UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - x

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff,

- against -

CR INTRINSIC INVESTORS, LLC, MATHEW MARTOMA and DR. SIDNEY GILMAN,

Defendants,

-and-

CR INTRINSIC INVESTMENTS, LLC, S.A.C. CAPITAL ADVISORS, LLC, S.A.C. CAPITAL ASSOCIATES, LLC, S.A.C. INTERNATIONAL EQUITIES, LLC and S.A.C. SELECT FUND, LLC,

Relief Defendants.

: : : : : : : : : : : : : : : : : :

No. 12 Civ. 8466 (VM)

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ELAN AND WYETH INVESTORS’ SUBMISSION TO THE SECURITIES AND EXCHANGE COMMISSION CONCERNING ESTABLISHMENT OF A FAIR FUND

Deborah Clark-Weintraub Joseph P. Guglielmo Tom Laughlin SCOTT+SCOTT, ATTORNEYS AT LAW, LLP The Chrysler Building 405 Lexington Avenue, 40th Floor New York, New York 10174 Telephone: (212) 223-6444

Gregg S. Levin David P. Abel MOTLEY RICE LLC 28 Bridgeside Boulevard Mt. Pleasant, South Carolina 29464 Telephone: (843) 216-9000

Co-Lead Counsel for Wyeth Investors

Ethan D. Wohl Krista T. Rosen Sara J. Wigmore WOHL & FRUCHTER LLP 570 Lexington Avenue, 16th Floor New York, New York 10022 Telephone: (212) 758-4000

Marc I. Gross Tamar A. Weinrib POMERANTZ LLP 600 Third Avenue, 20th Floor New York, New York 10016 Telephone: (212) 661-1100

Co-Lead Counsel for Elan Investors

TABLE OF CONTENTS

INTRODUCTION .......................................................................................................................... 1 

STATEMENT OF FACTS AND PROCEDURAL HISTORY ...................................................... 4 

ARGUMENT .................................................................................................................................. 8 

I.  THE PRESENT CASE MEETS THE CRITERIA FOR ESTABLISHING A FAIR FUND.........................................................................................................................8 

A.  Summary of the Criteria for Establishing Fair Funds and Decisionmaking Authority Respecting Such Funds ................................................8 

1.  Statutory and Decisional Authority .............................................................8 

2.  Commission Policy with Respect to Fair Funds ........................................10 

B.  The Investor Plaintiffs Suffered Economic Harm from SAC’s Insider Trading Under Long-Settled Law ..........................................................................11 

1.  The Second Circuit Has Repeatedly Rejected Arguments that Open-Market Traders Are Not Harmed by Insider Trading, and This Follows from the Duty to Disclose Imposed by the Classical “Disclose or Abstain” Theory of Insider Trading ......................................11 

2.  The Commission’s Reliance on the Misappropriation Theory and Fraud-on-the-Source Does Not Vitiate the Investor Plaintiffs’ Injury Under the Classical Theory .............................................................18 

3.  The Position that the Investor Plaintiffs Have Not Suffered Economic Harm Would Be Detrimental to the Commission in Future Actions and Should Not Be Adopted, Even if Precedent Did Not Foreclose It..........................................................................................20 

C.  Creation of a Fair Fund Here Is Supported by a Long Line of Prior Insider Trading Cases ............................................................................................22 

D.  There Is No Administrative Impediment to Creation of a Fair Fund ....................27 

E.  The Central Importance of Administrative Factors Warrants Deferring Any Final Decision Against Incorporating Civil Penalties Until the District Court Determines How Disgorged Funds Will Be Applied .....................29 

F.  Failure to Create a Fair Fund Here Would Be Particularly Inequitable Because the Investor Plaintiffs’ Damages Are Limited to Disgorgement and the Commission’s Disgorgement Recovery Reduces the Investor Plaintiffs’ Potential Recovery Dollar-for-Dollar ...............................29 

II.  FAILURE TO RECOMMEND THAT A FAIR FUND BE ESTABLISHED WOULD CONSTITUTE AN ABUSE OF DISCRETION ...............................................30 

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A.  In Light of the Controlling Second Circuit Precedent, Any Determination that the Investor Plaintiffs Are Not Victims Harmed by the Fraud Would Constitute a Reversible Error of Law ........................................30 

B.  Given the Commission’s Practice of Establishing Fair Funds in Other Insider Trading Cases, Failure to Do So Here Would Be Arbitrary and Capricious ..............................................................................................................30 

III.  PFIZER, AS SUCCESSOR TO WYETH, IS ENTITLED TO THE REMAINING WYETH SETTLEMENT FUNDS AFTER WYETH INVESTORS ARE COMPENSATED FOR ACTUAL LOSSES.....................................31 

CONCLUSION ............................................................................................................................. 32 

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Page(s) FEDERAL CASES

Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972) .................................................................................................................13

Brodzinsky v. FrontPoint Partners LLC, No. 3:11CV10 WWE, 2012 WL 1468507, at *5 (D. Conn. Apr. 26, 2012) .........................................................................................................28

In re Cady, Roberts & Co., 40 S.E.C. 907 (1961)..........................................................................................................11, 12

Chiarella v. United States, 445 U.S. 222 (1980) ...............................................................................................11, 12, 13, 16

Dirks v. SEC, 463 U.S. 646 (1983) ...........................................................................................................15, 16

Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980)...........................................................13, 14, 15, 19, 21, 25, 29, 30

Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006) .................................................................................................31

Hasan v. U.S. Dept. of Labor, 545 F.3d 248 (3d Cir. 2008).....................................................................................................30

Hongsheng Leng v. Mukasey, 528 F.3d 135 (2d Cir. 2008).....................................................................................................30

Lentell v. Merrill Lynch & Co., 396 F.3d 161 (2d Cir. 2005).....................................................................................................17

Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb Inc., 734 F. Supp. 1071 (S.D.N.Y. 1990) .........................................................................................29

Moss v. Morgan Stanley & Co., 719 F.2d 5 (2d Cir. 1983) ..................................................................................................19, 20

Official Comm. of Unsecured Creditors of WorldCom, Inc. v. SEC, 467 F.3d 73 (2d Cir. 2006).........................................................................................................9

SEC v. Certain Unknown Purchasers of the Common Stock of and Call Options for the Common Stock of Santa Fe Int’l Corp. (“Santa Fe”), 817 F.2d 1018 (2d Cir. 1987).........................................................................................9, 27, 29

SEC v. Citigroup Global Markets, Inc., 752 F.3d 285 (2d Cir. 2014).......................................................................................................7

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SEC v. Obus, No. 06 Civ. 3150 (GBD), 2010 WL 3703846 (S.D.N.Y. Sept. 20, 2010), rev’d, 693 F.3d 276 (2d Cir. 2012)............................................................................................................19

SEC v. One or More Unknown Traders in Secs. of Onyx Pharm., Inc., 296 F.R.D. 241 (S.D.N.Y. 2013) .............................................................................................16

SEC v. Suman, 684 F. Supp. 2d 378 (S.D.N.Y. 2010), aff’d, 421 F. App’x 86 (2d Cir. 2011) ........................26

SEC v. Wang, 944 F.2d 80 (2d Cir. 1991).......................................................................................................27

Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir. 1974).......................................................................13, 15, 19, 21, 25, 30

Speed v. Transamerica Corp., 99 F. Supp. 808 (D. Del. 1951) ................................................................................................12

Transactive Corp. v. United States, 91 F.3d 232 (D.C. Cir. 1996) ...................................................................................................31

United States v. Falcone, 257 F.3d 226 (2d Cir. 2001).....................................................................................................12

United States v. Gupta, 904 F. Supp. 2d 349 (S.D.N.Y. 2012) ......................................................................................16

United States v. Newman, 664 F.2d 12 (2d Cir. 1981).......................................................................................................19

United States v. O’Hagan, 521 U.S. 642 (1997) ...........................................................................................................18, 19

Wilson v. Comtech Telecomms. Corp., 648 F.2d 88 (2d Cir. 1981).........................................................................14, 15, 19, 21, 25, 30

Zhao v. U.S. Dept. of Justice, 265 F.3d 83 (2d Cir. 2001).......................................................................................................31

CASES INVOLVING FAIR FUNDS

SEC v. Bradlee, No. 04 Civ. 2011 (D.D.C.) .......................................................................................................26

SEC v. Bucknum, C.A. No. 06-CV-10065-PBS (D. Mass.) ...........................................................................23, 24

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SEC v. Favilla, No. 06-CV-1333 (E.D. Pa.) ...............................................................................................25, 26

