SEC TRENDS 2011: CLOSE COOPERATION
This is the fourth in a series of articles that will be published periodically analyzing the direction of SEC enforcement. Article 1 is here, 2 here and 3 here.
In a recent speech Attorney General Eric Holder emphasized the need to continue to “make use of the full range of parallel criminal and civil enforcement resources to combat financial fraud . . . “ (here). There is no doubt that over the years the SEC and DOJ have tended to work closer. There was a time when the SEC used a formal process under, for example, Section 21(d) of the Exchange Act to refer a matter to the Department of Justice. Under that process the Commission would approve a staff request for the referral. Now, as the SEC Enforcement Manual makes clear, the process is much more likely to be informal and done by the staff. SEC Enforcement Manual, Section 5.6.
Joint working task forces have undoubtedly accelerated this trend. In 2002 in the wake of Enron and other corporate scandals DOJ, the SEC and other law enforcement agencies formed a Financial Fraud Task Force which fostered closer relations. That task force was broadened in November 2009 by an Executive Order from the President. More recently the SEC joined with the U.S. Attorney’s Office for the Eastern District of Virginia and Virginia state securities officials to form a task force which will concentrate on financial fraud. Those cases will be brought on the “rocket docket” of the Eastern District since the Commission’s electronic filing system is located in that district.
Parallel inquires can benefit all. For the government it offers efficiencies while conserving scarce resources. For those who may become defendants in an enforcement action, it can offer the opportunity for a coordinated resolution. In the FCPA area, for example, there typically are coordinated settlements involving DOJ, the SEC and in some instances other regulators and prosecutorial agencies. The settlement with Chevron Corporation is a good example. There the company simultaneously settled FCPA issues with the U.S. Attorney for the Southern District of New York, the SEC, OFAC and the Manhattan District Attorney (here).
At the same time the criminalization of securities enforcement and the blurring of the line between criminal and civil cases appears to be accelerating. Perhaps the best example of this trend is the option backdating cases. The first of these cases were announced at a joint press conference by the SEC and the U.S. Attorney’s Office for the Northern District of California in July 2006 centered on backdating at Brocade Communications (here). With the filing of those cases conduct which had not been the focus of even civil enforcement authorities suddenly became criminal. Since the filing of those cases dozens of others have been brought.
The implications of this trend can be significant for defendants. A case concluded last year provides a good example. In SEC v. Davis, Case No. 03-CV6672 (S.D.N.Y. Filed Sept. 4, 2003) the Commission brought insider trading charges against Peter Davis Jr., a financial analyst, John Youngdahl, formerly a vice president at Goldman Sachs and Steven Northern, formerly a manager of several funds for MFS. The charges were based on claims that Mr. Davis tipped the other two defendants and others about information at a treasury auction which was embargoed. All three defendants settled with the SEC. Messrs. Davis and Youngdahl pleaded guilty to criminal charges. Mr. Youngahl, who convinced the SEC to dismiss its case against him in Manhattan but later settled in a similar action filed in Boston, was not charged criminally. There is no apparent explanation for the difference in the charges (here).
These trends also have serious implications for law enforcement. In view the increased use of parallel proceedings, securities practitioners have little choice but to defend every investigation as if it is criminal. This approach is fully consistent with the SEC’s Enforcement Manual which instructs staff attorneys conducting investigations to tell defense counsel asking about possible parallel criminal inquiries to review Release 1662, the Commission’s standard set of warning. Stated differently, defense counsel is told to “assume the worst.” See generally, SEC Enforcement Manual, Section 5.2.1.
Yet defending every civil inquiry as if it were criminal can significantly compromise the ability of a client to cooperate with enforcement authorities. At the same time this approach can have a negative impact on the ability of law enforcement to effectively complete its inquiry. It may also undercut the new cooperation initiatives of the SEC introduced in January 2010.
These trends can also result in overreaching. The distinction between a “willful” violation which is criminal under Exchange Act Section 32(a), for example, and “scienter” for a civil violation of the antifraud statutes is virtually non-existent. Compare U.S. v. Tarallo, 380 F.3rd 1174, 1188 (9th Cir. 2004)(defining willfully to mean the defendant knew the conduct was wrongful) and U.S. v. King, 351 F. 3rd 859, 866 (8th Cir. 2004)(deliberate ignorance is sufficient for conviction) with Ernst & Ernst v. Hockfelder, 425 U.S. 185 (1976)(scienter required for Section 10(b)) and Sunstrand Corp. v. Sun Chem. Corp., 553 F. 3d 1033, 1045 (7th Cir. 1977)(scienter includes recklessness).
A graphic example of overreaching came out of the cases centered on the option backdating at Broadcom Corporation. There DOJ and the SEC brought charges against the cofounders of the company, Henry Samueli and Henry Nicholas, and its former president William Rhuele. U.S. v. Samueli, Case No. 10-500024 (C.D. Cal.); U.S. v. Nicholas, Case No. 10-50005 (C.D. Cal.). Mr. Samueli eventually pleaded guilty in the criminal case to an obstruction charge. Later however, after listening to Mr. Samueli testify for two days during the trial of Mr. Nicholas, the court not only vacated the plea but dismissed all charges against both men based on prosecutorial misconduct (here). Early this year the sad saga of these cases came to an end when the government agreed to drop its appeal of the dismissal ruling (here).
Another but less dramatic example of this trend occurred in the simultaneous criminal and civil prosecutions of former OMB director David Stockman which concluded last year. U.S. v. Stockman (S.D.N.Y.); SEC v. Collins & Aikman, Civil Action No. 07-CV-24019 (S.D.N.Y. Filed March 27, 2007). Each action alleged that Mr. Stockman and others engaged in fraudulent schemes and falsified the financial statements of Collins & Aikman while he was Chairman and CEO of that company. Eventually the U.S. Attorney’s Office in Manhattan decided to drop all charges based on evidence furnished by Mr. Stockman (here).
The SEC pursued its case. In the end however the agency dropped its most serious fraud charges (here). Mr. Stockman resolved the case by consenting to an injunction based on Securities Act Sections 17(a)(2) and (3) as well as various reporting, record keeping and certification provisions. While the injunction included a provision regarding lying to the auditors and the deal required the payment of disgorgement and a civil fine, all of the intentional fraud claims were dropped by the SEC. The settlement clearly does not reflect the multiple claims of intentional fraud detailed in the civil complaint or the criminal indictment which received widespread publicity when brought.
Chief Judge Kozinski of the Ninth Circuit Court of Appeals recently penned an opinion in U.S. v. Goyal, No. 08-10436 (9th Cir. 2010) which succinctly summarizes the carnage caused by this kind of prosecutorial overreaching. Concurring in the reversal of a financial fraud case for a lack of evidence the Chief Judge noted that “This case has consumed an inordinate amount of taxpayer resources, and has no doubt devastated the defendant’s personal and professional life. The defendant’s former employer also paid a price, footing a multimillion dollar bill for the defense. And, in the end, the government couldn’t prove that the defendant engaged in any criminal conduct . . . This is not the way criminal law is suppose to work. Civil law often covers conduct that falls in a gray area of arguable legality. But criminal law should clearly separate conduct that is criminal from conduct that is legal . . .This is not only because of the dire consequences of conviction . . .but also because criminal law represents the community’s sense of the type of behavior that merits the moral condemnation of society . . When prosecutors have to stretch the law or the evidence to secure a conviction, as they did here, it can hardly be said that such moral judgment is warranted.” (emphasis original).
Next: The Supreme Court and The Reach of SEC Enforcement