Corporate Finance & Securities

SEC Fails to Prove its Case; “Where’s Waldo?” Defense Prevails

The SEC failed to prove that Citigroup banker, Brian H. Stoker, had violated securities laws. A federal jury found that the SEC did not meet its burden of proving that Mr. Stoker knew or should have known that his statements were misleading in the documents prepared for the sale of a collateralized debt obligation based on subprime mortgages in 2007.

Citigroup settled with the SEC to resolve the civil charges, agreeing to pay $285 million in penalties.

The SEC did not bring any Rule 10b-5 claims—arguably its strongest securities fraud weapon—which requires showing intentional or reckless behavior. However, the claims it did bring under Section 17(a)(2) and (3)  of the Securities Act of 1933 only require showing negligence in making the misleading statements. Even with the minimal level of intent for the violation, the SEC could not prove its case.

It wasn’t that Citigroup was innocent here. In fact, the jury foreman said, “I wanted to know why the  bank’s C.E.O. wasn’t on trial. Citigroup’s behavior was appalling,” in an interview with Dealbook.

The problem was that Mr. Stoker operated well below senior management, and could hardly be described as having significant authority over the sale, aside from preparing the offering materials for the security. Stoker’s attorney used a “Where’s Waldo?” defense by arguing that his client should not be the only one held responsible when he was just a minor player throughout the transaction. A tactic that seems to have persuaded the jury in this case.

As a result, many believe that this “Where’s Waldo?” defense is likely to become a featured defense for other defendants who operated below senior management if they accused of securities violations. The defense doesn’t rely on ignorance, rather it admits to some participation but seeks absolution based on the individual’s limited role, or authority, within the organization.

Encouragement to continue pursuit of securities violations
In its finding, the jury gave encouragement to the SEC to continue to investigate and pursue securities fraud, stating “this verdict should not deter the SEC from continuing to investigate the financial industry, review current regulations and modify existing regulations as necessary.”

While a nice gesture, and perhaps encouraging to the SEC, it does not deal with the central issue here: how do we hold individuals responsible for misconduct in large corporations.  The major problem is that it is extremely difficult to peel away the many layers of a corporation to determine who is responsible for misconduct.

The lower-level workers will invoke the “Where’s Waldo?” defense, pointing fingers up the chain of management. While senior management will disclaim responsibility for misconduct that occurs beneath them, as senior management rarely are involved with the day-to-day operations of the company.  Furthermore, holding the company itself responsible fails to achieve justice because it results in a monetary penalty paid by the company to the detriment of its shareholders.

Until this problem is sorted out, winning cases against individuals for securities violations will continue to be an almost undefeatable obstacle.

If you’d like to learn more about securities laws or how your business can maintain compliance, please contact us to schedule your free consultation.


Gavin Johnson

Gavin enjoys craft beer and is learning the art of brewing.

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