by T. GormanPosted on Posted in SECActions

In Part I of our series on SEC Enforcement Trends (see post of February 23, 2007) we noted that some commentators have questioned the vitality of the enforcement program. Three recent cases reflect on this question:

First, in SEC v. Blue Bottle et al., Civil Action No. 07Civ.01-CV-1380 (CSH)(KNF)(S.D.N.Y.)(February 26, 2007) the SEC was successful in obtaining a temporary retraining order prohibiting future violations of the antifraud provisions of the federal securities laws as well as an order directing that certain funds be repatriated from overseas bank accounts in an insider trading case. Specifically, the SEC claims that Blue Bottle, a Hong Kong company and defendant Matthew Charles Stokes, a citizen of Guernsey, repeatedly traded in the securities of twelve different companies immediately prior to the publication of news releases about those entities. According to the complaint the defendants realized profits of over $2.7 million. The information about the twelve companies was obtained, according to the agency, through fraudulent means which included hacking into computer networks. The brokerage accounts used to execute the trades were opened with fake documents and false information.

Second, in SEC v. Thomas W. Jones et al., Civil Action No. 05Civ. 7044(RCC)(S.D.N.Y. February 26, 2007) the court entered summary judgment against the SEC and in favor of the defendants. The agency alleged defendants, employees of Citigroup Asset Management, a business unit of Citigroup that provides investment advisor and management services to Citigroup sponsored mutual funds, aided and abetted violations of Section 206 of the Investment Advisors Act. Specifically, the complaint alleged that defendants profited at the expense of mutual fund investors through a deal to hire a bank-affiliated fund transfer agent which had an undisclosed side deal. The SEC sought an injunction, penalties and disgorgement. The court began by dismissing the claim for penalties as time bared under 28 U.S.C. Section 2462 which provides for a five year statute of limitations in suits where a civil fine, penalty or forfeiture is sought. In reaching its conclusion the court rejected an SEC claim that the statute should be tolled because of fraud, finding that the agency failed to present any facts demonstrating that the claimed misrepresentations or omissions were unknowable. The court also concluded that the SEC’s request for injunctive relief was time barred because the there was no showing that the requested relief was necessary to prevent future harm beyond the claim of a past violation. Accordingly, the injunction was more in the nature of a penalty and thus subject to the five year statute of limitations which had run. Finally, while disgorgement is an equitable remedy not subject to the statute of limitations, the SEC failed to present evidence demonstrating the amount which should be ordered.

Finally, U.S. v. Reyes, Civil Action No. C06-04435 (CRB) (N.D. Cal July 19, 2006)(the Brocade stock option backdating case) is reportedly set for trial in June. While the allegations in the criminal case and the SEC’s complaint paint a picture of clear fraud, problems may be arising for the government. As reported earlier (post of February 20, 2007) parallel proceedings issues have been raised in the SEC’s civil case. While those have currently been resolved in favor of the SEC, the court cautioned the agency’s lawyers that if problems persist a remedy for the defendants would be fashioned. Now in the criminal case evidence is appearing which may call into question government claims. BusinesWeek Online reports in a story dated March 5, 2007 (but now available) that former CEO Reyes has vowed to fight the case. Documents which are coming out appear to undercut the very clear cut claims made by the government. Specifically, it appears that an operations manual specified that the options clerk pick the lowest stock price since the previous option grant when preparing new options paper work for Mr. Reyes to sign. Unlike other option backdating cases, apparently Mr. Reyers was not involved in the dating process. These facts may prove to be significant in a case which focuses on an intentional and concealed fraud. While the government started this case with a great deal of fanfare last year, press releases are one thing, proof in court, as the Jones case cited above suggests, is another.

Next: Part III of the Series on SEC Enforcement Trends

by T. GormanPosted on Posted in SECActions

Significant Policy Statements
Two significant policy issues impacted the SEC’s Enforcement Program in 2006, two of which should be followed closely in 2007.  First, in January 2006, the SEC issued its Statement on Financial Penalties for Corporations,  SEC Press Rel. No. 2006-4, www.sec.gov/news/press/2006-4.htm.  For the first time the SEC articulated the points it considers in assessing penalties against issuers.  According to the Statement, the two key factors  are:  1) the presence or absence of a benefit to the corporation, and 2) the degree to which the penalty will recompense or harm the shareholders.  Other factors include deterrence, level of injury to innocent parties, pervasiveness of the violation, the level of intent and the difficulty of detection.     