SEC v. Fitts, C.A. No. 03-CV-10658 (DPW) (D. Mass.) .............................................................................25

SEC v. Franco, No. 01 CV 3872 (JGK) (S.D.N.Y.) ......................................................................................1, 24

SEC v. Gallucci, No. 04 Civ. 4493 (SAS) (S.D.N.Y.) ........................................................................................25

SEC v. Hendrix, C.A. No. C00-20655 (JW) (N.D. Cal.) ....................................................................................26

SEC v. McCloskey, No. 1:04 CV 01294 (D.D.C.) ...................................................................................................24

SEC v. Raza, No. CV 08 00375-JF (N.D. Cal.) .............................................................................................25

SEC v. Rocklage, C.A. No. 05-CV-10074-MEL (D. Mass.) ................................................................................23

SEC v. Sibal, No. 2:05-cv-3133 (C.D. Cal.) ..................................................................................................25

SEC v. Skowron, No. 10 Civ. 8266 (DAB) (S.D.N.Y.) ...................................................................1, 8, 22, 23, 28

SEC v. Suman, No. 07 Civ. 6625 (WHP) (HP) (S.D.N.Y.) ........................................................................26, 27

FEDERAL STATUTES, RULES AND REGULATIONS

SEC Rules of Practice, Rule 1102(b), 17 C.F.R. § 201.1102(b) ...............................................10, 6

SEC Rule 10b-5, 17 C.F.R. § 240.10b-5 .................................................................2, 11, 13, 15, 19

Crime Victims’ Rights Act, 18 U.S.C. § 3771 ...........................................................................7, 15

Insider Trading and Securities Fraud Enforcement Act of 1988 .........................................2, 11, 19

Sarbanes-Oxley Act of 2002, Section 308 .......................................................................8, 9, 10, 22

Securities Exchange Act of 1934, Section 10(b) ...............................................2, 11, 13, 15, 19, 21

Securities Exchange Act of 1934, Section 20A .................................................2, 14, 15, 19, 24, 29

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OTHER AUTHORITIES

Rory C. Flynn, SEC Distribution Plans in Insider Trading Cases, 48 BUS. LAW. 107 (1993) .......................................................................................................................................27

H.R. Rep. No. 100-910 (1988), available at 1988 WL 1096434 ..................................................19

18 Donald C. Langevoort, Insider Trading: Regulation, Enforcement & Prevention § 1.3 (2012) .......................................................................................................................................20

Robert A. Prentice, Clinical Trial Results, Physicians, and Insider Trading, 20 J. LEGAL

MED. 195 (1999) ......................................................................................................................15

Reply Brief for Defendant-Appellant Anthony Chiasson, United States v. Newman, No. 13-1837-cr(L) (2d Cir.), ECF No. 199 .....................................................................................21

SEC, Fiscal Year 2013 Agency Financial Report (2013), available at http://www.sec.gov/about/secpar/secafr2013.pdf ....................................................................10

SEC, Report Pursuant to Section 308(c) of the Sarbanes Oxley Act of 2002, available at http://www.sec.gov/news/studies/sox308creport.pdf ..............................................................10

David E. Kaplan, Michael S. Allen, Chi-Pin Hsu, Gary W. Muensterman and Fred M.

Ross (collectively, the “Elan Lead Plaintiffs”), on behalf of the class of similarly-situated

investors in Elan Corporation, plc (“Elan”) securities (the “Elan Investor Class”), together with

the City of Birmingham Retirement and Relief System and KBC Asset Management NV

(together, the “Wyeth Lead Plaintiffs”), on behalf of the class of similarly-situated investors in

Wyeth securities (the “Wyeth Investor Class”), make this submission to the Securities and

Exchange Commission (the “Commission” or “SEC”), pursuant to the Order of the Court entered

July 2, 2014 [ECF No. 68] (the “July 2 Order”), in support of the establishment of a Fair Fund in

the above-captioned action (this “Action”) consisting of all settlement monies obtained from

Defendant CR Intrinsic Investors (“CR Intrinsic”) and Relief Defendants CR Intrinsic

Investments, LLC, S.A.C. Capital Advisors, LLC, S.A.C. Capital Associates, LLC, S.A.C.

International Equities, LLC and S.A.C. Select Fund, LLC (collectively, the “Relief Defendants”

and together with CR Intrinsic, “SAC”).1

INTRODUCTION

The Commission should recommend to the District Court that a Fair Fund be established

for the benefit of the Elan and Wyeth Investor Classes and secondarily for the benefit of Pfizer,

Inc. (“Pfizer”), as successor to Wyeth, because: (1) it is the Commission’s stated policy to create

Fair Funds “whenever reasonably possible” and (2) the Commission has a longstanding practice

of creating Fair Funds and disgorgement funds in insider trading cases for classes of investors

identical to those here – investors who traded on public exchanges contemporaneously with and

1 Consistent with the directive of the July 2 Order, this submission addresses only the question of whether the Commission should establish a Fair Fund for the benefit of investors, and does not address the particular contents of a distribution plan for investors. We note that the Commission has itself followed a similar two-step approach. See SEC v. Skowron, No. 10 Civ. 8266 (DAB) (S.D.N.Y.), ECF Nos. 23 (motion to create a Fair Fund) and 42 (motion to approve distribution plan); SEC v. Franco, No. 01 CV 3872 (JGK) (S.D.N.Y.), ECF Nos. 62 (motion to create a Fair Fund) and 74 (motion to approve distribution plan).

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opposite to the defendants. To our knowledge this is the first case in which the Commission has

ever questioned whether insider trading proceeds are properly paid to investors for reasons other

than administrative infeasibility.

The Commission’s counsel has invited the Elan and Wyeth Lead Plaintiffs (collectively,

the “Investor Plaintiffs”) to address whether and how they suffered an economic loss from

SAC’s insider trading. This question has long been settled in the Second Circuit – multiple

decisions by the Circuit Court have repeatedly affirmed contemporaneous open-market traders’

private right of action under Section 10(b) of the Securities Exchange Act of 1934 (the

“Exchange Act”) and SEC Rule 10b-5 for insider trading, directly addressing and rejecting

objections based on an asserted absence of causation or damages. These holdings flow directly

from the rationale of the “classical” disclose or abstain theory, which treats insider trading as

fraud because insiders and their tippees owe a duty of disclosure to the stockholders with whom

they trade.

We understand that the Commission may view its preference for proceeding on the

“misappropriation” theory of insider trading as warranting a different analysis, but it does not.

While the misappropriation theory is based on fraud-on-the-source, nothing in the

misappropriation theory restricts the duty of disclosure to stockholders imposed under the

classical theory, and the Supreme Court has described the two theories as “complementary.” In

addition, when Congress enacted the Insider Trading and Securities Fraud Enforcement Act of

1988 (“ITSFEA”), it conferred a private right of action for misappropriation theory cases by

enacting Exchange Act Section 20A, expressly overruling a Second Circuit case that had limited

private claims under Section 10(b) to those based on the classical disclose or abstain theory.

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Finally, the Commission should refrain from taking the position that the Investor

Plaintiffs are not victims injured by SAC’s fraud because doing so could significantly undermine

the Commission’s position in future cases where the misappropriation theory is unavailable, such

as in cases against issuers or parties who can fairly assert that the issuer authorized them to trade.

In policy statements, in its Rules of Practice, and in court filings, the Commission has

consistently cited administrative impediments as the sole basis for declining to make recovered

funds available to injured investors. Here, there are no such impediments, and the historic size

of the recovery from SAC and simple, seven-consecutive-day insider trading period make this a

particularly straightforward case to administer.

While the SEC has discretion with respect to civil penalties, whether to order creation of

a disgorgement fund for investors is within the discretion of the District Court. Because of the

importance of administrative considerations, in the event the Commission preliminarily

determines against recommending a Fair Fund, it should reserve decision with respect to the civil

penalty pending the District Court’s determination with respect to the gains disgorged by SAC.

Finally, refusal to create a Fair Fund here would be particularly inequitable because the

Commission’s disgorgement recovery reduces the Investor Plaintiffs’ potential recovery dollar-

for-dollar and their damages claims are limited to disgorgement, unlike the full compensation for

out-of-pocket losses available in other types of securities cases.

Based on the foregoing, a failure by the Commission to recommend that a Fair Fund be

established would constitute an abuse of discretion, first, because any determination that the

Investor Plaintiffs are not victims who were economically harmed by the fraud would violate

settled Second Circuit law, and second, because the Commission’s practice of establishing Fair

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Funds in many indistinguishable cases and its stated policy of creating Fair Funds “whenever

reasonably possible” would render its failure to do so here arbitrary and capricious.

