Part III: SEC Enforcement Trends and Priorities 2008 – Policies (Cont)

Three key enforcement policies concern corporate penalties, parallel proceedings and private actions. Each of these policies raises significant questions.

The SEC has what can be viewed as a two-fold policy toward corporate penalties. One part is reflected in the policy statement issued in 2006. Then, the SEC enunciated a number of factors to be considered in assessing whether and to what extent a corporate penalty should be imposed. The two key factors in the equation are the presence or absence of a benefit to the corporation and the degree to which a penalty will recompense or harm the shareholders.

The 2006 policy must be considered in conjunction with the policy announced by Chairman Cox in an April 13, 2007 speech which dictates the procedure for determining such penalties. Under the Chairman’s new approach, the staff must meet with the Commission in any case where there is an issue regarding corporate penalties and receive instructions on the amount or range for the amount of any penalty. After receiving instructions, the staff can proceed to meet with defense counsel and negotiate a settlement. This procedure contrasts sharply with the traditional approach under which the staff and defense counsel negotiated a tentative settlement which was then submitted to the Commission for consideration.

The impact of these policies is difficult at best to determine. The two cases cited in yesterday’s post are good illustrations. In the BISYS Systems case, the SEC did not impose any penalty. In Nortel, the Commission imposed a $35 million tax. Both cases involved financial fraud. In both cases, the Commission acknowledged the cooperation of the company. Yet, in one case there is no penalty, while in the other there is a substantial penalty. While there may be other factors which explain the disparate results, they are not readily apparent from the information disclosed by the Commission.

Nor is it clear that Chairman Cox’s new settlement procedure for cases involving corporate penalties empowers the staff and facilitates the settlement process as he announced it would in his speech. To the contrary, it is unclear at best as to whether counsel for the issuer has any meaningful opportunity to discuss and negotiate with the staff regarding a penalty. It is equally unclear whether the policy facilitates the process. Indeed, given the apparent slow pace of many enforcement cases, it appears that it may be further slowing the process.

The Commission’s policy regarding parallel proceedings was affirmed by the Ninth Circuit in the Stringer case, discussed here, on April 4, 2007. In that decision, the Circuit Court upheld the SEC’s reliance on standard form 1662 (standard warnings which note, in part, that the SEC may make its files available to criminal prosecutors) as an appropriate response to any inquiry by defense counsel regarding the existence of a parallel criminal proceeding. The only apparent limitation on the Court’s holding is that the SEC cannot make an affirmative misrepresentation. The court did not seem to be troubled by the fact that the investigations of the SEC and DOJ in Stringer were not parallel. but had merged.

This policy, like the SEC’s cooperation policy, may not facilitate cooperation with its investigations. In view of Stringer, defense counsel representing individuals many have little choice when faced with any situation where there are potential criminal charges to advise a witness to invoke his or her constitutional right not to testify rather than cooperate. This may also be the case in internal investigations where it is clear that the business organization intends to waive privilege and turn over all interview notes to the SEC. This is particularly true in view of the trend toward deputization, under which witnesses in internal investigations have been charged with making false statements where they reasonably could know that their statements would be given to the government.

Finally, there is a substantial question concerning the SEC’s current position on private securities damage actions. Traditionally, the Commission has taken the position that private damage actions are a necessary supplement to its enforcement actions. Yet, last year it seems to have taken conflicting positions on two key private actions before the Supreme Court. In Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), the SEC argued in an amicus brief for an interpretation of the “strong inference” of scienter pleading standard in private actions that was more stringent than the one adopted by the Court. Many commentators argued that the SEC’s proposed standard was pro-business rather than pro-plaintiff.

In contrast, in Stoneridge Investment Partners, LLC. V. Scientific-Atlanta, Inc., 128 S.Ct. 761 (Jan. 15, 2008), the SEC adopted a position on the question of scheme liability which supported plaintiffs and which was ultimately rejected by the Court. While the Solicitor General did not permit the SEC to file an amicus brief, it is clear that the Commission sought to take an aggressive, pro-plaintiff position. The SEC’s position in this case stands in stark contrast to the one taken in Tellabs, creating an open question as to the agency’s position on private damage actions.

Next: Calls for the reform of SEC policies

Part II: SEC Enforcement Trends and Priorities 2008 — Policies

SEC enforcement has traditionally combined the functions of the cop on the beat and regulation through litigation. The policies and procedures which govern the SEC’s enforcement efforts can have a critical impact on those involved in its cases. While some policies served the program well, others have led to calls for reform, most of which have gone unheeded.

