By Sarah N. Lynch and Aruna Viswanatha
WASHINGTON, March 10 As the U.S. Securities and
Exchange Commission seeks to become a more formidable force in
the courtroom, a string of trial defeats in the past six months
has exposed a weak spot: witness testimony.
In four of the five trials that the securities regulator
recently lost, the jury or judge were not convinced by the
witnesses brought in by SEC litigators, according to court
transcripts, rulings and interviews with defense lawyers.
While there were also other factors influencing the
verdicts, some legal experts said the issues with witness
credibility were significant and reflect the need for SEC
litigators to better vet and prepare their witnesses - or drop
cases where they aren't strong enough.
One trial the SEC lost in December involved the chief
financial officer of website management company NIC Inc
, who was accused of helping to hide $1.18 million in
alleged personal expenses incurred by the CEO at the time.
The SEC summoned accountant Steven Henning as an expert
witness and he testified that he had gone through NIC's records
and found almost no receipts for more than 5,000 expenses logged
by the CEO, ranging from flights to jewelry purchases to $5,250
worth of gift certificates from Kansas City Steak Company.
Defense lawyer Nicole Rabner, who represented NIC CFO
Stephen Kovzan, poked holes in Henning's review by pointing to
what appeared to be legitimate reasons for some of the items.
Some of the flight bills, for instance, matched up with business
trips. A company ledger confirmed the CEO had reimbursed NIC for
a jewelry purchase. And a letter to the Kansas City Steak
Company showed the gift certificates were meant as holiday gifts
for employees, according to a trial transcript.
U.S. District Judge John Lungstrum said he was "a little
troubled" by Henning's methodology and considered tossing out
his testimony. An SEC lawyer defended Henning, telling the judge
that he had "scoured the record in this case trying to find a
business purpose" for the expenses.
Lungstrum ultimately decided to let the testimony stand.
The jury cleared Kovzan of all charges. It is difficult to
know for certain what factors determined the verdict, but
Kovzan's defense team viewed Henning's cross-examination as one
of the critical reasons.
Henning, a partner with the accounting firm Marks Paneth &
Shron LLP, stands by his testimony. "As a CFO, a person is
responsible for maintaining adequate books and records," he
said. "Irrespective of the verdict, that is still true."
Kovzan declined to comment through an NIC spokeswoman.
Without commenting specifically on individual cases, the SEC
said it was not concerned about recent trial losses, which
reflect the regulator's efforts to pursue challenging cases.
"I'm very confident in our trial unit," SEC Chair Mary Jo
White told Reuters on the sidelines of a conference last month.
"Trials are not always predictable or easy. You can't win
every case," said White, who was known to be a hard-nosed
Manhattan federal prosecutor before she moved into private
practice and then joined the SEC in April last year.
The agency scored a high-profile win last summer, when a
jury found former Goldman Sachs Vice President Fabrice
"Fabulous Fab" Tourre liable for fraud in connection with a
failed mortgage deal.
But the SEC's trial win rate has fallen to 58 percent since
the start of its current fiscal year on Oct. 1, compared with 76
percent to 84 percent in recent years, according to SEC data.
Of the 12 cases that the SEC has received verdicts or
rulings on since the fall, it suffered a full defeat in five and
clearly won three. In four other trials, the agency was dealt
mixed verdicts that found the SEC did not prove its case on all
of the allegations it put forth. (See factbox [ID: nL1N0LW2M0])
Whether the losses represent a minor blip or a broader trend
remains to be seen. The cases were all green lighted before
White's arrival, but the losses come at a crucial time as she
has pledged to extract more admissions of wrongdoing - which
means the SEC is prepared to take more cases to court, rather
than settle them at negotiating tables.
'LEAKY WATER PISTOL'
The problems are particularly acute in insider trading
cases, which are often based on circumstantial evidence and
witness testimony. Of the five cases the SEC recently lost,
three involved insider-trading allegations.
One of those losses was against Dallas Mavericks owner Mark
Cuban, who was acquitted of insider-trading charges in October.
He is a vocal critic of how the SEC handles its cases, and has
been buying transcripts of SEC trials and publishing snippets on
his blog, Blog Maverick.
In another insider trading case, a judge in January cleared
retired engineer Larry Schvacho of charges that he traded on
inside information about the sale of staffing company Comsys IT
Partners Inc to rival ManpowerGroup Inc in early 2010.
Schvacho was close friends with Larry Enterline, then CEO of
Comsys. They had dinner the day Manpower first expressed
interest in Comsys and, as Comsys was considering the merger,
the two called each other almost daily and went on a sailing
trip together, according to the facts established at trial.
Schvacho, who had long traded in Comsys stock, bought more
than $750,000 worth between November 2009 and February 2010, and
sold around half his holdings the day the merger was announced.
In documents filed before trial, the SEC said Enterline had
denied providing Schvacho any information "knowingly," but the
agency said it believed he did reveal news about the merger
because he trusted his best friend not to trade on it.
At trial, Enterline testified that he had never provided
Schvacho with any inside information, and that he did not
discuss Comsys business matters with people outside the company.
"The SEC's interpretation of the evidence is contradicted,
convincingly, by the testimony of Enterline," U.S. District
Judge William Duffey in Atlanta wrote in his ruling. "There is,
at most, scant, unconvincing circumstantial evidence."
A lawyer for Schvacho, former SEC attorney Ross Albert,
said, "The SEC was looking for a smoking gun, but wound up with
a leaky water pistol."
The SEC defended its decision to pursue insider trading
cases like the one against Schvacho, and said that even if such
cases are not suitable for criminal prosecution, civil actions
would still be appropriate.
"We're proud of our long record of success at trial in
difficult cases," said Andrew Ceresney, the SEC's enforcement
director and a former federal prosecutor. "We will continue to
bring aggressive cases to protect investors and hold wrongdoers
UPPING ITS GAME
About seven months ago, the SEC made structural changes to
try to up its game by pairing investigators and trial attorneys
earlier in the process. The agency has also sought help from a
jury consulting service to help determine the effectiveness of
its arguments, and in recent years built a team of economists
with a strong background in litigation support services.
Some legal experts say the SEC is outspent by the defense
bar when it comes to litigating cases, though at times the
agency has shown it is able to pay substantial amounts for trial
support. Henning, for instance, received $600,000 for his work
on the NIC case.
Getting partners from top accounting and consulting firms to
be expert witnesses for the SEC can also be a problem because
they work for major U.S. companies and either cannot testify
against them due to conflicts of interest or do not want to
because they see them as potential clients.
"I think they have an expert witness problem," said Michael
Perlis, a partner at Locke Lord LLP, who handles SEC litigation
and previously worked in its enforcement division. "Most of the
... major experts are people that won't testify for them."
Last year, the SEC pursued two former executives of Basin
Water Inc, who were accused of improperly recognizing revenue to
disguise the water treatment equipment maker's financial
performance. In a 44-page ruling in December, U.S. District
Judge Manuel Real found fault with four of the eight witnesses
the SEC called.
Real wrote that he "places little weight on the substance"
of some of the witnesses' testimony, and that he was not
convinced by the SEC's expert witness, whose methodology he
called "unreliable." He rejected the securities fraud case. The
SEC is currently appealing the ruling.
Matt Solomon, head of the SEC's trial unit, said expert
witnesses on both sides are routinely challenged in court. "As
every experienced trial lawyer knows, there are nits you can
point to in any trial. There is no such thing as a perfect trial
for either side."