STATEMENT OF FACTS AND PROCEDURAL HISTORY

On November 20, 2012, the Commission filed this Action, charging unlawful insider

trading based on material nonpublic information concerning the Phase 2 clinical trial of

bapineuzumab (“bapi”), an Alzheimer’s disease treatment under joint development by Elan and

Wyeth.

As charged in the operative complaint in this Action [ECF No. 25] (the “SEC Complaint”),

SAC traded on inside information obtained by a portfolio manager, Defendant Mathew Martoma

(“Martoma”), from Defendant Sidney Gilman (“Gilman”), the medical doctor who chaired the

Safety Monitoring Committee (the “SMC”) that oversaw the bapi clinical trial on behalf of Elan

and Wyeth. As alleged in the SEC Complaint (at 8-9, 21), Gilman owed a duty of confidentiality

to Elan based on his role as chairman of the SMC and presenter at the medical conference where

the bapi clinical trial results were announced; the express language of his consulting agreement

with Elan; and the SMC operating guidelines to which he was subject.

The SEC Complaint further charged (at 2-3, 19) that, as a result of SAC’s trades based on

the inside information obtained by Martoma, SAC generated illegal profits and avoided losses of

approximately $275 million from sales of long positions and from short sales over seven

consecutive trading dates, from July 21-29, 2008 (the “Insider Selling Period”).

Simultaneously with the filing of this Action, the Commission announced its settlement

with Gilman, requiring him to disgorge $186,781, together with $48,087 in prejudgment interest.

A parallel criminal action based on the same conduct was contemporaneously filed against

Martoma on November 19, 2012 by the U.S. Attorney’s Office for the Southern District of New

York (the “USAO”), United States v. Martoma, No. 12 Cr. 973 (PGG) (S.D.N.Y.).

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On December 21, 2012, certain of the Elan Lead Plaintiffs filed a securities class action

against SAC arising out of its insider trading in Elan during the Insider Selling Period. Kaplan v.

S.A.C. Capital Advisors, L.P., No. 12 Civ. 9350 (VM) (KNF) (the “Kaplan action”). The Elan

Lead Plaintiffs were later appointed as lead plaintiffs by the Court on behalf of the Elan Investor

Class – investors who traded Elan securities contemporaneously with and opposite to SAC. A

separate class action was filed by one of the Wyeth Lead Plaintiffs, and they were subsequently

appointed as lead plaintiffs by the Court on behalf of the Wyeth Investor Class – investors who

traded Wyeth securities contemporaneously with and opposite to SAC. The action on behalf of

the Wyeth Investor Class was subsequently consolidated into the Kaplan action for pretrial

purposes.

On March 15, 2013, the Commission announced that it had entered into a proposed

settlement with SAC. The Commission simultaneously filed an amended complaint naming the

Relief Defendants.

Under the terms of the proposed settlement (the “SEC-SAC Settlement”), SAC agreed to

pay $601,747,463 (the “Settlement Funds”), consisting of $274,972,541 in disgorgement,

together with $51,802,381 in prejudgment interest (collectively, the “Disgorged Funds”) and a

1x civil penalty in the amount of $274,972,541 (the “Civil Penalty”).2

The proposed judgments submitted to the Court by the Commission provided that the

Settlement Funds would be paid to the U.S. Treasury. See ECF No. 30.

On March 25, 2013, the Elan Lead Plaintiffs submitted a letter to the Court, objecting to

the SEC-SAC Settlement insofar as it provided for payment of the Settlement Funds to the U.S.

Treasury, rather than to injured investors, citing the Commission’s stated policy of establishing 2 A portion of the Settlement Funds, approximately $124 million, is attributable to SAC’s insider trading in Wyeth securities (the “Wyeth Settlement Funds”); the balance, approximately $478 million, is attributable to SAC’s insider trading in Elan securities (the “Elan Settlement Funds”).

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Fair Funds “whenever reasonably possible” and practice of making payment to the U.S. Treasury

only when the costs of administration rendered distribution to investors impracticable, as

provided by Rule 1102(b) of the SEC Rules of Practice.

On March 27, 2013, the Commission advised the Court by letter that it consented to the

Settlement Funds being paid into a Court Registry Investment System (“CRIS”) account,

pending further order of the Court.

On March 28, 2013, the Court, the Honorable Victor Marrero, held a hearing on the

proposed SEC-SAC Settlement, during which he twice described the issue of whether to create a

Fair Fund as “an important issue,” Tr. at 7, 8, and noted “the Court’s appreciation of the SEC’s

willingness to put the issue of the use of the funds to the side, and create a [CRIS] account.” Id.

at 20.

On April 16, 2013, the Court rendered a Decision and Order [ECF No. 33], reported at

939 F. Supp. 2d 431, that conditionally approved the SEC-SAC Settlement but noted its concerns

about the “neither admit nor deny” provision in the settlement. The Court reserved on the issue

of whether it would condition its approval on an admission of liability by SAC, pending the

outcome of the then-pending appeal in the SEC v. Citigroup Global Markets, Inc. case.

In July 2013, the USAO indicted Defendant CR Intrinsic, Relief Defendant S.A.C.

Capital Advisors, LLC, and two other SAC-affiliated entities. See United States v. S.A.C.

Capital Advisors, L.P., No. 13 Cr. 541 (LTS) (“United States v. SAC”). In an accompanying

press release, the USAO described SAC as a “veritable magnet for market cheaters” that

“trafficked in inside information on a scale without any known precedent in the history of hedge

funds.” The USAO also filed a related civil forfeiture action.

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On November 1, 2013, SAC entered into a plea agreement (the “Plea Agreement”) with

the USAO, pursuant to which the defendant entities agreed to plead guilty to wire fraud and

securities fraud, pay $1.184 billion in fines and civil forfeiture (in addition to the Settlement

Funds), and terminate their investment advisory business.

On November 7, 2013, the Investor Plaintiffs filed an objection to the Plea Agreement on

the grounds that it did not require SAC to admit its guilt with respect to insider trading in Elan

and Wyeth, the principal criminal conduct charged in the indictment. See United States v. SAC,

ECF No. 16. The Investor Plaintiffs asserted standing pursuant to the Crime Victims’ Rights Act

(the “CVRA”), 18 U.S.C. § 3771. Id. The Court granted the Investor Plaintiffs’ motion to be

heard. ECF No. 19. On November 8, 2013, the USAO submitted a letter contending that the

Investor Plaintiffs were not “victims” within the meaning of the CVRA, arguing that they were

not “directly and proximately harmed” by the charged offenses. United States v. SAC, ECF No.

17. The Court reserved decision on the issue of the Investor Plaintiffs’ status, Nov. 8, 2013 Tr.

at 5, and no further ruling on the issue was made.

In February 2014, Martoma was convicted by a jury on all counts.

In April 2014, the Court in United States v. SAC approved the Plea Agreement after

confirming that the criminal fine imposed was based on all conduct charged in the indictment.

See April 10, 2014 Hearing Tr. at 11, 13-15.

On June 4, 2014, the Second Circuit issued its decision in SEC v. Citigroup Global

Markets, Inc., 752 F.3d 285 (2d Cir. 2014), and Judge Marrero thereafter finally approved the

SEC-SAC Settlement by Decision and Order entered June 18 [ECF No. 59], reported at 2014

WL 2768054. A related implementing Order [ECF No. 66] provided for payment of the

Settlement Funds to a CRIS account on or before August 4, 2014.

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After conferring with the Investor Plaintiffs and Pfizer, the Commission proposed to the

Court by letter dated June 30, a procedure under which interested parties, including the Investor

Plaintiffs, could provide their views to the Commission and the Commission would thereafter

make its determination whether to recommend that the Court establish a Fair Fund.

On July 2, the Court entered the Order proposed by the Commission [ECF No. 68].

This is the Investor Plaintiffs’ submission to the Commission pursuant to the July 2

Order.

ARGUMENT

I. THE PRESENT CASE MEETS THE CRITERIA FOR ESTABLISHING A FAIR FUND

Consistent with the Commission’s determination in numerous other insider trading cases,

the present case meets the criteria for establishing a Fair Fund, and doing so accords with

Commission policy favoring the creation of Fair Funds “whenever reasonably possible” and

faces no administrative impediment. In addition, refusal to create a Fair Fund here would be

particularly inequitable because the Commission’s disgorgement recovery reduces the Investor

Plaintiffs’ potential recovery dollar-for-dollar, and their damages claims are limited to

disgorgement.

