A general exterior view of the U.S. Securities and Exchange Commission (SEC) headquarters in Washington, June 24, 2011. REUTERS/Jonathan Ernst ·Reuters
Reuters
By Sarah N. Lynch and Aruna Viswanatha
WASHINGTON (Reuters) - 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 (EGOV), 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 (GS.N) 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 October 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 )
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. (For a video of Cuban's comments, go to http://reut.rs/1mhILV4)
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 (MAN) 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 accountable."
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."
(Reporting by Aruna Viswanatha and Sarah N. Lynch; Editing by Karey Van Hall and Tiffany Wu)
