by T. GormanPosted on Posted in SECActions

Privilege

Last week, a key privilege issue typically raised by government and SEC prosecutors with issuers seeking cooperation credit was raised against by a defendant in an option backdating case. In many cases, a key issue in such discussions is the notes taken by internal investigators during interviews of various company employees. This is particularly true when the employee asserts a constitutional right not to testify in response to a government request for testimony.

Now, however, former McAfee, Inc. General Counsel Kent Roberts is raising the issue in his option backdating case concerning the refusal of internal investigators from Howrey to turn over their notes prepared while interviewing company employees as part of their inquiry. Mr. Roberts has been named as a defendant in a criminal case and an SEC enforcement action for his alleged role in an option backdating scheme at his former employer. U.S. v. Roberts, Case No. 3:07-cr-00100 (N.D. Cal. Filed February 27, 2007); SEC v. Roberts, Civil Action No. 07-CV-00407 (D.D.C. February 28, 2007).

Mr. Robert’s claims that notes from interviews of company employee’s taken by the internal investigators will support his claim that others at the company frequently backdated options. Investigators claim the notes are privileged and have refused to turn them over.

Previously, in the option backdating case of Gregory Reyes, U.S. v. Reyes, discussed here, the court held that Brocade Communications had waived privilege, making interview notes subject to production. That ruling was based on the fact that the notes had been shared with the government. The ruling in Reyes is consistent with that of most courts. Nevertheless SEC has long argued that companies can share privileged material with it under a so-called non-waiver agreement and preserve the privilege as to third parties.

In Roberts, the confidentiality of the notes has been preserved and they have not been shared with the government. The court has not ruled on the issue.

Insider trading

Former UBS employee Mitchel Guttenberg pled guilty last week to two counts of conspiracy and four counts of securities fraud. Sentencing is set for June 2.

Mr. Guttenberg is at the center of an insider trading case which many have called the most significant since the days of Ivan Boesky, Dennis Levine and others in the late 1980s, discussed here, because it involved so many Wall Street players. Mr. Guttenberg is alleged to have shared information about up coming UBS recommendations on stocks prior to their announcement. To date, eleven of the thirteen criminally charged in this matter have pled guilty. U.S. v. Guttenberg, 1:07-cr-00141 (S.D.N.Y. Filed February 26, 2007). Fourteen were named as defendants in the related SEC enforcement action. SEC v. Guttenberg, Civil Action No. 07 CV 1774 (S.D.N.Y. March 1, 2007).

Finally, a study by David Yermack, a finance professor at New York University, has concluded that that chief executives and company chairman appear to be able to repeatedly make gifts of large amounts of company stock to their family foundations directly prior to big declines in share price. This finding is based on a study of 155 gifts of more than $1 million made by C.E.O.’s and chairmen to their family foundations between 2003 and 2005. Professor Yermack estimates that while most of the 90 persons in his sample are playing by the rules about 20% are not.

While the results of Professor Yermack’s research may not establish a misuse of inside information, his earlier work on option backdating was key in the evolution of that scandal. Similarly, other academic studies have triggered SEC scrutiny of executive practices such as trading under Rule 10b5-1 plans as discussed here. One has to wonder if this study will trigger new scrutiny by the enforcement division of executive gifts of stock.

by T. GormanPosted on Posted in SECActions

The books, records and internal control provisions of the FCPA are contained in Securities Exchange Act Sections 13(b)(2)-(7). Generally, these provisions apply to all issuers and transactions. They are broader than the anti-bribery provisions, which focus on certain corrupt payments.

Section 13(b)(2)(A) is perhaps the key provision. It requires every SEC registrant or issuer to “make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the issuer” (emphasis added). The Section includes neither a materiality nor a scienter requirement. Rather, the “in reasonable detail” provision of the statute is intended as a substitute to “effectively prevent off-the-books slush funds and payments of bribes.” H.R. Rep. No. 95-831, at 10 (1977), reprinted in 1977 U.S.C.C.A.N. 4121, 4122.

The “in reasonable detail” requirement of Section 13(b)(2)(A) was given further definition in the 1988 amendments to the statute, which added Section 13(b)(7), defining “reasonable.” In the FCPA, that term means that degree of detail which “would satisfy prudent officials in the conduct of their own affairs.” The concept of a prudent man is not an “unrealistic degree of exactitude.” H.R. Rep. No. 100-576 at 917 (1988).

The books and records provisions have three key objectives: (1) to ensure that the books and records reflect the transactions in conformity with acceptable method of reporting economic events; (2) to prohibit inaccurate financial books and records; and (3) to make sure that transactions are properly reflected to permit the preparation of financial statements in accord with GAAP.

To implement the books and records provisions the SEC promulgated two rules. Rule 12b-2-1 prohibits the falsification of the books and records: “No person shall directly or indirectly, falsify or cause to be falsified, any book, record or account.” That Rule is fortified by Rule 13(b)2-2, which prohibits making false statements to an auditor, thus aiding in the preparation of accurate books and records.

The internal control provisions are contained in Section 13(b)(2)(B). That Section requires that every issuer:

devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that:
(1) transactions are executed in accord with management’s general or specific authorization;
(2) to maintain accountability for assets;
(3) access to assets is permitted only in accord with management’s general or specific authorization; and
(4) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences …

The purpose of these provisions is to ensure that entities adopt accepted methods of recording economic events, protecting assets and conforming transactions to management’s authorization. No specific system of controls is mandated. Section 13(b)(5) aids enforcement by providing that “[n]o person shall knowingly circumvent or knowingly fail to implement a system of internal controls or knowingly falsify any book, record or account.”

The books and records (a phrase not defined in the statute) and internal control provisions were designed to compliment each other. These provisions, which were fortified in the Sarbanes-Oxley Act by, for example, the CEO/CFO certifications in Section 302 and 906 requirements, work together to ensure that transactions are accurately recorded. The sections also aid enforcement of the anti-bribery provisions by requiring disclosure of any bribe – prevention through “sun-light” or disclosure.

Next: An overview of the anti-bribery provisions