A. Summary of the Criteria for Establishing Fair Funds and Decisionmaking Authority Respecting Such Funds

1. Statutory and Decisional Authority

Section 308(a) of the Sarbanes-Oxley Act of 2002 (“SOX”) authorized the creation of

Fair Funds and provides, in relevant part:3

3 SOX Section 308(a) was incompletely codified at 15 U.S.C. § 7246(a). The Commission ordinarily cites the language of SOX rather than 15 U.S.C. § 7246(a), see, e.g., SEC v. Skowron, No. 10 Civ. 8266 (DAB) (S.D.N.Y.), ECF No. 23, at 3, and we accordingly do the same.

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If in any judicial or administrative action brought by the Commission under the securities laws . . . the Commission obtains an order requiring disgorgement against any person for a violation of such laws . . . or such person agrees in settlement of any such action to such disgorgement, and the Commission also obtains pursuant to such laws a civil penalty against such person, the amount of such civil penalty shall, on the motion or at the direction of the Commission, be added to and become part of the disgorgement fund for the benefit of the victims of such violation.

As the text reflects, SOX Section 308(a) had the purpose and effect of allowing civil

penalties to be added to disgorgement funds established for the benefit of fraud victims.

However, the authority to create such disgorgement funds from monies recovered as

disgorgement from defendants in enforcement actions long predated SOX. See, e.g., SEC v.

Certain Unknown Purchasers of the Common Stock of and Call Options for the Common Stock

of Santa Fe Int’l Corp. (“Santa Fe”), 817 F.2d 1018, 1021 (2d Cir. 1987) (pre-SOX; affirming

creation of disgorgement fund in insider trading case). In judicial proceedings, the decision

whether to create a disgorgement fund for the benefit of victims was and remains within the

equitable discretion of the District Court, rather than the Commission. See Santa Fe, 817 F.2d at

1020 (“we limit our review of Judge Conner’s order approving the settlement to determining

whether there was an abuse of discretion”); Official Comm. of Unsecured Creditors of

WorldCom, Inc. v. SEC, 467 F.3d 73, 81 (2d Cir. 2006) (post-SOX; with respect to disgorged

profits, “it remains within the court’s discretion to determine how and to whom the money will

be distributed, and if the district court determines that no party is entitled to receive the

disgorged profits, they will be paid to the United States Treasury”) (emphasis added, internal

quotation marks and citations omitted).

The Commission’s position with respect to whether the Disgorged Funds should be made

available to the Elan and Wyeth Investor Classes is thus in the nature of a recommendation to the

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District Court, and only the Commission’s position with respect to the Civil Penalty is entitled to

deferential review.

2. Commission Policy with Respect to Fair Funds

The Commission has repeatedly stated as agency policy, and has established pursuant to

regulation in administrative proceedings, that it will establish a Fair Fund whenever practicable.

SOX Section 308(c) directed the Commission to study and report on its efforts to provide

compensation for investors. In the resulting report, the Commission stated that “[m]aking

appropriate distributions to investors, by applying the Fair Fund provision, is a desirable and

important objective. The Commission intends to use the provision whenever reasonably possible,

consistent with its mission to protect investors.” SEC, Report Pursuant to Section 308(c) of the

Sarbanes Oxley Act of 2002, at 22 (emphasis added), available at http://www.sec.gov/news/

studies/sox308creport.pdf. Accord SEC, Fiscal Year 2013 Agency Financial Report 147 (2013),

available at http://www.sec.gov/about/secpar/secafr2013.pdf (“Disgorged funds are normally

distributed to those affected by the action, but in certain cases may be deposited in the General

Fund of the Treasury.”).

Rule 1102(b) of the SEC Rules of Practice, 17 C.F.R. § 201.1102(b), applicable by its

terms to administrative proceedings and authoritative here because identical issues are presented,

adopts the same position. It states that payment shall be made to the U.S. Treasury, rather than

investors, only “[w]hen, in the opinion of the Commission or the hearing officer, the cost of

administering a plan of disgorgement relative to the value of the available disgorgement funds

and the number of potential claimants would not justify distribution of the disgorgement funds to

injured investors . . . .”

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B. The Investor Plaintiffs Suffered Economic Harm from SAC’s Insider Trading Under Long-Settled Law

The Commission’s counsel has invited the Investor Plaintiffs to address how they

suffered an economic loss from the insider trading at issue in this Action. The injury suffered by

the Investor Plaintiffs from SAC’s insider trading flows from the fundamental nature of insider

trading under the classical “disclose or abstain” rule, and has been long recognized in Second

Circuit decisions addressing the private right of action for insider trading under Section 10(b).

The Commission’s use of the misappropriation theory, premised on fraud on the source of the

information, does not vitiate the Investor Plaintiffs’ classical theory claim, and challenging the

Investor Plaintiffs’ status as victims under the misappropriation theory would also run afoul of

Congress’ express intent when enacting ITSFEA. Finally, any challenge to the Investor

Plaintiffs’ status as victims would significantly undermine future insider trading enforcement

efforts that could not be brought under the misappropriation theory.

1. The Second Circuit Has Repeatedly Rejected Arguments that Open-Market Traders Are Not Harmed by Insider Trading, and This Follows from the Duty to Disclose Imposed by the Classical “Disclose or Abstain” Theory of Insider Trading

As the Commission is well aware, insider trading constitutes fraud in violation of Section

10(b) and SEC Rule 10b-5 under two distinct theories: (1) the “classical” disclose or abstain

theory, and (2) the “misappropriation” theory.

The classical disclose or abstain theory is the original basis for deeming insider trading to

constitute fraud, and is the theory adopted by the Commission in In re Cady, Roberts & Co., 40

S.E.C. 907 (1961). Under the classical theory, as adopted and articulated by the Supreme Court

in Chiarella v. United States, 445 U.S. 222 (1980), insider trading is held to be fraudulent and a

violation of Section 10(b) and Rule 10b-5 because an insider or tippee is deemed to owe a

fiduciary duty to the stockholder with whom he or she trades, and is therefore obligated to

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disclose all material information to that stockholder. By trading without disclosure, the insider

or tippee commits an actionable omission that constitutes a fraud on that stockholder.

As explained in Chiarella, “the relationship between a corporate insider and the

stockholders of his corporation gives rise to a disclosure obligation,” 445 U.S. at 227 (emphasis

added), and that “[i]n its Cady, Roberts decision, the Commission recognized a relationship of

trust and confidence between the shareholders of a corporation and those insiders who have

obtained confidential information by reason of their position with that corporation. This

relationship gives rise to a duty to disclose because of the ‘necessity of preventing a corporate

insider from . . . tak[ing] unfair advantage of the uninformed minority stockholders.’ ” Id. at 228-

29 (quoting Speed v. Transamerica Corp., 99 F. Supp. 808, 829 (D. Del. 1951) (alterations in

Chiarella)) (emphases added). Accord United States v. Falcone, 257 F.3d 226, 229 (2d Cir.

2001) (“Although the requirement that the deception be ‘in connection with’ the purchase or sale

of a security is not often discussed in traditional insider trading case law, the connection is

almost self-evident: the duty of disclosure being breached is to persons with whom the insider is

engaging in securities transactions, and the insider breaches that duty when he or she engages in

the securities transaction without disclosure.”) (emphasis added).

Based on the logic of the disclose or abstain rule, the economic harm suffered by

counterparty stockholders from breach of the duty to disclose or abstain is no different from the

injury suffered by any stockholder who is a victim of a fraudulent omission or affirmative

misrepresentation by the issuer or another party. No less than in the case of affirmative fraud by

corporate executives, a stockholder who trades opposite to an insider who possesses material

nonpublic information is harmed by buying at a higher price or selling at a lower price than he or

she would have paid or accepted in the absence of the fraud.

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These principles were recognized and adopted by the Second Circuit more than forty

years ago, when it recognized a private right of action for insider trading under Section 10(b) for

classes of open-market investors, expressly rejecting the defendants’ arguments concerning

causation and damages.

In Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir. 1974),

an insider trading class action asserting claims by open-market traders under Section 10(b) and

Rule 10b-5 indistinguishable from the Investor Plaintiffs’ claims here, the defendants argued that

“since defendants’ sales were unrelated to plaintiffs’ purchases and all transactions took place on

anonymous public stock exchanges, there is lacking the requisite connection between

defendants’ alleged violations and the alleged losses sustained by plaintiffs.” 495 F.2d at 238.

The Second Circuit flatly rejected this contention, citing the injury flowing from fraudulent

omissions recognized in Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972).

