Part I: Self-Reporting And Cooperation: Key Issues

An analysis of the question of self-reporting begins with the legal obligation to take this step. In some instances, there is a clear legal obligation. In others, there may, in practical terms, be an obligation to report. And, in still others, a complex of legal obligations and the ramifications of a potential charging decision virtually compels self-reporting, in the view of some commentators.

In some instances, a business organization may have an obligation to self-report. Section 10A(3) of the Securities Exchange Act of 1934 for example, requires that after receiving a report from its auditors under Section 10A(2) of illegal acts, the issuer “shall inform the Commission by notice not later than 1 business day after the receipt of such report …”

In other instances, there may be a practical obligation which effectively compels self-reporting. If, for example, an issuer discovers a material error in its financial statements, a restatement may be required under SFAS 154, Accounting Changes and Error Corrections. That, in turn, will require the issuer to file amendments to its periodic filings made with the SEC. Under these circumstances, self-reporting is virtually required.

In other instances, the broad liability faced by a business organization coupled with the obligations imposed by the Sarbanes-Oxley Act and the severe consequences of a charging decision virtually compel self-reporting:

• Corporate liability principles have created virtually open-ended liability for business organizations since the Supreme Court’s decision in New York Central and H.R.R. v. U.S., 212 U.S. 481 (1909), which gives prosecutors almost unfettered charging discretion;

• SOX requires corporate mangers to monitor and certify organizational systems and information in Sections such as 302 (CEO, CFO certifications), 906 (certifications), 404 (internal controls), 301 (audit committee authority and obligations) and 307 (counsel), thereby imposing a duty of detection and knowledge; and

• Being named as a defendant in a DOJ criminal or SEC civil enforcement action can have debilitating, if not draconian consequences, for a business organization.

Collectively, these principles and obligations have led some commentators to conclude that there is a fiduciary duty to self-report. As one commentator noted: “Under current federal law and Department of Justice Policy, it would be irresponsible for management to attempt to defend the corporation or its employees.” John Hasnas, Department of Coercion, Wall Street Journal, March 11, 2006. At a minimum, there is significant compulsion to take the step. In this context, the choice is not whether to self-report, but when, and not if to cooperate, but what steps to take to try and earn cooperation credit.

Next: Ill-defined prosecution and cooperation standards

SEC Injunctions: When Is This Extraordinary Remedy Necessary?

Injunctions are extraordinary remedies, invoking the equitable power of the courts to prevent future violations of the law in SEC cases. The Commission, at times, uses them to halt claimed fraudulent conduct. In its recent campaign against insider trading for example, it has brought several actions within days of the corporate announcement which triggered the claimed insider trading — typically a merger — and obtained emergency injunctive relief to halt the dissipation of the claimed illegal trading profits. Typical of these cases is SEC v. De Colli, filed in May 2008 and discussed here. There, the Commission brought the action and won an asset freeze order within days of the announcement of the corporate transaction involved in the Wall Street Journal and after interviewing Mr. De Colli, an Italian national residing in Italy. No doubt, injunctive relief was necessary and appropriate.

Financial fraud cases are a different story. All too often, the conduct is these cases is years and years old, not infrequently dating to last century or the very early years of this one. By the time of the SEC’s case, frequently a restatement giving anyone who cares to look a road map to the fraud has been on file for years and the executives involved are gone. SEC v. El Paso, filed earlier this year and discussed here, is not untypical. In that financial fraud case, the books were cooked between 1999 and 2003. The company restated is financial statements in 2004. Four years after that restatement, five years after the fraud ended and nine years after it began, the SEC filed a settled civil case with an injunction. Just why this case took so long to investigate and resolve and, even more importantly, the reason an injunction was necessary, is something of a mystery.

Now consider SEC v. Crowley, Civil Action No. 08-cv-1388 (S.D. Cal. Filed Aug. 1, 2008) and SEC v. Burdick, Civil Action No. 08-cv-1390 (S.D. Cal. Filed Aug. 1, 2008). Both of these cases are based on a financial fraud at SeraCare Life Sciences, Inc. a supplier and manufacture of biological product for the biotechnology and pharmaceutical industry. Defendant Michael Crowley was the former chief executive officer of the company. Defendant Jerry Burdick was a member of the board and the interim chief financial officer.

The complaints allege that Mr. Crowley failed to disclose in a Form 10Q and an earnings release that the day before the earnings call the company learned that a bill and hold sale representing about 11% of the company’s pretax quarterly income had been cancelled. Nevertheless, Mr. Crowley subsequently executed the SOX certification covering the incorrect earnings.

Mr. Burdick, according to the complaint, improperly released reserves in two quarters. As a result, the quarterly earnings were improperly inflated by 20% in one quarter and 17% in another.

Both men settled the actions, consenting to the payment of financial penalties and Section 17(a)(2)&(3) and books and records injunctions. Mr. Burdick also agreed to a Rule 102(e) one-year suspension from practice before the Commission. Neither was barred from being an officer and director.

Now what is perhaps most interesting about these cases is the fact that the conduct involved occurred in 2005 — only three years ago. And, there was no restatement to give the Commission a roadmap to the improper accounting as in so many cases. Of course, by the time of the action both men were gone and the company had moved from the west coast in Oceanside, California to Milford, Massachusetts. Nevertheless, three years is far quicker than in many financial fraud cases — but one still has to wonder if an injunction was really necessary under the circumstances, particularly one based on negligent conduct.