This Week In Securities Litigation (July 11, 2008)
This week, legislation was introduced in Congress to enhance the SEC’s enforcement and other capabilities. Attorney General Michael Mukasey told a Senate panel that the cooperation standards in the McNulty memo, which redrafted the Department’s Thompson memo in the wake of the holding in the U.S. v. Stein (the KPMG tax shelter litigation discussed here), finding portions of the memo unconstitutional, is being redrafted. And, the SEC staff issued a report on the workings of three key credit rating agencies, indicating that they are over worked and have significant conflicts of interest.
In addition, two more option backdating probes came to an end. The SEC filed a settled action against Sycamore Networks, as DOJ concluded its criminal probe of Apple’s option backdating practices.
SEC enhancement legislation
Legislation was introduced by House Capital Markets subcommittee chairman Paul Kanjorski (D. Pa.) to enhance the efficiency of the SEC. The purpose of the legislation is to enhance the efficiency of the divisions of enforcement, corporate finance, trading and markets, investment management and its inspection process. The bill was referred to a House subcommittee for consideration.
The bill includes sections which would give the SEC the authority to impose civil penalties in administrative proceedings (Section 2), require an annual report to Congress on simplifying the financial reporting process (Section 10), preserve the privilege of materials transferred by the SEC to other agencies (Section 19) and give the SEC nationwide service of process in its civil enforcement actions (Section 20) (which would be similar to that available under the Federal Criminal Rules).
Cooperation standards
On Wednesday, hearings were held by the Senate Judiciary Committee at which Attorney General Michael Mukasey indicated that the McNulty Memo may be under revision. That memo, issued in late 2006, revised DOJ’s organizational prosecution standards and imposed restrictions on the circumstances under which DOJ prosecutors can request a waiver of the attorney client privilege. The memo has been controversial since it was issued, with many critics contending that it has had little impact on the so-called “culture of waiver.”
During his testimony, Mr. Mukasey indicated that Deputy Attorney General Mark Filip is drafting a letter to Senator Arlen Specter addressing “real significant proposed changes” that could replace the policies in the McNulty memo. Senator Specter is a sponsor of The Attorney Client Protection Act of 2008, discussed here and here, which passed the House and is pending in the Senate. Generally, that bill would preclude DOJ prosecutors, SEC attorneys and other federal law enforcement attorneys from seeking a waiver of the attorney client privilege or work product protection from a business organization.
SEC staff report on credit rating agencies
Earlier this week, the SEC staff issued a summary report discussing its examination of credit rating agencies Fitch Ratings, Ltd., Moody’s Investors Services, Inc. and Standard & Poor’s Rating Services. Summary of Report of Issues Identified in the Commission Staff’s Examinations of Select Credit Rating Agencies, July 2008. The report, discussed in more detail here, provides an overview of the industry and examines the operations of these three key rating agencies. In sum, it found that these rating agencies were overworked, understaffed and suffered from significant conflicts of interest.
Option backdating cases
The SEC filing another settled option backdating action on Wednesday, discussed here, which named as defendants Sycamore Networks, Inc., an optical networking company, its former CFO Frances M. Jewels, former Director of Financial Operations Cheryl E. Kalinen and former Director of HR Robin A. Friedman. SEC v. Sycamore Networks, Inc., Civil Action No. 1:08-CV-11166 (D. Mass. July 9, 2009).
According to the Commission’s complaint, between 2000 and 2005 Sycamore used backdated options to compensate employees, without properly accounting for about $250 million in related expenses. Between October 1999 and July 2002 defendants repeatedly backdated option grants, providing themselves and employees with options with prices at which they could purchase shares which were lower than the market price at the time the options actually were granted. To conceal these practices, the two falsified grant approval documentation and concealed the practices.
To settle the case, Sycamore consented to the entry of a permanent injunction prohibiting future violations of the antifraud, reporting and proxy provisions of the federal securities laws. Defendant Jewels consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions and an order requiring the payment of disgorgement of $30,000 plus prejudgment interest and a directive that Sycamore be reimbursed under SOX Section 304 for the $190,000 in cash bonuses paid to Ms. Jewels and that she pay a civil penalty of $230,000. Ms. Jewels will also be barred from serving as an officer or director of any public company for five years and, in a related administrative proceeding, barred from appearing or practicing before the Commission as an attorney or accountant for a period of five years.
Defendant Kalinen consented to the entry of a permanent injunction prohibiting future violations of the antifraud and reporting provisions and an order requiring the payment of $28,000 in disgorgement plus prejudgment interest and the payment of a civil penalty of $150,000. Ms. Friedman also consented to the entry of a permanent injunction and an order requiring her to pay a civil penalty of $40,000.
The Wall Street Journal reported this week that DOJ had ended its criminal probe of Apple’s option backdating practices. The report was confirmed by attorneys representing two subjects in the inquiry.
Former Apple general counsel Nancy Heinen is, however, still contesting an SEC enforcement actions discussed here.