Relatedly, addressing the fact that the purchases in Shapiro occurred on the open market

rather than in face-to-face transactions, the Circuit Court rejected this as a relevant consideration,

stating that “it would make a mockery of the ‘disclose or abstain’ rule if we were to permit the

fortuitous matching of buy and sell orders to determine whether a duty to disclose had been

violated.” 495 F.2d at 236. The Circuit Court further explained that to limit claims to “face-to-

face transactions or to the actual purchasers or sellers” would “frustrate a major purpose of the

antifraud provisions of the securities laws: to insure the integrity and efficiency of the securities

markets.” Id. at 237. Shapiro was later cited with approval by the Supreme Court in Chiarella.

445 U.S. at 230 n. 12.

The Second Circuit later reaffirmed Shapiro’s standing and causation holdings in Elkind

v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980). In Elkind, the Circuit Court recognized

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that while public investors are ordinarily “wholly unacquainted with and uninfluenced by the

tippee’s misconduct,” they “are, however, entitled to an honest market in which those with

whom they trade have no confidential corporate information.” 635 F.2d at 169. Thus, “[t]he

reason for the ‘disclose or abstain’ rule is the unfairness in permitting an insider to trade for his

own account on the basis of material inside information not available to others.” Id.

In Elkind, the Second Circuit further addressed at length the measure of damages suffered

by open-market investors. Id. at 170-72. After considering other alternatives, the Circuit Court

adopted a measure under which it would “allow any uninformed investor, where a reasonable

investor would either have delayed his purchase or not purchased at all if he had had the benefit

of the tipped information, to recover any post-purchase decline in market value of his shares up

to a reasonable time after he learns of the tipped information or after there is a public disclosure

of it but (2) limit his recovery to the amount gained by the tippee as a result of his selling at the

earlier date rather than delaying his sale until the parties could trade on an equal informational

basis.” Id. at 172. This “disgorgement measure” was later adopted by Congress when it enacted

Section 20A of the Exchange Act, conferring an express cause of action for insider trading on

contemporaneous open market traders like the Investor Plaintiffs. See Section 20A(b)(1).

A year after Elkind, in Wilson v. Comtech Telecommunications Corp., 648 F.2d 88 (2d

Cir. 1981), the Second Circuit limited the relevant class to contemporaneous traders and further

explained the rationale for conferring standing on them, explaining that the duty of disclosure by

insider traders “is owed only to those investors trading contemporaneously with the insider; non-

contemporaneous traders do not require the protection of the ‘disclose or abstain’ rule because

they do not suffer the disadvantage of trading with someone who has superior access to

information.” Id. at 94-95.

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Here, the Investor Plaintiffs’ claims with respect to SAC’s Insider Selling Period trades

arise under Section 10(b) and Rule 10b-5 (as well as Section 20A), see Kaplan ECF No. 127, at

165-67, as did the Commission’s claims in the present matter, see ECF No. 25, at 20-22, and as

did the plaintiffs’ claims in Shapiro and Elkind. As in Shapiro and Elkind, the insider trading

here fits squarely within the classical disclose or abstain theory: as chair of the bapi Safety

Monitoring Committee, Gilman owed a duty of confidentiality to Elan and Wyeth, see Kaplan

ECF No. 127, at 37, 165, 167, and is therefore deemed an insider for purposes of the classical

theory. See Dirks v. SEC, 463 U.S. 646, 655 n. 14 (1983) (recognizing that under the classical

theory “where corporate information is revealed legitimately to an underwriter, accountant,

lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the

shareholders”); Robert A. Prentice, Clinical Trial Results, Physicians, and Insider Trading, 20 J.

LEGAL MED. 195, 205 (1999) (recognizing that physicians who act as “consultants to clinical

drug trials typically will be temporary insiders because they are shown the results of the trial for

a business purpose and certainly with an expectation of confidentiality”).

Both Gilman and (assuming adequate knowledge of his breach and personal benefit) his

direct and indirect tippees are therefore liable under the classical disclose or abstain theory, as

were the defendants in Shapiro and Elkind.

The Second Circuit’s decisions in Shapiro, Elkind and Wilson are thus direct, controlling

precedent on the issue of whether the Investor Plaintiffs have suffered economic harm under

Section 10(b) and Rule 10b-5 from the insider trading at issue here.

We are aware that in opposing the Investor Plaintiffs’ application to be heard pursuant to

the CVRA last year in United States v. SAC, the USAO argued in its November 8, 2013 letter to

Judge Swain that “particular investors who trade without the benefit of inside information are not

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properly understood as the direct and proximate victims of those that do,” citing Chiarella and

Judge Jed Rakoff’s decision in United States v. Gupta, 904 F. Supp. 2d 349, 352 (S.D.N.Y.

2012). The USAO fundamentally miscited both opinions.

As discussed above, Chiarella held that insider trading is actionable as fraud under the

disclose or abstain theory when the insider or tipper owes a fiduciary duty to the stockholders of

the company whose securities are traded. Correspondingly, Chiarella held that in the absence of

such a fiduciary duty, there can be no liability under the disclose or abstain rule. Thus, an

outsider like the financial printer in Chiarella is not liable to stockholders under the disclose or

abstain theory because, as the Supreme Court explained, “[h]e was not their agent, he was not a

fiduciary, he was not a person in whom the sellers had placed their trust and confidence.” 445

U.S. at 232-33. In the absence of grounds to impose a fiduciary duty on the defendant (or the

defendant’s tipper), there was no basis to impose liability “without recognizing a general duty

between all participants in market transactions to forgo actions based on material, nonpublic

information.” Id. at 233. This the Court refused to do.

Gupta makes exactly the same point (though in language susceptible to

misinterpretation), citing Chiarella and explaining that Congress, the Commission and the

Supreme Court have “never treated [insider trading] as a fraud on investors” but instead have

proceeded “on one or more theories of defrauding the institution (or its shareholders) that owned

the information.” 904 F. Supp. 2d at 352 (emphasis added).

The USAO’s error is thus to view SAC as in the same position as the financial printer in

Chiarella – a stranger to the Investor Plaintiffs who owes them no duty. It is not. Rather, it is

the tippee of an insider, and thus is liable under the well-settled rules governing tippee liability

under the classical disclose or abstain theory. See Dirks, 463 U.S. at 662-64; SEC v. One or

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More Unknown Traders in Secs. of Onyx Pharm., Inc., 296 F.R.D. 241, 250 (S.D.N.Y. 2013)

(discussing tippee liability under both the classical and misappropriation theories).

The USAO further reasoned in its November 8, 2013 letter to Judge Swain that “[a]ny

proximate and direct harm to the purchasers of Elan and Wyeth securities that Class Counsel

seeks to represent resulted from the negative drug trial results announced in July 2009 [sic] that

caused the price of the securities to fall” and that “[t]he direct and proximate cause of the Class

Plaintiffs’ losses was the negative news announced on July 29, 2009 [sic], irrespective of

whether others violated the law.”

These statements fundamentally misunderstand the nature of causation in fraud cases. It

is true for every fraud involving a publicly-traded security that the injury occurs when the truth is

later revealed to the market and it reacts. In each case, “proximate cause” is established by a

connection between the misstatement or omission and the risk of loss thereby concealed. The

Second Circuit explained this point directly in its leading loss causation decision, Lentell v.

Merrill Lynch & Co., 396 F.3d 161, 172-73 (2d Cir. 2005) (citations and internal quotation

marks omitted, first emphasis added):

We have described loss causation in terms of the tort-law concept of proximate cause, i.e., that the damages suffered by plaintiff must be a foreseeable consequence of any misrepresentation or material omission; but the tort analogy is imperfect. A foreseeable injury at common law is one proximately caused by the defendant’s fault, but it cannot ordinarily be said that a drop in the value of a security is “caused” by the misstatements or omissions made about it, as opposed to the underlying circumstance that is concealed or misstated. Put another way, a misstatement or omission is the “proximate cause” of an investment loss if the risk that caused the loss was within the zone of risk concealed by the misrepresentations and omissions alleged by a disappointed investor.

Here, there is no serious question that loss causation exists – the loss that the Elan and

Wyeth Investor Classes suffered upon disclosure of the disappointing bapi clinical trial results is

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clearly within the zone of risk concealed by SAC’s violation of its duty to the Investor Plaintiffs

to disclose, upon having elected to trade on the confidential trial results then in its possession.

In sum, the view that the Investor Plaintiffs were not injured by SAC’s fraud is contrary

to controlling Second Circuit caselaw and is inconsistent with the fundamental rationale for the

classical disclose or abstain theory of insider trading.

