Different River

”You can never step in the same river twice.” –Heraclitus

June 19, 2005

Prosecuted For Legal Acts?

Filed under: — Different River @ 5:26 am

If you follow business news, you probably know that New York Attorney General Eliot Spitzer has made his reputation lately by prosecuting big corporations — especially financial corporations like banks and Wall Street firms — for all sorts of vicious corporate crimes. Except, he has not actually been prosecuting these firms in actual courtrooms. Apparently what he does is investigate a firm for a few months, driving them nuts with subpoenas for all sorts of financial records — then he calls a press conference and accuses them of fraud, or some other form of “greed” invariably involving making money for “insiders.” The company is worried about being sued, the officers are worried about going to jail — so they cut a deal. Eliot Spitzer then calls another conference, claims a victory for the “little guy” and brags about how big a fine he got the company to pay for whatever it was they admitted to to avoid prosecution. The company doesn’t get sued, and Eliot Spitzer gets lots of great publicity for his anticipated run for governor without having to actually prove his case in court.

Which all worked fine until Theodore C. Sihpol, a mid-level broker at Bank of America, refused to play along. Spitzer accused Sihpol of mutual fund “late trading” — that is executing trades after 4:00 pm Eastern Time. Bank of America settled, but Spitzer went after Sihpol personally, and offered him a plea deal that included jail time, and Sihpol said no. So Spitzer filed 33 criminal charges, with a potential jail time of 30 years. Bank of America thew him to the wolves and refused to pay for his defense, even though he’d acted on their instructions (and probably would have been fired for refusing to execute the trades).

There’s only one problem with this: late trading is not illegal.. Or at least, the illegal part is not defined as “after 4:00 pm.” As the Wall Street Journal points out:

[W]hen Mr. Sihpol, a mid-level functionary, refused a plea offer that included jail time, the Attorney General came down on him like J. Edgar Hoover on John Dillinger, with multiple counts and potential jail time of up to 30 years.

This led Mr. Spitzer into the terra incognita of a jury trial, where he’d have to prove to a dozen men and women that “late trading” was illegal. In the normal course of things, mutual funds are valued once a day, in a price known as the Net Asset Value (NAV), usually after the New York market closes at 4 p.m. Mr. Spitzer argued that Mr. Sihpol, who had been helping Canary execute trades at the same-day price even after the 4 p.m. close, was a felon.

Mr. Spitzer’s public declarations had made the case seem a sure thing, and even we were inclined to think that on mutual funds he might be right. But Mr. Sihpol’s attorneys argued that nowhere in the pertinent law, the Investment Company Act, is there any mention of “late trading” or “4 p.m.” Rather, the law says only that trades can’t be made after the NAV is “next computed.” As it happens, many current-day NAVs are not set until approximately 5:30 p.m. Mr. Sihpol’s manual trade tickets were received before that time.

This helps explain why Mr. Sihpol had done his work entirely in the open, and with the approval of superiors. His attorneys argued that what Mr. Spitzer had called criminal–”late trading”–was in fact accepted practice, with no law prohibiting it. And, as it happens, in November of 2003 the director of the SEC’s enforcement division testified before Congress that more than 25% of broker-dealers responding to an SEC survey had reported that customers had placed or confirmed mutual fund orders after 4 p.m. and received the same-day price. The SEC later termed that estimate “conservative.”

Smaller firms actually advertised their ability to do post-4 p.m. trades, while leading law firms, including Akin Gump and Piper Marbury, advised their clients that such trading was permissible so long as they got the order in before the new computation. Prior to Mr. Spitzer’s September 2003 indictment of Mr. Sihpol, there had never been any SEC enforcement proceeding or other criminal prosecution based on so-called “late trading.”

Sihpol’s lawyers did not call a single witness on his behalf. Nonetheless, he was acquited on 29 criminal counts, and the jury deadlocked 11-1 for acquittal on the remaining four counts.

My prediction: Spitzer will not re-try Sihpol — but will continue to crow about how he’s fought the “scandal” of late trading, and will campaign for governor as if Sihpol had been convicted.

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