by T. GormanPosted on Posted in SECActions

The SEC announced the filing of a settled enforcement action centered on a pervasive corporate accounting fraud. The settlement appears to bring into play the SEC’s policies on corporate penalties and cooperation. The settled civil injunctive action was filed against New Jersey based BISYS Group, Inc., a leading provider of products and support services to financial institutions such as insurance companies, banks and mutual funds. According to the SEC’s complaint the company repeatedly utilized improper accounting techniques over a period of years to inflate its income. Those actions resulted from what the complaint called an improper focus on meeting Wall Street expectations and lax internal controls in one division which experienced rapid growth, largely through acquisition. http://www.sec.gov/news/press/2007/2007-103.htm

The SEC’s complaint details a series of improper accounting practices primarily in one division but also found in other areas which occurred from at least July 2000 through December 2003. As a result the company’s reported financial results were overstated for the fiscal years ended June 30, 2001, 2002 and 2003 by about $180 million. Based on two restatements of its financial statements, BISYS overstated pretax income by 69%, 58% and 43% for fiscal years 2001, 2002 and 2003 respectively. For the same periods the company overstated EPS by 73%, 62% and 46%. The complaint alleges that the company inflated its income through an improper focus on meeting Wall Street expectations and lax internal controls in its insurance services division which experienced rapid growth during the period. The company used a variety of improper accounting practices to inflate its income, including:

 

–Improperly recording commissions previously earned by an acquired company, but not yet paid, as its own revenue, contrary to GAAP and its own revenue recognition policies; 

–Not adequately reserving against a substantial aging receivable balance;

–Improperly accounting for renewal commissions;

–Improperly accounting for bonus commissions;

–Increasing the rate at which commissions were accrued on certain products;

–Booking unsupported revenue entries with offsetting expense accruals toward the end of a quarter; and

–Failing to maintain proper internal controls in its insurance division

 

BISYS profited by over $19.6 million thought he sale of convertible notes and the issuance of stock and options either for cash or in acquisitions at an inflated price according to the complaint. The action was settled with the entry of a statutory injunction prohibiting future violations of the books, records and internal control provisions of the federal securities laws and the payment of approximately $25 million in disgorgement and prejudgment interest. 

What is perhaps most notable about this case is what was omitted from the settlement. First, the SEC did not allege violations of the antifraud provisions despite what appears to be the pervasive nature of the scheme and the involvement of top management. In addition the SEC did not impose a penalty on the company. Under its announced policies on corporate penalties a key consideration is whether the company profited from the improper acts. This may have resulted from the cooperation of the company which the SEC acknowledged in its press release, although it did not detail what was entailed.

by T. GormanPosted on Posted in SECActions

In her remarks at the 27th Annual Ray Garrett, Jr. Corporate and Securities Law Institute held in Chicago earlier this month SEC Enforcement Chief Linda Thomsen revisited the obligations of corporate counsel and cooperation. www.sec.gov/news/speech/2007/spch0504071ct.htm

Ms. Thomson’s comments in part echo those of others such as the Report of the Task Force on the Lawyer’s Role in Corporate Governance issued late last year and those of former SEC Enforcement Chief and District Court Judge Stanley Sporkin in a case about the savings and loan debacle. Lincoln Sav. & Loan Ass’n v. Wall, 743 F. Supp. 901, 920 (D.D.C. 1990). The former chronicles the obligations of lawyers faced with corporate misconduct to give the correct advice which may not be what the client wants to hear. Frequently, as Ms. Thomsen notes that is a difficult task, but one which must be faced and handled correctly despite the strain it may put on the relationship. Judge Sporkin put it more succinctly buy simply asking (essentially) where the lawyers? His comments reference the fact that most transactions do not happen without the lawyers having a key role.

While Ms. Thomson’s call for “courage” on the part of corporate counsel is no doubt correct, her comments about “cooperation” echo a familiar theme while failing to recognize the fallacy of the SEC’s position. There is no doubt that under Seaboard cooperation is not conditioned on the waiver of the attorney client privilege as Ms. Thomson noted in her remarks. There a number of instances where companies have been given “cooperation” credit without waiver. However, avoiding prosecution is another matter. Typically, to avoid prosecution the company is going to have to waive privilege. Indeed, the example of cooperation cited in the Seaboard Release demonstrates this point – the company was not prosecuted in view of cooperation which included privilege waivers. Ms. Thomson reaffirmed this point in her speech last month as noted in our post of April 23, 2007.

Nobody doubts the fact that the SEC respects the proper assertion of the attorney client privilege and the work product doctrine. Over the years the SEC has taken steps to preserve those protections as Ms. Thomsen notes by proposing legislation on limited waiver and advocating “non-waiver” agreements in the courts. The other side to those efforts however is clear: each is predicated on the fact that the SEC is able to obtain privileged material. This fact can hardly be lost on any defense counsel considering cooperation as a possible course of action for a corporate client. Indeed, it is the SEC’s long history of seeking such material coupled with the pressure of a potential prosecution and the harm it can cause the company which precipitates the so-called “voluntary waiver” by the company. What Ms. Thomsen’s remarks and the SEC (and DOJ since the McNulty memo has the same problem) miss is the key point. In her comments Ms. Thomsen says that what the SEC wants is the facts, not the advise given (unless it is a defense in which case it must be produced). This thread runs through out Seaboard and the McNulty memo. That SEC enforcement attorneys and DOJ prosecutors want the fact should hardly be a surprise — Seaboard and McNulty are about making a prosecutorial charging decision which hinges on the facts.What is incongruous about all of this is that in most instances the facts are not privileged. The facts to the situation typically are not covered by the attorney client privilege or the work product doctrine. The former is limited in scope to the seeking/rendering of legal advise. The latter is equally limited being confined to the thoughts and metal impressions of counsel in anticipation of litigation. Production of the facts need not entail a waiver of either the attorney client privilege or the work product doctrine in most instances if these protections are properly asserted. If what the SEC wants is the facts the company should be willing to produce them — without any waivers. If what the SEC wants is the facts, it should be able to obtain them without any waivers. This of course puts a responsibility on both parties: the company must produce all the relevant facts to a matter and not seek to shield them from production with privilege assertions. On the other hand the SEC (and DOJ) should seek nothing but the facts absent the most compelling of circumstances. Where all the facts are produced the company has cooperated and the government has what it needs.

All of this suggests that government cooperation standards should focus on what the SEC and DOJ need — the facts. Companies that want to cooperate should give the government what it needs and receive appropriate cooperation credit. Conversely no cooperation credit should be given for what the government says it does not usually need –privileged material and waivers. To paraphrase a famous rock song: “the government should ask for what it needs, not what it thinks it wants.” You Can’t Always Get What You Want, M. Jagger & K. Richards, Let It Bleed, 1969 (“You can’t always get what you want, but if you try sometimes, you just might find you get what you need.”)