Cooperation is a key policy. On one side is cooperation with other regulators, and on the other is the cooperation of issuers and others with the SEC. While the SEC has traditionally cooperated with other regulators, those efforts seems to be increasing, particularly with DOJ. Many of the SEC’s high profile insider trading and FCPA cases last year were brought with either the assistance of foreign regulators or criminal prosecutors. The TXU Options case (SEC v. One or More Unknown Purchasers of Call Options of the Common Stock of TXU Corp., Civil Action No. 1:070cv-01208 (N.D. Ill. Marc 2, 2007)) is just one of a series of cases in which the SEC acknowledge the assistance of foreign regulators. In that case the Commission thanked the U.K. Financial Services Authority and the Swiss Federal Banking Commission for their assistance.

In the Chevron FCPA case (SEC v. Chevron Corp., Civil Action No. 07-10299 (S.D.N.Y. Nov. 14, 2007)) the SEC coordinated with the Office of the U.S. Attorney, the Manhattan District Attorney and the Office of Foreign Asset Control. This is just one of a rising tide of cases in which the SEC is working with criminal prosecutors.

The other facet of cooperation is issuers and others assisting with the SEC’s regulatory and investigative efforts in the hope of receiving credit in the prosecutorial charging process. The SEC’s policies on cooperation are set forth in its 2001 Seaboard Release which details considerations for charging a business organization. Like those of DOJ, the policies offer business organizations the prospect of credit in return for cooperation. Like those of DOJ, they reference the prospect of privilege waivers as part of what may constitute cooperation. Like those of the DOJ, those policies have been under fire for fostering a “culture of waiver” in which the waiver of important rights like the attorney client privilege is the currency which purchases cooperation credits in the charging decision.

While DOJ has revised its policies and Congress is considering legislation, the SEC has steadfastly maintained that waivers are not a perquisite to cooperation. Linda Thomson, Director the SEC’s Enforcement Division, made this clear in a speech in April 2007. In her speech Ms. Thomson cited two examples of cases in which the issuer received cooperation credit that impacted the resolution of its case. In one, the company waived privilege. In the other it did not. In the former the company was not prosecuted. In the latter the company was prosecuted.

The debate over the waiver of privilege however, is only one part of the debate about cooperation credit. A more fundamental difficulty is what credit the company receives and its value in contrast to the difficulties waivers and cooperation may cause for the company. A close study of SEC cases in which the agency acknowledges cooperation reveals little. Consider for example the following examples:

• SEC v. Wagner, Civil Action No. 07-22123 (D.D.C. Dec. 7, 2007) involved a corporate director who traded in advance of a corporate event and then self reported to the SEC. The case was resolved with a standard consent decree and the payment of disgorgement but no penalty.

• The Retirement System of Alabama, Release No. 574461 (March 6, 2008) involved a pension system which obtained inside information and used it to trade. The system did not have any procedures according to the Commission to prevent insider trading. The investigation was resolved with a Section 21(a) report and no enforcement action.

• SEC v. The BISYS Group, Inc., 07-Civ-4010 (S.D.N.Y. Filed May 23, 2007) concerned a company that engaged in a pervasive corporate accounting fraud involving its senior management. The SEC acknowledged “extensive cooperation.” The case settled with a books and records injunction.

• SEC v. Nortel Networks, Corp., Case No. 07-CV-051 (S.D.N.Y. Oct. 15, 2007) saw a company engaged in financial fraud by improperly accelerating revenue recognition and improperly established and maintained reserves. The SEC acknowledged Nortel’s “substantial remedial efforts and cooperation.” The case settled with a consent to a statutory injunction prohibiting future violations of the antifraud and reporting provisions and the payment of a $35 million civil penalty.

Precisely why Wagner ends with an injunction, while Retirement System of Alabama concludes with a Section 21(a) report is difficult to determine. Perhaps even more difficult to parse is the difference between the corporate fraud cases where one company is not fined and anther pays a very substantial penalty. The lack of transparency in this area, coupled with the “culture of waiver” questions, makes it most difficult for any person to assess how to proceed with the SEC. That difficulty is compounded by the rise of parallel proceedings and the SEC’s policies in that area.

Next: Parallel proceedings and calls for increased transparency in Enforcement procedures