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Ray
Dirks v. the SEC, Part II
Brian
Trumbore
President/Editor, StocksandNews.com
I thought I would clean up some loose
ends on the Ray Dirks story. If you didn't read part
I, the following won't make any sense to you.
And admittedly this is very dry stuff, but the case
of Raymond L. Dirks v. Securities and Exchange Commission
was an historic one and helped define insider trading,
as well as the treatment of whistleblowers, analysts
and the press. As you read the full tale, though,
it's also more than a bit apparent that the SEC has
continually failed to execute its regulatory duties,
decade after decade.
Reminder,
the Justice Department under the presidency of Ronald
Reagan fought for Dirks when he took his suspension
all the way to the U.S. Supreme Court. Following are
further details, in the solicitors' words, of the
'brief' filed by Dirks' supporters. The High Court
later reversed the ruling of the Appeals Court and
Dirks was cleared. [Note: "Commission" refers to the
SEC and I have substituted Dirks where "petitioner"
was used to make it a little easier to read.]
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Both
the state and the public at large have an interest
in exposing corporate misconduct. Ordinarily, we would
expect that official law enforcement agencies would
be sufficient for that task, but this case shows that
the organs of government are not always able to accomplish
swift investigation of possible crimes. The press
also has an historic role in discovering and exposing
wrongdoing, but here, too, the press failed to move
as quickly as Dirks, who had more immediate financial
and reputational incentives to discover the truth
about Equity Funding?.
The
Commission's erroneous imposition of liability in
this case has serious consequences for federal law
enforcement, which frequently depends on private initiative
to uncover criminal conduct. If the antifraud provisions
of the federal securities laws, backed by administrative,
civil, and criminal sanctions, forbid analysts to
trade with or transmit evidence of crime obtained
through honest investigation, then few analysts will
have an incentive to invest the resources needed to
investigate corporate frauds like the Equity Funding
fraud. Few analysts will be willing to devote substantial
resources and expose themselves to personal danger
to investigate rumors of crime - as Dirks did - if
they are forbidden to utilize the information they
obtain until after it is fully revealed to the investing
public?.
The
Commission and the court of appeals concluded that
Dirks was subject to a duty to disclose to the public
at large his evidence of criminal conduct or abstain
from passing it on to anyone. The premise of that
conclusion was that the sources of the information
- present and former officers of Equity Funding -
were subject to a fiduciary duty to the company's
securityholders. The Commission believed that Dirks
"assumed" that fiduciary duty simply by receiving
the information, and that this prevented him from
either tipping or trading?.
?The
information at issue in this case - evidence of a
massive, ongoing criminal scheme - was not "confidential"
information available "only for a corporate purpose."
Evidence of crime is not the private property of anyone.
It is not amenable to "conversion." Those who discover
it and spread the news to others are not guilty of
misappropriation or theft. Quite to the contrary,
any effort to disseminate such information is encouraged
by the law, while efforts to preserve its secrecy
are strictly forbidden?.
?Secrist
(the Equity Funding official who first went to Dirks),
originally provided the information and monitored
its use, (intending for Dirks) to divulge the information
to institutional traders who would precipitate large-scale
market activity, and thereby hasten the investigation
and termination of the fraud. Secrist also gave his
permission to convey the information to the Wall Street
Journal. Dirks' communications with the auditors further
advanced Secrist's stated objective of exposing the
fraud. And, precisely as Secrist anticipated, Dirks'
activities quickly achieved the desired objective
while regulatory authorities lagged behind. Far from
inflicting a tortuous injury on the corporation, Dirks'
actions served to expose and terminate corrupt wrongdoing
by some of its highest ranking officials?
As
(Appeals Court) Judge Wright observed, "Largely thanks
to Dirks one of the most infamous frauds in recent
memory was uncovered and exposed," while governmental
authorities "repeatedly missed opportunities to investigate
Equity Funding." The Commission also acknowledged
Dirks' "important role in bringing Equity Funding's
massive fraud to light", but concluded that its censure
order would not "chill" other analysts in the "investigation
of rumors" of similar corporate frauds. We are not
so sanguine about the impact of the Commission's order
on the private investigation of corporate crime?..
Dirks
spent several weeks investigating Secrist's allegations
- on his own time, at his own expense, and despite
substantial personal danger. The direct result of
his investigation was that the price of Equity Funding
stock fell dramatically, trading was suspended, and
government authorities ultimately took remedial action.
As the principal architect of the Equity Funding fraud
conceded, Dirks deserves "personal credit" for uncovering
it. Had Dirks not taken action, the illegal scheme,
which lasted for nearly a decade, could have persisted
for an additional period of time - causing even greater
injury to the public?.
The
Commission's decision in this case (to suspend Dirks)
threatens to undermine, rather than enhance, investor
confidence. If administrative rulings strip away the
incentive of security analysts to investigate frauds,
there will be more frauds in the future and they will
persist for longer periods of time. By contrast, if
investors may continue to expect that competent analysts,
acting in their own economic interest, will assist
the government in policing the securities markets,
their reliance on the integrity of the marketplace
will be strengthened?.
It
was inevitable that the Equity Funding fraud would
have victims. Because of Dirks' actions leading to
the discovery of the fraud, there were fewer victims
than there otherwise would have been. And to the extent
that private parties retain an incentive to act as
Dirks acted there are likely to be fewer victims of
such frauds in the future.
Respectfully
submitted,
Rex
E. Lee, Solicitor General
Dl Lowell Jensen, Assistant Attorney General
Stephen M. Sharpiro, Special Assistant to the Solicitor
General
Roger M. Olsen, Deputy Assistant Attorney General
October,
1982
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Note:
As part of the investigation into the fraud, it was
discovered that of more than $3 billion worth of life
insurance ostensibly issued by Equity Funding between
1964 and 1973, more than $2 billion proved to be fictitious.
Source:
U.S. Department of Justice archives, briefs / 1982
Brian
Trumbore
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