Second, the SEC issued its Standards for issuing subpoenas to reporters, www.sec.gov/news/press/2006/2006-55.htm.  The SEC issued this statement shortly after SEC Chairman Cox withdrew subpoenas issued to news organizations as part of an on-going enforcement investigation.  According to some news reports, at least one of the subpoenas had been approved by SEC Enforcement Chief Linda Thomsen.  Under the Release, before issuing investigative subpoenas to reporters or news organizations the enforcement staff is required to essentially follow a “meet and confer” type procedure, discussing the need for and scope of a potential subpoena with counsel for the new organization and/or reporter.  Any subpoena issued under the Release needs to be approved by the Director of the Division of Enforcement. 

These two statements are significant steps for the SEC.  Both represent the agency’s efforts to provide guidance and explanations about its enforcement activities.  Clearly, the statement on penalties has more day to day impact for companies.
 Despite the apparent guidance offered by the Statement on Penalties, however, its application remains elusive – particularly when considered in conjunction with the SEC’s 2001 Seaboard Release concerning cooperation.  Consider three examples:

SEC v. Tyco International (S.D.N.Y. April 17, 2006), www.sec.gov/litigation/litreleases/2006/lr19657htm.  Here, the defendant consented to a $50 million civil penalty in what was alleged to be a $1 billion accounting scandal. 

SEC v. Fed. Nat. Mortg., (D.D.C. May 22, 2006), www.sec.gov/litigation/litreleases/2006/lr19710.htm.  In this case the defendant entered into a consent decree under which it was ordered to pay a $400 million penalty in what the complaint claimed was an $11 billion accounting scandal.  The SEC’s release did note that the defendant cooperated with its investigation. 

SEC v. AIG (S.D. N.Y. Feb. 9. 2006), www.sec.gov/news/press/2006-19.htm.  In this case AIG agreed to a consent decree under which it was ordered to pay a penalty of $100 million in a case which was claimed to involve a $700 million accounting fraud.  Again cooperation was noted. 

None of the releases explained how the factors cited in the Statement on Penalties were applied.  Although two of the cases cite to cooperation, there is no explanation of how that impacted the settlement.  While the focus of the Statement on Penalties on benefit to the company might suggest that issuers consider bringing an economist to the settlement table to evaluate any claimed benefit, the Releases concerning each case does not give any indication of how the penalty imposed relates to the factors in the policy statement. 

Similarly, a review of the Enforcement Program does nothing to alleviate criticisms of the manner in which the agency is imposing fines.  For example, the U.S. Chamber of Commerce Report on the SEC’s Enforcement Program claims that the agency’s use of financial penalties is inconsistent with the intent of congress.  Congress gave the SEC the authority to inflict financial penalties in the 1990 amendments to the securities laws, known as the Remedies Act.  According to the legislative reports, penalties were not suppose to be inflicted routinely.  Yet a review of the SEC’s Enforcement releases demonstrates that financial penalties are routinely demanded, a point consistent with recent statements by the enforcement staff. 

Furthermore, the references to cooperation in the two examples cited above only muddy the waters.  Cooperation is a sensitive topic because many charge that the current SEC cooperation standards under the Seaboard Report (similar to DOJ’s Thompson and McNulty memos) have contributed significantly to the current “culture of waiver,” where issuers are forced to waive important rights, such as the attorney-client privilege, in order to be viewed as cooperative and try and avoid prosecution.  In the cases cited above, which are typical, there is no explanation of how cooperation impacted in the determination of the penalty.  Supposedly two key SEC policy statements are interacting in the AIG and Federal National Mortgage cases to impact the outcome, but there is no explanation.  Neither Release discusses how the factors cited in the Statement on Penalties are considered.  Neither Release discusses the manner in which cooperation impacted the settlement. 

At the same time the SEC staff has defended Seaboard and the use of penalties.  There is no indication at the moment that the SEC will reconsider Seaboard despite the criticism of the standards and a recent letter to Chairman Cox from the ABA  proposing revisions although SEC Commissioner Cox has called for a review of the Release.  The staff has  stated repeatedly that it will continue to seek penalties as in the past.  In view of the criticism of both policies, as the enforcement program moves forward it would seem appropriate for a further clarification of the use of penalties and a revision of Seaboard to eliminate the culture of waiver.
Next:  Key issues in SEC investigations.