2. The Commission’s Reliance on the Misappropriation Theory and Fraud-on-the-Source Does Not Vitiate the Investor Plaintiffs’ Injury Under the Classical Theory

We understand that the Commission generally prefers to proceed on the alternative,

“misappropriation” theory of insider trading, which is premised on the view that use of

nonpublic information to trade in breach of a duty of confidentiality to the source of the

information constitutes a fraud on that party. Unlike the classical theory, the misappropriation

theory thus does not depend on the deception of market counterparties. See United States v.

O’Hagan, 521 U.S. 642, 652 (1997) (“In lieu of premising liability on a fiduciary relationship

between company insider and purchaser or seller of the company’s stock, the misappropriation

theory premises liability on a fiduciary-turned-trader’s deception of those who entrusted him

with access to confidential information.”).

The Commission’s preference for this theory, or view that it was the grounds for

proceeding in the present action, however, does not vitiate the Investor Plaintiffs’ claims for

damage or the grounds for finding economic harm, for three independent reasons.

First, while the misappropriation theory expands the scope of insider trading liability by

extending it to misuse of inside information belonging to parties other than the securities issuer

and its shareholders, in cases where the source is the company itself, as here, nothing in the

misappropriation theory justifies deeming the duties breached restricted to the company only,

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where the classical theory would recognize that the same conduct violates a duty of full

disclosure to the company’s shareholders.

Second, the availability of an alternative theory does not alter the fact that SAC’s illegal

conduct, as pled in the SEC Complaint, also constitutes a violation of Section 10(b) and Rule

10b-5 under the classical theory. As the Supreme Court recognized in O’Hagan, the two

theories are “complementary,” 521 U.S. at 652, and the Commission pleads both where

warranted. See SEC v. Obus, No. 06 Civ. 3150 (GBD), 2010 WL 3703846, at *1 (S.D.N.Y.

Sept. 20, 2010), rev’d, 693 F.3d 276 (2d Cir. 2012). Accordingly, the controlling authorities

discussed above, Shapiro, Elkind and Wilson, continue to apply and control the outcome here.

Third, the view that open market counterparties are not injured by misappropriation-

theory insider trading was specifically rejected by Congress when it enacted Section 20A as part

of ITSFEA. According to ITSFEA’s legislative history:

Although the courts have recognized an implied private right of action in insider trading cases, this section would codify an express right of action against insider traders and tippers for those who traded the same class of securities ‘contemporaneously’ with and on the opposite side of the market from the insider trader. . . . In particular, the codification of a right of action for contemporaneous traders is specifically intended to overturn court cases which have precluded recovery for plaintiffs where the defendant’s violation is premised upon the misappropriation theory. See e.g., Moss v. Morgan Stanley, 719 F.2d 5 (2d Cir. 1983). The Committee believes that this result is inconsistent with the remedial purposes of the Exchange Act, and that the misappropriation theory fulfills appropriate regulatory objectives in determining when communicating or trading while in possession of material nonpublic information is unlawful.

H.R. Rep. No. 100-910 (1988), available at 1988 WL 1096434, at *19 (emphasis added).

In Moss (a parallel private case arising out of the insider trading at issue in the early

misappropriation case United States v. Newman, 664 F.2d 12 (2d Cir. 1981)), the Second Circuit

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reasoned that there was no basis for holding that the employees of an investment banking firm

advising an acquirer owed a duty to the shareholders of the target. 719 F.2d at 13. This is the

holding that Congress overturned.

By adopting a view that misappropriation-theory insider trading causes no cognizable

harm to shareholders of the company whose securities are traded, the Commission would thus

adopt a position that Congress has, by legislative enactment, expressly rejected.

3. The Position that the Investor Plaintiffs Have Not Suffered Economic Harm Would Be Detrimental to the Commission in Future Actions and Should Not Be Adopted, Even if Precedent Did Not Foreclose It

Even if Second Circuit precedent did not control the issue of whether contemporaneous

open market traders suffer economic harm from insider trading, taking the position that they do

not would undermine the Commission’s enforcement efforts in other cases and so should be

rejected as a matter of policy.

First, as discussed above, the contention that insider trading inflicts no injury on

shareholder counterparties is directly at odds with the classical disclose or abstain theory, which

focuses on deception of those investors. Whatever the Commission’s preference for proceeding

under the misappropriation theory, it should not take a position that undermines one of the core

theories of insider trading. This is particularly true because the misappropriation theory does not

reach some insider trading that the Commission has and should rightly seek to proscribe,

including insider trading by the issuer itself, and insider trading validly authorized by the issuer.

Because there is no basis for arguing a breach of duty to or fraud on the source in such cases,

they can be litigated only using the classical theory.

Second, the contention that “no one is harmed” by insider trading is a staple of

commentators who seek to argue that insider trading should be legal. See 18 Donald C.

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Langevoort, Insider Trading: Regulation, Enforcement & Prevention § 1.3, at 1-12 to 1-13

(2012). Indeed, these arguments have been trod out in the media and in Court in the present

matter. See Doug Bandow, Free The Insider Traders: Stop Treating Market Efficiency Like A

Crime, Forbes.com (Feb. 10, 2014), available at http://www.forbes.com/sites/dougbandow/2014/

02/10/free-the-insider-traders-stop-treating-market-efficiency-like-a-crime/ (commentary on the

current matter, arguing that “Martoma simply got out of the investment starting gate early. His

actions hurt no one. . . . SAC avoided losses suffered by other shareholders, but it did not hurt

the latter. They would have lost money nonetheless. Even the buyers of SAC’s shares had no

complaint: They wanted to purchase based on the information available to them. Their

understanding was incomplete, but not because of Martoma’s actions. They would have

purchased the shares from someone else had SAC not sold.”).

Shapiro, Elkind and Wilson notwithstanding, SAC itself has likewise brazenly argued that

“contemporaneous traders are not harmed by insider trading.” Kaplan, ECF No. 130, at 1.

The USAO’s ill-considered arguments regarding the CVRA last year have already been

deployed against it by the defense bar. In the crucial pending appeal before the Second Circuit

addressing the knowledge required of remote tippees for Section 10(b) liability, United States v.

Newman, No. 13-1837-cr, one of the defendants, Anthony Chiasson, has cited the USAO’s letter,

arguing “[t]he government identifies no particular loss or victim, however, and it has conceded

elsewhere that ‘particular investors who trade without the benefit of inside information are not

properly understood as the direct and proximate victims of those that do.’ ” United States v.

Newman, ECF No. 199, at 39-40.

The Commission should not adopt a position that is so valuable to those who seek to

excuse the market cheating it seeks to police.

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C. Creation of a Fair Fund Here Is Supported by a Long Line of Prior Insider Trading Cases

Any decision not to establish a Fair Fund here would also be at odds with the

Commission’s longstanding position in many other insider trading cases. Indeed, the

Commission recently moved for creation of, and is presently supervising administration of, a

Fair Fund in another insider trading case strikingly similar to the present one, SEC v. Skowron,

No. 10 Civ. 8266 (DAB) (S.D.N.Y.). In Skowron, as here, the insider trading involved

information concerning a clinical drug trial supplied to a hedge fund manager by a doctor

involved with the trial. There, the Commission moved for creation of a Fair Fund for the benefit

of a class of open-market contemporaneous traders in the shares of a publicly-traded

pharmaceutical company, indistinguishable from the Elan and Wyeth Investor Classes here. See

Skowron, ECF No. 23. The Commission there saw no policy question concerning investors’

entitlement to a Fair Fund. Rather, its motion for creation of a Fair Fund simply cited SOX

Section 308 and stated that:

The Commission brought this action under the securities laws, Skowron and Benhamou were ordered to pay disgorgement and penalties pursuant to the consent judgments entered against them, and the FrontPoint Healthcare Funds, as relief defendants, were ordered to pay disgorgement equal to the amounts by which they had been unjustly enriched. Accordingly, the requirements of Section 308 have been satisfied and the Court should establish a Fair Fund, consisting of the [$35.8 million paid by the defendants].

In its subsequent motion seeking Court approval for a plan of distribution to open-market

contemporaneous traders, Skowron, ECF No. 43, the Commission repeatedly recognized that

those investors – indistinguishable from the Investor Plaintiffs here – suffered an injury and were

therefore entitled to the monies paid by the defendants. The Commission’s motion asked the

District Court to approve its “proposed plan to distribute more than $35 million to injured

investors who purchased the common stock of Human Genome Sciences, Inc. (‘HGSI’) on

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specific dates” and explained that its plan “would allocate the available funds fairly and

reasonably, in a manner proportional to the injury that investors in HGSI common stock suffered

as a result of the actions of Skowron,” and “directs the Fair Fund’s proceeds to investors who

traded [contemporaneously with the defendants] and were harmed by the improper conduct

alleged in the Commission’s lawsuit.” Id. at 1, 4, 6 (emphasis added).

