Part XV: SEC Enforcement Trends And Priorities, 2008

Last year, the Commission brought 10 cases which named lawyers as defendants. This was a record number. Many of these cases were based on allegations of insider trading, options backdating and fraud.

Two cases from last year which are currently in litigation and of note are:

SEC v. Collins, Case No. 07 CV 111343 (S.D.N.Y. Dec. 18, 2007) which arose out of the collapse of Refco. The Commission’s complaint alleges that Joseph Collins, a partner at the law firm of Mayer Brown LLP and Refco’s long time outside counsel, learned that Refco Group Holdings, Inc., a non-Refco entity controlled by Phillip Bennett, Refco’s CEO, owed Refco hundreds of millions of dollars. Mr. Collins participated in, worked on, and supervised other attorneys who documented periodic transactions in which a Refco subsidiary appeared to loan Refco Group Holdings millions of dollars in transactions which were later reversed. In the transactions, Refco assumed hundreds of millions of dollars in liabilities. Specifically, in 2004 Refco placed $600 million in senior subordinated notes with certain financial institutions pursuant to an offering circular. The next year, Refco conducted an IPO. The offering circular did not disclose Refco Group Holdings debts or the round trip transactions used to conceal it at times.

The SEC is seeking a permanent injunction which would enjoin defendant Collins from future violations of Section 10(b) and a civil penalty. Mr. Collins was also indicted on similar charges. U.S. v. Collins, Case No. 1:0-cr-01170 (S.D.N.Y. Dec. 18, 2007).

A second case involves Christi R. Sulzbach, former general counsel and chief compliance officer of Tenet Healthcare Corp., SEC v. Tenet Healthcare Corp., No. CV-07-2144 (C.D. Cal. April 2, 2007). The complaint in this case alleges that the company and several officers, along with Ms. Sulzbach, misled the investing public by failing to disclose a company strategy, its impact on revenues and earnings and the fact that it could not be sustained in the MD&A section of the filings.

All of the officers except Ms. Sulzbach settled. This case, and both of those involving Mr. Collins, is in litigation.

Next: The subprime crisis

What Value Cooperation? Another Option Backdating Case Raises The Question

For a disclosure agency, the SEC certainly does not disclose much. Brooks Automatic, Inc., a semiconductor capital equipment company in Chemsford, Massachusetts agreed to settle a Commission enforcement action alleging option backdating. Prior to settling the action the company cooperated with the SEC’s investigation. The SEC called the actions of the company “swift, extensive, and extraordinary cooperation.” Not swift or extraordinary enough to avoid prosecution, however. SEC v. Brooks Automation, Inc., Civil Action No. 08 CA 10834 (D. Mass. May 19, 2008). So, just what did the company do to cooperate and why was it still prosecuted?

The complaint alleged that former company president and CEO Robert Therrien backdated an option grant for 225,000 shares in November 1999 after learning that the initial grant had expired worthless. Mr. Therrien, according to the complaint, created and executed false documents causing the issuance of in-the-money options for himself. The options were exercised with a loan from the company ratified by three other directors. Mr. Therrien netted $5.2 million in undisclosed compensation. The company failed to properly account for this expense in its filings.

Brooks also issued several company-wide option grants for which the grant dates were inaccurate. As a result of the grant to Mr. Therrien and the company-wide grants, the Brooks’ financial statements and other filings were inaccurate.

In 2006, the company restated its financial statements for fiscal years 1996 through 2005. In that restatement, Brooks recorded cumulative non-cash, pre-tax stock-based compensation expense of $64.5 million, partially offset by a $1.8 million tax benefit.

To resolve the case, Brooks consented to the entry of a permanent injunction prohibiting future violations of the reporting provisions of the Exchange Act. A separate action was filed against Mr. Therrien last year which alleges violations of the antifraud and reporting provisions of the securities laws. SEC v. Therrien, Civil Action No. 07-CA 11364 (D. Mass. July 26, 2007).

Clearly, the settlement with Brooks reflects the cooperation the company extended to the staff during the investigation. Unlike the action against Mr. Therrien, the complaint against the company does not allege fraud. Likewise, the consent injunction does not prohibit future violations of the antifraud provisions. And, unlike many similar cases, the company was not required to pay a civil penalty.

At the same time, one has to wonder just why an action was brought against the company at all. Seaboard offers a company in the position of Brooks the prospect of amnesty for cooperation. After all, the company on which the Release and Section 21(a) report is based discovered a financial fraud as did Brooks which presumably impacted its filings. Cooperation however saved the company in Seaboard from the usual civil injunctive action and even an administrative proceeding and a cease and desist order. It did not save Brooks.

Perhaps the difference between Brooks and Seaboard is the nature of the conduct. The Seaboard release does state that one of the factors considered by the Commission in making its prosecutorial decision involving cooperation is the nature of the conduct. In Seaboard the financial fraud was limited to a subsidiary and one person was the primary violator, although two others in supervisory positions were also dismissed. In contrast, the fraud at Brooks is at the company and directed by its former president and CEO, although three directors also assisted.

At the same time Brooks is troubling. If the cooperation was “swift” and “extraordinary” as the Commission states, this would seem to be a case in which no action should have been brought. This is particularly true in view of the fact that the conduct is years old. Indeed, an injunction prohibiting future violations hardly seems necessary for years old conduct and when a company cooperates to the degree suggested by the SEC’s press release.

On the other hand, perhaps the lesson of Brooks and Seaboard is that extraordinary cooperation only yields non-prosecution for a confined and relatively small malfeasance. If this is the case – and it is difficult to tell since so little information is actually disclosed about the cooperation and how it is evaluated – then this casts the notion of cooperation credit and its attendant costs a different light. For the future, it would no doubt aid issuers in their efforts to cooperate if the Commission would furnish additional guidance in its Litigation and press releases about the cooperation and how it was evaluated.