Proposed “Fair Fund” for CR Intrinsic Case Stirs Dustup among SEC’s Commissioners

In the right kind of enforcement action, the SEC can take the money it’s generated and set up what’s called a Fair Fund to redistribute that money to harmed investors.  But what is the right kind of case?  This procedure was established as part of the 2002 Sarbanes-Oxley law, and it’s relatively easy to contemplate such funds in the context of the giant accounting fraud cases that spurred that law.  Commissioners Dan Gallagher and Michael Piwowar strongly believe the SEC’s massive insider trading case against CR Intrinsic isn’t the right vehicle for it.  I tend to agree.

With a Ponzi scheme, it is quite clear what investors have lost.  In an accounting fraud case, a large swath of investors has arguably bought shares at inflated prices and can measure the difference between what they paid and what they should or would have paid with complete information.  But an insider trading case is different from most of the enforcement cases the SEC handles.  As Gallagher and Piwowar put it:

Fair funds can play an important role in returning money to defrauded investors, but in this case it will be incredibly difficult and expensive to identify and compensate the victims. In fact, it may not be possible to know who was harmed.

They’re right.  Pinpointing who the counterparties are in insider cases is really hard, painstaking work that falls on the shoulders of the SEC market surveillance staff.  Which is why we said on Twitter yesterday: “That fund is ludicrous.”  Maybe a little harsh.  If you follow that last link, you’ll see that Alison Frankel at Reuters wondered why we said that, and we basically recited the quote from Gallagher and Piwowar above.

Bruce Carton then jumped in and, to my mind, pointed out the tension in fair funds for insider trading cases.  He said, “If your trade is matched with a purchaser/seller with inside info you’re a victim. If not, then not a victim?”  Leaving aside how hard it is to find those people, it sounds sensible, right?  Then he said, “So if you sell at market price then it is just luck of who you’re matched with that determines if you’re a victim?”  Hmmmm.  Well, yes.  That is exactly how it would have to go.  Here, a trader who bought shares in the two pharmaceutical companies at issue would either be a victim or not a victim based on who the counter-party was on particular days – in faceless, electronic transactions.  If they were lucky enough to have been matched with CR Intrinsic, they win a piece of the fair fund.  If not, they lose.

Does that seem, um, fair to you?  I don’t think the benefits of distribution to these particular investors outweigh the significant administrative costs involved. Of course, the alternative is to send the money to the general U.S. Treasury.  Maybe not very satisfying, but here we are.