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Regulatory Change: 2015 Diagnosis, 2016 Prognosis Schulte Roth & Zabel's leading securities litigation practice HAMLIN LOVELL


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HFJ visited the New York office of Schulte Roth & Zabel LLP (SRZ) and met with partners from the firm's Securities Litigation


Group. With offices in New York, Washington DC and London, SRZ is a leading law firm serving the alternative investment management industry.


SRZ is among only a handful of law firms to have successfully defended a federal securities fraud class action all the way through trial to a jury verdict of no liability. The lawyers in the firm's leading securities litigation practice routinely handle complex multi- year matters involving high-profile financial and investment management companies and their officers involved in investigations and cases.


In recent years, regulation has become a leviathan, riddled with traps for the unwary that can lead to arbitrary, disproportionate and perverse sanctions. Elsewhere, the lack of clearly defined rules creates uncertainty over areas such as determining investor collusion or defining bribery. The absence of preventative policies and procedures is increasingly sufficient for sanctions, without any actual or intended wrongdoing.


SRZ is helping clients navigate through these treacherous waters, where one omitted policy or wrong step can suddenly result in managers being caught in the net of many other regulations. The firm's litigators are always thinking laterally about how clients could be impacted by regulations that have federal criminal, regulatory civil and private civil dimensions, sometimes involving multiple regulators, self-regulatory organisations and multiple plaintiffs. Hedge fund managers also need to think laterally about how their firm-wide positions over multiple investment vehicles, and/or across the capital structure of an investee company, could be aggregated for regulatory purposes.


SRZ's Litigation Group includes nine former Assistant U.S. Attorneys and two former Securities and Exchange Commission (SEC) officials. When THFJ met with the SRZ partners, the discussion was led by Howard Schiffman, co-chair of the Litigation Group and a former SEC Division of Enforcement trial attorney. Joining Schiffman were SRZ partners contributing in their specialist areas – Eric A. Bensky, Brian T. Daly, Harry S. Davis, William H. Gussman, Jr., David K. Momborquette, Gary Stein and Michael E. Swartz. Other key members of the securities litigation practice include Martin L. Perschetz, co-chair of the Litigation Group and a former federal prosecutor, and Charles J. Clark, litigation partner and a former SEC official who recently joined the firm.


The SRZ partners touched on the following nine hot topics during the informative discussion.


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INSIDER TRADING: NEWMAN IS NOT AN END GAME SRZ attorneys recently updated and expanded the Insider Trading Law and Compliance Answer Book 2016, a book published by Practising Law Institute and edited by Harry Davis.


Schiffman believes the seminal Newman judgment was the biggest securities law issue in 2015. "After Newman held that the remote tippees in that case were not liable, the government was pressured to meet a higher standard of proof of pecuniary benefit", Schiffman explains. Adds Davis, "Newman is a hot-button issue about breach of duty and the way courts look at it. There has to be a tangible personal benefit to the tipper and the downstream tippee must know of it".


The SRZ lawyers said they did not think that the Justice Department would succeed in its attempt to have Newman reversed, and the Supreme Court's denial of the government's appeal proved that prediction correct. Now that Newman is final, some former convictions have been overturned, such as that of SAC Capital's Michael Steinberg.


Newman Impact to Be Reduced Not Reversed However, there is no cause for complacency. Schiffman believes the impact of Newman could be reduced in several ways. "Newman could be more narrowly interpreted, with the benefit to tippers re-defined in a narrower range; other judgments could supersede Newman; and the courts could limit the impact of Newman". Already Schiffman has seen signs of this in the Ninth Circuit (covering Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon and Washington), and he admits that "the defense bar had hoped for a higher standard of proof".


Additionally, "Newman is only binding in the Second Circuit (New York, Connecticut and Vermont )", Davis points out and, accordingly, "the SEC could bring many of its cases in other jurisdictions in order to attempt to avoid the impact of Newman". Moreover, the Department of Justice could seek to prosecute insider trading under the umbrella of other statutes, Stein explains, and try to "argue that personal benefit does not apply" under those laws. But the SEC has no jurisdiction to enforce these criminal laws.


Overseas Collaboration And outside the United States, different rules apply – Greenlight Capital's David Einhorn fell afoul of the UK rules but not the then US rules. The United States is often characterised as "the world's policeman" in matters of defence, and increasingly many US regulators seem to have extraterritorial ambitions, now including the SEC. Indeed, Davis points out


how "the SEC acts as a conduit for investigations elsewhere, such as FCA investigations, which go through the SEC Office of International Affairs". This unit has been issuing subpoenas initiated by regulators from countries including the United Kingdom, France, Spain and Brazil. "The only country we would not expect to see involved is Switzerland, as their secrecy laws could preclude them from reciprocating", opines Davis.


Private Civil Claims Separately from any criminal or civil actions instigated by US or overseas regulators, private parties (including hedge funds) can bring their own claims against alleged inside traders on a civil basis (though any disgorgements to the SEC are typically offset against those paid to private claimants). In addition, funds are increasingly opting out of securities class actions and bringing individual actions in an effort to maximise recoveries. Swartz counsels that on the defense side, "we are seeing more cases being brought against funds in a wider range of areas."


Credit and Debt Markets Additionally, insider trading now reaches well beyond public equity markets, in particular, into credit and debt markets. Schiffman has seen "allegations of insider trading in bankruptcy cases in relation to equitably subordinating a claim". What is perhaps most surprising, he adds, is that even after companies have "cleansed" the market by disclosing material non-public information, in accordance with trading protocols, "there can still be allegations that information might have been shared with informal, ad hoc committees of creditors that might be involved with out-of-court restructurings". Momborquette concurs with all of this: "Though Newman gets tremendous focus, we do not see them taking the foot off the gas on insider trading, which remains a big focus of SEC examinations and enforcement. We see no sign that the volume of civil insider trading cases is going down".


HIGH-FREQUENCY TRADING (HFT) RELATED ACTIONS Yet Momborquette does entertain the possibility that market manipulation-related actions "could at some stage replace insider trading as the core focus for the SEC". Schiffman recently handled a big investigation "that raises very significant issues". Next year, he anticipates some "gigantic sell-side HFT cases, as the SEC is really concerned with HFT". The cases are likely to focus on specific aspects of HFT where there is potential for market abuse. There is no general campaign against HFT and some associated practices (such as exchange rebates for liquidity providers) are not a major issue, as Schiffman thinks the SEC has historically said these are appropriate if disclosed.


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