Skowron is just one of many similar cases in which Fair Funds have been established by

the Commission on facts indistinguishable from the present case. Another such case is SEC v.

Rocklage, C.A. No. 05-CV-10074-MEL (D. Mass.), also involving insider trading on negative

clinical drug trial results, there by the wife of the company’s CEO, her brother, and his friend.

The Commission’s distribution plan again provided for distribution to contemporaneous open-

market purchasers of the company’s shares, explaining that “the Commission seeks to distribute

all the monies in the Disgorgement Fund to injured market investors, which in this case are

persons or entities who purchased shares of Cubist common stock on either January 2, 2002 or

January 3, 2002, and who retained ownership of at least some of those shares through to and

until the public announcement on January 16, 2002,” Rocklage, ECF No. 73, at 3 (emphasis

added).4

The Commission likewise approved payments to contemporaneous open market investors

in SEC v. Bucknum, C.A. No. 06-CV-10065-PBS (D. Mass.), another insider trading case

involving negative clinical drug trial results. In Bucknum, the defendant was the general counsel

of Biogen Idec Inc. (“BIIB”). The Commission’s distribution plan provided for distribution to

contemporaneous open-market purchasers of BIIB shares, indistinguishable from the Investor

Plaintiffs here, explaining that “the Commission seeks to distribute all the monies in the 4 While the Commission’s brief refers to a “Disgorgement Fund,” the fund explicitly included civil penalties and was established as a Fair Fund pursuant to SOX Section 308(a). See id. at 3, ECF Nos. 46, 47 and 48.

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Disgorgement Fund to market investors who were potential victims of Defendant’s insider

trading, which in this case are persons or entities who purchased shares of Biogen common stock

on February 18, 2005, the date on which Defendant sold his shares, and held such shares through

to and until February 28, 2005, the date of the public announcement” and that “[t]he claimants

are essentially the victims of Defendant’s alleged insider trading.” Bucknum, ECF No. 30, at 2-4

(emphases added).

The Commission has also repeatedly approved Fair Funds for contemporaneous open

market traders in insider trading cases involving mergers and tender offers. In SEC v. Franco,

No. 01 CV 3872 (JGK) (S.D.N.Y.), an insider trading case arising out of the tip of an impeding

tender offer by a board member of the target, Nalco Chemical Co., the Commission’s

distribution plan provided for pro rata distribution of disgorged funds and civil penalties to

contemporaneous open-market sellers, which the plan described as “investors harmed by the

insider trading scheme.” Franco, ECF No. 85, at 2, 6-7 (emphasis added).

Similarly, in SEC v. McCloskey, No. 1:04 CV 01294 (D.D.C.), a case involving tipping

an impending merger, the Commission established a Fair Fund providing for payment to

contemporaneous traders, explaining that its plan “specifies as potential claimants all those

individuals and/or entities that were potentially defrauded by the defendants’ behavior.”

McCloskey, ECF No. 22, at 5 (emphasis added). Because actual counterparties could not be

identified, the Commission allowed all persons who sold on the day that the defendants bought to

assert a claim, “consistent with the ‘contemporaneous trading’ rule adopted in private insider

trading cases that are authorized under Section 20A of the Securities Exchange Act of 1934.” Id.

(citations omitted).

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In SEC v. Sibal, No. 2:05-cv-3133 (C.D. Cal.), another case involving insider trading on

merger tips, the Commission also paid the recovered funds to options trader counterparties.

Sibal, ECF No. 56, at 7-8. With respect to funds recovered in respect of stock trades, the

Commission acknowledged the harm to counterparty investors, but cited the small amount of the

available funds and associated administrative challenges as a basis for making no distribution to

them. In that regard, the SEC explained that “assuming that the Commission could identify and

locate all of the investors who were harmed by Defendants’ conduct, each investor would receive

only a nominal amount of disgorgement.” Id. at 9 (emphasis added).

The Commission has applied the same approach in many other insider trading cases,

repeatedly approving Fair Funds providing payments to contemporaneous traders. See SEC v.

Fitts, C.A. No. 03-CV-10658 (DPW) (D. Mass.), ECF No. 5, at 3-4, 6 n.2 (merger tip,

Commission’s plan of distribution paid the recovered funds to contemporaneous traders,

allocated pro rata among them, relying on the Second Circuit’s decisions in Shapiro, Elkind and

Wilson); SEC v. Gallucci, No. 04 Civ. 4493 (SAS) (S.D.N.Y.), ECF No. 51, at 4 (insider trading

based on merger tips from secretary of law firm partner; proceeds paid to contemporaneous

traders); SEC v. Raza, No. CV 08 00375-JF (N.D. Cal.), ECF No. 16, at 3 (insider trading case,

Commission explained that its distribution plan “directs the Distribution Agent to make an

appropriate pro rata distribution to equity traders that traded on the same day as the Defendant.

The exact contra-parties of Raza’s equity trades cannot be determined and, thus, a pro rata

distribution is a fair and reasonable method.”); SEC v. Favilla, No. 06-CV-1333 (E.D. Pa.), ECF

No. 25, at 5 (insider trading case, Commission’s plan “seeks to benefit persons who sold F&M

securities of the same series on one or more of the dates that the Defendants bought those same

securities and who suffered net losses from those transactions. For each eligible victim, the plan

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would simply direct the Distribution Agent to make an appropriate pro rata distribution.”); SEC

v. Bradlee, No. 04 Civ. 2011 (D.D.C.), ECF no. 34-1, at 5 (insider trading case involving the

same events as Favilla and the same plan to compensate “each eligible victim”).

In several insider trading cases, the Commission has proposed payment to the U.S.

Treasury and has been called on by district courts to explain its position. The Commission’s

explanations for its decisions in these cases are instructive – the only grounds for opposing

disbursement to investors cited by the Commission have involved administrative feasibility.

Thus, in SEC v. Hendrix, No. C00-20655 (JW) (N.D. Cal.), the Commission sought to have

disgorged funds and civil penalties paid to the U.S. Treasury “on the grounds that returning these

funds to investors through a Court-ordered Distribution Plan likely would not be economically

feasible.” Hendrix, ECF No. 304-1, at 3. After the District Court denied the Commission’s

motion and directed it to show cause why a distribution agent should not be appointed, the

Commission’s staff reconsidered the issue, determined that a distribution was feasible and

accordingly “proposed a plan to return the funds from the Court registry to harmed investors.”

Id. (citation omitted).

Likewise, in another insider trading case from the Southern District of New York, SEC v.

Suman, No. 07 Civ. 6625 (WHP) (HP), Judge William Pauley directed the Commission to “show

cause why distribution of any monies collected to the Defendants’ victims is not feasible or

otherwise unreasonable.” 684 F. Supp. 2d 378, 393 (S.D.N.Y. 2010), aff’d, 421 F. App’x 86 (2d

Cir. 2011). In response, the Commission devoted its brief almost entirely to the administrative

issues involved, explaining that “[a]s a general principle, the distribution of monetary recoveries

to identifiable victims is desirable,” but that “whether such a distribution is practical and

appropriate in this case will depend upon factors not yet known or knowable, such as how much

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money actually will be recovered from the Defendants, and whether a distribution to victims

would be cost-efficient, in light of the time and expense that would be needed to identify victims,

determine their losses, and make a distribution.” Suman, ECF No. 65, at 1-2.

The Commission’s policy recognizing contemporaneous investors to be the victims of

insider trading and entitled to compensation from funds recovered from defendants has existed

for decades. In a 1993 Business Lawyer article by an Assistant Chief Litigation Counsel in the

Commission’s Division of Enforcement, Rory C. Flynn, SEC Distribution Plans in Insider

Trading Cases, 48 BUS. LAW. 107 (1993), the author takes as given that funds will be paid to

investors whenever practicable, explaining that the Commission “has recommended that

disgorged funds be paid to the United States Treasury” only “[i]n cases where it is not

economically practical or efficient to identify investor claimants and provide them with

notice . . . .” Id. at 121. Indeed, this policy is reflected in two of the leading cases adjudicating

the legal standards governing creation of disgorgement funds – SEC v. Wang, 944 F.2d 80, 85

(2d Cir. 1991), and SEC v. Certain Unknown Purchasers of the Common Stock of and Call

Options for the Common Stock of Santa Fe Int’l Corp., 817 F.2d 1018 (2d Cir. 1987), both of

which involved payment of insider trading disgorgement to contemporaneous investors.

