which one party acts for the benefit of another and induces the trusting party to relax the care and vigilance which it would ordinarily exercise.” Is this definition clear enough to ensure that persons will have fair notice of of what constitutes a qualifying fiduciary duty?

The Supreme Court has upheld the constitutionality of the “honest services” fraud statute, see Skilling v. United States, 130 S.Ct. 2896 (2010), against challenges that it is unconstitutionally vague, explaining that the vast majority of “honest services” cases involve offenders who, in violation of a fiduciary duty, participate in bribery or kickback schemes. But Skilling does not define the limits of fiduciary relationships.

Milovanovic was an independent contractor retained by a company that provided translation services to government agencies, and in this instance for a state agency that oversaw commercial trucking drivers’ licensure. The State had contracted with a private company to provide testing services to prospective truck drivers. Milovanovic allegedly helped prospective drivers who did not speak English well, by telling them the answers to questions on the exam while he was purportedly “translating” the questions for them, in exchange for a payment, of course. When charged with depriving the State of its right to honest services, Milovanovic (and others involved in the scheme) argued that he had no agency or employment relationship with the State, and as an independent contractor owed no fiduciary duty; therefore, he could not have deprived another of any “honest services” as required by the federal statute.

The Ninth Circuit explained that the existence of a fiduciary duty in a criminal prosecution is a fact-based determination for the jury, and offered some support for instructing a jury on what constitutes a qualifying fiduciary. Those instructions should acknowledge that the mere fact of a business relationship between two persons does not mean a fiduciary relationship exists, and that mere direction and supervision by one person over another is also insufficient. It is only when one party places, and the other accepts, a special trust and confidence – usually involving the exercise of professional expertise and discretion – that a fiduciary relationship exists. However, the fact that parties memorialized or labeled a relationship as being that of an independent contractor, is not a basis for concluding that no fiduciary relationship exists.

Other circuits have wrestled with the difficult definitional limits of fiduciary relationships. Chances are, they will continue to wrestle with it. In the meantime, parties with contractual relationships in which there is an arguable element of trust, and some reduction in vigilance in one party dependent upon the other, beware.

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On May 20, the Securities and Exchange Commission charged James Putman the top executive at Wealth Management, LLC, an Appleton, Wisc.-based investment advisor, who was past president of the National Association of Personal Financial Advisors, with accepting $2 million in kickbacks on client investment pools. The company’s former president and chief investment officer, Simone Fevola, was also charged.

Filed in the U.S. District Court of Eastern Wisconsin, the civil suit alleged that Putman and Fevola breached fiduciary duties by placing their clients into investments not suited for them. The regulator also accuses the pair of fraud, saying they misrepresented the safety and values of client assets. The company has been placed into receivership, and its assets, as well as client investment pools, have been frozen.

Putman served as president of NAPFA from 1996 to 1997 term, but is no longer a member of the non-profit industry organization, said NAPFA chairwoman Diahann Lassus, co-owner of Lassus Wherley, a fee-based financial advisory firm in New Providence, N.J.

“While we are disappointed with the action taken by the SEC, we will continue to work cooperatively with them and anticipate a prompt and favorable resolution of these issues either through discussions with the SEC or the judicial process,” according to a statement from Putman released today. “I offer my sincere apologies to Wealth Management clients and staff for the concern and controversy this is causing.”

Putman also said the company had been working with the SEC on regulatory reporting requirements for the past 10 months.

From May 2003 through August 2008, the SEC alleges, Putman and Fevola each accepted $1.24 million in undisclosed payments to steer clients into illiquid investments, which violated fiduciary practices, said Robert Burson, a senior associate director of the SEC’s Chicago regional office. After their customers asked for low-risk, income-generating products, Wealth Management, used about $102 million of their money to fund real estate projects and viatical settlements, which are personal loans secured by life insurance policies, Burson said. The SEC is still investigating the situation.

But Wealth Management, which serves high-net-worth clients, may also have committed fraud when it overstated the values of the investment pools and when it collected management fees and paid out redemptions based on those inflated numbers, criminal attorney alleges. According to Wealth Management’s ADV statement, the company maintains custody of client assets. By press time Tuesday morning, was not clear whether the firm faces criminal fraud charges.

Wealth Management’s alleged wrongdoings fall against a backdrop of debate on the future role of financial market regulators, but it is not clear whether the incident will add to calls for reform. “The reality is that this situation, in comparison to the Madoff scheme, and many other things that have happened out there, is very small,” Lassus said. That the company had custody of client assets could raise red flags, because if the company were making direct investments in alternative products, clients would not have had the benefit of an outside custodian tracking the values of those investments, she said.

If Putman’s membership in NAPFA was current, the situation would have been turned over to the organization’s ethics committee, and he ultimately could have been banned.

