Jan. 14 (Bloomberg) -- Insider traders like Joseph F. “Chip” Skowron III must be held responsible for the harm they cause their employers, Morgan Stanley lawyers told an appeals court in a bid to recover $10.2 million.
Skowron, 43, who is serving five years in prison, was a hedge fund manager at Morgan Stanley’s FrontPoint Partners LLC until he was charged in April 2011 with using inside information to avoid $30 million in losses.
The U.S. Court of Appeals in Manhattan heard arguments today in Skowron’s appeal of a judge’s order that he pay $10.2 million in restitution to the New York-based bank, which closed FrontPoint after the scandal. Morgan Stanley and prosecutors argued in support of the judge’s order, saying he hid his activities from his employer and the government.
“There isn’t any doubt, had he not lied, he would have been fired immediately,” Kevin Marino, a lawyer for Morgan Stanley, told the court today. “And that was before he was paid $20 million.”
The bank has also sued Skowron for $65 million, part of what his spokesman Montieth Illingworth previously called an effort to “grind down what remains of Dr. Skowron’s life.”
Joshua Epstein, Skowron’s lawyer, told the appeals panel today that Morgan Stanley is entitled to file a lawsuit to seek the money it paid his client. The firm isn’t entitled to restitution in the criminal case, he said.
With U.S. prosecutors pursuing insider trading on Wall Street, banks and hedge funds will probably be watching the outcome of the case, said A. Jeff Ifrah, co-author of “Federal Sentencing for Business Crimes.”
“The reputation of an employer like this one can get killed by the conduct of its employee,” Ifrah said in a telephone interview.
Seeking restitution “is certainly a good strategy” to reclaim a company’s good name, said Ifrah, a Washington lawyer not involved in the case.
Today’s argument comes as Skowron, a doctor who trained at Harvard and Yale, completes his first year at the U.S. prison camp in Minersville, Pennsylvania.
On Aug. 5, 2011, he pleaded guilty to conspiracy to commit securities fraud and obstruct justice. He admitted helping FrontPoint avoid more than $30 million in trading losses on Human Genome Sciences Inc., a Rockville, Maryland, pharmaceutical firm that was acquired by GlaxoSmithKline Plc.
Skowron admitted that he got secret tips from a French physician, Yves Benhamou, who was helping to oversee a clinical trial of an HGSI hepatitis drug, Albuferon. After Benhamou told Skowron about disappointing results in the drug trial, Skowron sold HGSI shares in FrontPoint’s health-care funds.
At his sentencing in 2011, U.S. District Judge Denise Cote ordered Skowron to forfeit $5 million. She also required him to pay restitution of $5.9 million to five investors that bought FrontPoint’s HGSI stock in block trades just before HGSI announced the clinical-trial results in January 2008. Deutsche Bank AG and Galleon Group LLC were among the funds.
At the time of his sentencing, Skowron had a net worth of $22 million.
On March 20, the judge ordered Skowron to pay restitution of $3.8 million to a sixth victim, Morgan Stanley, for the bank’s legal fees and $6.4 million to cover one-fifth of his compensation from 2007 to 2010.
Morgan Stanley’s “expectation was that Skowron would abide by policies” that “prohibited insider trading,” Cote wrote in an opinion.
“His crimes deprived Morgan Stanley of the honest services of its employee, diverted valuable corporate time and energy in the defense of Skowron and FrontPoint and injured Morgan Stanley’s reputation,” she wrote.
The judge refused to award Morgan Stanley $33 million from Skowron that the bank paid to settle a related U.S. Securities and Exchange Commission lawsuit. The money was illegal profit, not funds FrontPoint was entitled to, Cote said.
In his appeal, Skowron advanced largely technical arguments for why Cote’s order violated the U.S. Mandatory Victims Restitution Act, which provides for repayment to “an identifiable victim” of a fraud.
For instance, he didn’t commit “honest services fraud” because he didn’t “accept a bribe or kickback from a third party,” as the law requires, he said.
He also argued there’s no proof that his compensation stemmed from the illegal trades. “This is entirely speculative,” Epstein wrote.
The U.S. Supreme Court in 2010 narrowed the scope of the U.S. restitution law, Ifrah said. Illingworth, Skowron’s spokesman, declined to comment on the appeal.
Prosecutors defend Cote’s decision, pointing to cases in which offenders were ordered to surrender part of their pay. In one, a police chief who took bribes from mobsters running a gambling business was ordered to pay an amount equal to about 25 percent of his salary.
Prosecutors say Skowron’s pay was tied to his funds’ performance.
“Skowron avoided approximately $1.36 million in losses to his own compensation by causing FrontPoint to avoid the $30 million loss,” they wrote.
By hiding the fraud from internal Morgan Stanley investigators beginning in early 2008, Skowron “profited by keeping the job that he certainly would have lost,” they said.
“He has a very clear choice in front of him,” Assistant U.S. Attorney David Massey told the court today, arguing that the amount Skowron was paid after he obstructed the government’s investigation was properly subject to return to Morgan Stanley. “If he tells the truth, he’ll be fired within the hour.”
Jerika Richardson, a spokeswoman for U.S. Attorney Preet Bharara, declined to comment on the case.
News of the fraud in November 2010 led Morgan Stanley to write down $116 million of the value of its FrontPoint investment and, after “massive redemptions,” to shutter FrontPoint’s health-care funds, which managed $1.55 billion, prosecutors said. The bank says it’s a victim.
“The significant compensation Morgan Stanley paid to Skowron was undeniably based in part on the success of his criminal scheme to commit insider trading and then conceal that crime from Morgan Stanley and the government,” the bank’s lawyers wrote.
Jim Wiggins, a Morgan Stanley spokesman, declined to comment on the appeal.
On Oct. 31, Morgan Stanley sued, seeking the $33 million Cote said it was not entitled to, as well as the entire $32 million it paid Skowron from 2007 to 2010.
The bank called Skowron a “faithless servant” who lied repeatedly to continue being paid by the bank and to avoid the blow to his reputation that a loss on HGSI would have caused. Skowron hasn’t responded yet.
Since August 2009, Bharara’s office has brought insider-trading charges against 76 people, many at Wall Street funds.
They and other employers, whose insurance carriers may require them to sue rogue employees, need to be certain they can’t be tarnished by wrongdoing before pursuing restitution, Ifrah said.
“You have to make sure you’re solid on noninvolvement before you throw yourself into the lion’s den,” he said. “Do you want to really get involved in a criminal proceeding? Are you confident and comfortable enough?”
The case is U.S. v. Skowron, 12-1284, U.S. Court of Appeals for the Second Circuit (Manhattan). Morgan Stanley’s suit is Morgan Stanley v. Skowron, 12-cv-8016, U.S. District Court, Southern District of New York (Manhattan).
To contact the reporters on this story: David Glovin in New York at firstname.lastname@example.org; David Voreacos in Newark, New Jersey, at email@example.com; Bob Van Voris in the U.S. Court of Appeals for the Second Circuit in New York at firstname.lastname@example.org.
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