To our knowledge, then, this is the first case in which the Commission has ever

questioned whether insider trading proceeds are properly paid to investors for reasons other than

administrative infeasibility.

D. There Is No Administrative Impediment to Creation of a Fair Fund

Given the historic size of the Settlement Funds, there is of course no question as to the

financial viability of administering a Fair Fund. In addition, SAC’s trading pattern makes this a

particularly easy case to administer.

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In Skowron, the insider trading at issue involved multiple non-contiguous trading days

spread over eight weeks and a plan that, in turn, sought to apportion a specified amount of the

recovered funds among each of eleven trading days, followed by reallocation of unclaimed

proceeds from one trading day to another. While we have not attempted to analyze all of the

issues that this approach presents, it would appear to effectively require eleven separate claim

analyses, a multi-step, iterative allocation process, and, potentially, very significant complexities

concerning the netting of intervening, offsetting trades.

By contrast, the trading here occurred over seven contiguous trading days and we see no

obvious impediment to administering the settlement as a single, pooled fund, consistent with the

standard approach in single-drop issuer fraud cases.5

If the Commission determines that a distribution plan should be structured otherwise, we

recognize that the Commission’s views are entitled to deference; the potential complexity of

alternative approaches, however, does not support a decision against establishing any Fair Fund.

We are aware that in some cases, the circumstances have limited investor response rates,

complicating fund distribution. Here, there is no question that a high level of investor interest

exists. The undersigned counsel for the Elan Lead Plaintiffs have been retained by dozens of

Elan investors to pursue these claims, an unprecedented level of interest in our experience.

As noted above (at 1 n.1), the Investor Plaintiffs do not now address the specific terms of

the distribution plan, but request the opportunity to provide input into the formulation of the plan

at the appropriate time.

5 Under the prevailing law in the Second Circuit, contemporaneous traders include all plaintiffs who have traded within five to seven days following the defendants’ insider trades. See Brodzinsky v. FrontPoint Partners LLC, No. 3:11CV10 WWE, 2012 WL 1468507, at *5 (D. Conn. Apr. 26, 2012).

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E. The Central Importance of Administrative Factors Warrants Deferring Any Final Decision Against Incorporating Civil Penalties Until the District Court Determines How Disgorged Funds Will Be Applied

In light of the central importance of administrative factors, any final decision by the

Commission with respect to the Civil Penalty should be guided by the determination of the

District Court with respect to the Disgorged Funds, because its determination to establish a

disgorgement fund would likely moot any objections to the addition of the Civil Penalty thereto.

F. Failure to Create a Fair Fund Here Would Be Particularly Inequitable Because the Investor Plaintiffs’ Damages Are Limited to Disgorgement and the Commission’s Disgorgement Recovery Reduces the Investor Plaintiffs’ Potential Recovery Dollar-for-Dollar

Finally, failure to create a Fair Fund here would be particularly inequitable because,

under Elkind and Exchange Act Section 20A(b)(1), the Investor Plaintiffs’ damages are capped

at disgorgement, and the Commission’s recovery acts as a set-off, dollar-for-dollar, against

SAC’s liability to them. See Section 20A(b)(2); Litton Indus., Inc. v. Lehman Bros. Kuhn Loeb

Inc., 734 F. Supp. 1071, 1076 (S.D.N.Y. 1990). Indeed, upon entering into the SEC-SAC

Settlement, SAC advised the District Judge that the Investor Plaintiffs’ case should be dismissed

in its entirety as a result of the settlement. See Kaplan ECF No. 29. In one pre-SOX insider

trading case brought by the Commission, Certain Unknown Purchasers of the Common Stock of

and Call Options for the Common Stock of Santa Fe Int’l Corp., 817 F.2d at 1021 n.1, the

Second Circuit specifically recognized the distinctive effect of disgorgement to the Commission

in insider trading cases, holding that the prospect of extinguishing an investor’s private claims

gave the investor standing to challenge the Commission’s distribution plan on appeal.

While the Civil Penalty does not operate as a set-off, the goal of compensating actual

investor losses supports inclusion of the Civil Penalty in a Fair Fund. As pled in the Kaplan

action, see Kaplan ECF No. 139-1, at 4, the Elan Investor Class’s estimated losses with respect

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to the Insider Selling Period were approximately $672 million, more than three times the

principal amount of Elan-related disgorgement from SAC.

II. FAILURE TO RECOMMEND THAT A FAIR FUND BE ESTABLISHED WOULD CONSTITUTE AN ABUSE OF DISCRETION

In light of the settled Second Circuit law governing insider trading claims by

contemporaneous investors and the Commission’s longstanding policy of creating Fair Funds

and disgorgement funds in other insider trading cases, the decision not to do so here would

constitute an abuse of discretion by the Commission.

A. In Light of the Controlling Second Circuit Precedent, Any Determination that the Investor Plaintiffs Are Not Victims Harmed by the Fraud Would Constitute a Reversible Error of Law

First, as discussed above in Point I.B, the Second Circuit’s decisions in Shapiro, Elkind

and Wilson control the questions of causation and damages raised by the Commission’s counsel.

On these issues, no deference to the Commission’s decisionmaking is due, Hongsheng Leng v.

Mukasey, 528 F.3d 135, 141 (2d Cir. 2008) (“[w]e review the agency’s legal conclusions de

novo”), and a failure to adhere to the Second Circuit’s rulings would constitute an error of law

warranting remand. See Hasan v. U.S. Dept. of Labor, 545 F.3d 248, 251 (3d Cir. 2008) (error

of law required remand to agency following correction by circuit court).

B. Given the Commission’s Practice of Establishing Fair Funds in Other Insider Trading Cases, Failure to Do So Here Would Be Arbitrary and Capricious

Second, the Commission’s practice of establishing Fair Funds in substantially identical

circumstances, as discussed in Point I.C above, would make its failure to do so here arbitrary and

capricious. As the District of Columbia Circuit has explained, “[a] long line of precedent has

established that an agency action is arbitrary when the agency offered insufficient reasons for

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treating similar situations differently.” Transactive Corp. v. United States, 91 F.3d 232, 237

(D.C. Cir. 1996).

This principle applies with greater force here given the Commission’s stated policy and

practice of establishing Fair Funds “whenever reasonably possible,” as discussed in Point I.A.2

above. See, e.g., Zhao v. U.S. Dept. of Justice, 265 F.3d 83, 93 (2d Cir. 2001) (abuse of

discretion where agency “inexplicably departs from established policies”); Goldstein v. SEC, 451

F.3d 873, 883 (D.C. Cir. 2006) (in light of Commission’s failure “adequately to justify departing

from its own prior interpretation of” statute, its decision to do so “appear[ed] completely

arbitrary” and was accordingly vacated).

III. PFIZER, AS SUCCESSOR TO WYETH, IS ENTITLED TO THE REMAINING WYETH SETTLEMENT FUNDS AFTER WYETH INVESTORS ARE COMPENSATED FOR ACTUAL LOSSES

Under both the classical and misappropriation theories of insider trading, the company

whose information is misappropriated is also a victim of the insider trader’s misconduct.

Accordingly, it is appropriate that, after compensating the Wyeth Investor Class for its actual

losses, the balance be paid to Pfizer.

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CONCLUSION

For the foregoing reasons, the Commission should recommend to the District Court that a

Fair Fund be established for the benefit of the Elan and Wyeth Investor Classes, and secondarily

for the benefit of Pfizer.

Dated: New York, New York July 31, 2014 SCOTT+SCOTT, ATTORNEYS AT LAW, LLP By: Deborah Clark-Weintraub Joseph P. Guglielmo Tom Laughlin The Chrysler Building 405 Lexington Avenue, 40th Floor New York, New York 10174 Telephone: (212) 223-6444

Gregg S. Levin David P. Abel MOTLEY RICE LLC 28 Bridgeside Boulevard Mt. Pleasant, South Carolina 29464 Telephone: (843) 216-9000

Co-Lead Counsel for Wyeth Investors

WOHL & FRUCHTER LLP

By: Ethan D. Wohl Krista T. Rosen Sara J. Wigmore 570 Lexington Avenue, 16th Floor New York, New York 10022 Telephone: (212) 758-4000 Facsimile: (212) 758-4004

Marc I. Gross Tamar A. Weinrib POMERANTZ LLP 600 Third Avenue, 20th Floor New York, New York 10016 Telephone: (212) 661-1100 Facsimile: (212) 661-8665

Co-Lead Counsel for Elan Investors