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Moin Yahya has posted The Legal Status of Dump and Sue. Here’s the abstract:

There is some evidence that plaintiffs and their attorneys are profitably short-selling the stock of the companies they intend to sue. The status of such short sales is undecided in the law. Lawsuits against companies can cause large drops in market value, and hence such an action by the plaintiff should cause concern. Plaintiffs, however, are not traditional insiders, and they do not owe the shareholders any fiduciary duties. They can therefore consent to their attorneys also short-selling the stock of the defendant corporation. The attorneys need to receive such permission to avoid misappropriating the information concerning their client’s decision to sue. A plaintiff’s decision to sue after short-selling does not constitute market manipulation in the traditional sense, since the decision to sue is a true fact that causes the drop in the share price as opposed to those who commit fraud by spreading false negative stories about the company. Plaintiffs need, therefore, to be legally deemed temporary insiders until they publicly reveal their intention to sue or actually sue. The reasons for deeming them insiders, and hence prohibiting them from short-selling, are threefold. First, allowing such activities would raise the same concerns regarding market integrity raised by those opposed to insider trading. Second, allowing such short-selling is a form of fraud by silence against those who purchase the shares. Third, allowing short-selling would give the plaintiffs double recovery for their lawsuit, as they could gain a large share of their claim against the company from the profitable short sales in addition to any verdict or settlement. Furthermore, proposals to extend Regulation FD to plaintiff’s attorneys would be ineffective in combating the harm from such short-selling. The law, therefore, through either developments by the courts, regulatory promulgations by the SEC, an act of Congress, or a combination of any of the preceding three mechanisms should be used to treat plaintiffs as insiders until they sue or announce their intention to sue.

If a plaintiff or his lawyer (with the plaintiff’s permission, so no misappropriation) is short-selling based on the true information that a suit is forthcoming I don’t see how this is illegal under current law – it’s not fraud without a duty to disclose, and it’s probably not illegal insider trading or manipulation.

Should it be illegal? Yahya argues that this trading in effect permits “double recovery.” Assuming there’s extra-compensatory recovery, is this a problem? That depends on whether there are excessive incentives to sue. Where the suit is representative, and the plaintiff must share recovery with others, the incentives otherwise may be too weak rather than too strong to encourage the socially optimal amount of litigation. Even in an individual claim the recovery may not reflect the full deterrence value, and therefore the social benefit, of the suit.

It follows that allowing short-selling theoretically might compensate the plaintiff or the class lawyer for producing the information that led to the suit where capitalizing on the information before it becomes public otherwise might be difficult.

Bruce Kobayashi and I explored a similar issue in Class Action Lawyers as Lawmakers. We suggested incentivizing lawyers who write socially valuable class action complaints through fee awards that do not depend on the winner-take-all lead plaintiff selection under the current version of the Private Securities Litigation Reform Act. I wonder if short-selling might be an alternative approach to the same problem.

Now, I can already hear the moaning about evil plaintiffs’ lawyers, and I sympathize. But litigation abuse might be better resolved through procedural rules that filter out the bad cases.

This is basically an issue of property rights in information. Law and economics types who argue for recognizing such property rights in, e.g., tender offers and insider trading, should similarly be willing to devise reward systems to encourage adequate production of litigation information.

Originally posted by Prof. Larry Ribstein on Ideoblog

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Today’s WSJ summarizes the debate between Thaler, a leading skeptic of market efficiency, and Fama, the leading defending of the efficient capital markets hypothesis. As the article notes, the debate could have implications for privatizing social security. It quotes Thaler as saying, “[i]f you give people 456 mutual funds to choose from, they’re not going to make great choices.” The result may be that the securities markets get detached from fundamental values and misallocate resources.

Thaler concedes that “it is not easy to beat the market, and most people don’t.” This is an important point, since it follows that we have no alternative to accepting the wisdom of markets, even if it’s imperfect.

But even if we can’t beat the market, we should be concerned if the market is detached from real values, because then investment dollars would be misallocated. On this point Thaler has little doubt, saying that Fama “is the only guy on earth who doesn’t think there was a bubble in Nasdaq in 2000.” In fact, Fama’s not alone, as I’ve noted.

Assuming markets are inefficient in the weaker sense just noted, what should we do about it? Those who align with Thaler suggest that privatizing social security would further misalign securities prices from value by bringing more irrational investors into the market. The WSJ says that “in a rational world, share prices should move only when new information hit the market. But with more than one billion shares a day changing hands on the New York Stock Exchange, the market appears overrun with traders making bets all the time.”

My main point here is that this conclusion, if true, has implications beyond social security. As I’ve noted, our securities laws are based on the principle that markets should be safe for ordinary investors. If we’re really concerned about a lot of irrational investors running around, then we should be skeptical not only about privatizing social security, but about the securities laws as well. This would mean drastic revisions of disclosure rules, and being honest with investors and voters about what the securities laws are able to accomplish. Investors are either rational or irrational. Public policy should follow logically and consistently from whichever conclusion we choose to accept.

Originally posted by Larry Ribstein on Ideoblog.

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Includes the counties of Bronx, Kings, New York, Queens and Richmond

Note: The 2001 data presented here exclude the offenses which occurred in the September 11^th attacks on the World Trade Center (2,795 homicides and 7,233 aggravated assaults as of December 17, 2002).

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