by T. GormanPosted on Posted in SECActions

In SEC v. Citigroup Global Markets, Case No. 11-5227-cv (2nd Cir.) the critical issue is the role of the court when presented with a proposed consent decree. There the SEC asked U.S. District Judge Rakoff to enter a consent decree negotiated by the parties which would have imposed an injunction, certain ancillary relief and a fine. The court declined. The SEC appealed. While much has been written about the case and the role of the Commission’s neither admit nor deny settlement policy, the ultimate question in the action is the role of the court when it is requested to lend its authority to implement a consent decree.

Now that question has been raised in a criminal case involving a deferred prosecution agreement which may have significant implications for FCPA actions. In U.S. v. HSBC Bank USA, N.A., Case No. 12-CR-763 (E.D.N.Y. Order dated July 1, 20130) Judge Gleeson held that parties submitting a deferred prosecution agreement to the court have placed “a criminal matter on the docket of a federal court [and have thus] . . . subjected their DPA to the legitimate exercise of that court’s authority.” While Judge Gleeson approved the deferred prosecution agreement, he will continue to monitor it despite the arguments of the parties.

The case is based on violations of the Bank Secrecy Act and the International Emergency Economic Powers Act by HSBC Bank and HSBC Holdings Plc. Specifically, the defendants were charged with failing to maintain an effective anti-money laundering or AML program and willfully facilitating financial transactions on behalf of sanctioned entities. The collective failures of the AML program permitted Mexican and Columbian drug traffickers to launder at least $881 million in drug trafficking proceeds through HSBC Bank USA undetected, according to the agreed statement of facts. HSBC Group also knowingly and willfully engaged in practices outside the U.S. which caused HSBC Bank USA and other U.S. financial institutions to process payments on behalf of banks and other entities located in Cuba, Iran, Libya, Sudan and Burma in violation of U.S. sanctions.

To resolve the charges the defendants entered into a deferred prosecution agreement. Under the terms of that agreement, the defendants admitted criminal liability and to a detailed statement of facts regarding the events surrounding the violations. They also agreed to continue cooperating with the government, to complete certain remedial steps initiated and to undertake others. The agreement requires that a monitor be in place for five years. At the end of that time the case would be dismissed.

The government filed a criminal information alleging the violations along with the deferred prosecution agreement with the court. The parties then requested that the court exclude for purposes of the Speedy Trial Act, the term of the DPA. At the same time the DOJ and the defendants asserted that the “Court lacks any inherent authority over the approval or implementation of the DPA.” Judge Gleeson rejected this claim.

Initially, the question regarding the Speedy Trial Act is committed to the discretion of the Court, according to the ruling. Thus whether the five year period of the DPA is carved-out or not is a decision for the Court. That decision, however, is separate from the question of the Court’s authority regarding the DPA.

The critical question here was the authority of the Court with respect to the DPA. On this issue Judge Gleeson held that “This Court has authority to approve or reject the DPA pursuant to its supervisory power. ‘The supervisory power . . . permits federal courts to supervise the ‘administration of criminal justice’ among the parties before the bar,’” quoting U.S. v. Payner, 447 U.S. 727, 735 n. 7 (1980). While the Court recognized that its ruling is novel, and that its supervisory powers are typically invoked for other reasons, at the same time one of the primary purposes of those powers is to protect the integrity of judicial proceedings.

Here the parties chose to initiate a proceeding before the Court by placing on the docket a federal criminal case and requesting a ruling as to the Speedy Trial Act. This implicated the powers and authority of the Court. As Judge Gleeson stated “. . . the contracting parties have chosen to implicate the Court in their resolution of this matter. There is nothing wrong with that, but a pending federal criminal case is not window dressing. Nor is the Court, to borrow a famous phrase, a potted plant. By placing a criminal matter on the docket of a federal court, the parties have subjected their DPA to the legitimate exercise of that court’s authority.”

In contrast, the Department of Justice has absolute discretion to decide not to prosecute, the court stated. Thus, a non-prosecution agreement is “not the business of the courts.” Likewise, the DOJ has near absolute power to extinguish a case it has brought. This is because the courts are “’not concerned with law enforcement practices except in so far as courts themselves become instruments of law enforcement,’” quoting McNabb v. U.S., 318 U.S. 332, 347 (1943). When, however, the Court becomes involved in the resolution of an action, as here, it has an important role within the limits of its supervisory powers.

After reviewing the terms of the DPA Judge Gleeson approved it. He also held that “my approval is subject to a continued monitoring of its execution and implementation.”

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by T. GormanPosted on Posted in SECActions

Last week the SEC announced the formation of a Financial Reporting and Audit Task Force. Its purpose is to detect “fraudulent or improper financial reporting” and “enhance the [Enforcement] Division’s ongoing enforcement efforts related to accounting and disclosure fraud.” At the same time the Commission announced the formation of a similar group focused on microcap fraud and the creation of the Center for Risk and Quantitative Analysis. The new Center for Risk and Quantitative Analysis will work in close coordination with the Division of Economic and Risk Analysis and “serve as both an analytical hub and a source of information about characteristics and patterns indicative of possible fraud or other illegality.”

While this is clearly a positive step for the Enforcement Division, there is little that is new about the financial fraud task force — except perhaps its apparently “high tech” adjunct, the Center for Risk and Quantitative Analysis. In 1998 then SEC Chairman Arthur Levitt originated a similar effort. In his well known address titled “The Numbers Game,” Chairman Levitt announced an eight part plan to combat abuses in financial reporting because he had “become concerned that the motivation to meet Wall Street earnings expectations my be overriding common sense business practices. Too many corporate managers, auditors, and analysts are participants in a game of nods and winks. In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation. As a result, I fear that we are witnessing an erosion in the quality of earnings, and therefore, the quality of financial reporting. Managing may be giving way to manipulation; Integrity may be losing out to illusion.”

Chairman Levitt identified five key practices being used to manipulate financial results through what he labeled as “accounting hocus-pocus:”

Big Bath charges; The use of restructuring charges to clean up the balance sheet;

Acquisitions/R&D: The classification of portions of the acquisition price as “in-process” research and development so it can be written-off in a one-time charge to avoid a drag on future earnings;

Cookie jar reserves: The use of unrealistic assumptions to create pools of cash to smooth earnings;

Materiality: Building in flexibility by creating small errors that are just below the so-called materiality threshold which can then later be utilized; and

Revenue recognition: Boosting earnings through inappropriate manipulation of the recognition of revenue.

In the wake of Chairman Levitt’s speech the Commission brought a series of financial statement fraud actions. Two years later, for example, Richard Walker, then the Director of the Enforcement Division stated that for fiscal 1999 the Commission brought about 90 financial statement and reporting actions, a 15% increase over 1998. Those cases “cover a broad spectrum of conduct – from multi-faceted pervasive frauds to more subtle instances of earnings management to situation involving violations of auditor independence rules,” he noted. Richard H. Walker, Director, Division of Enforcement, addressing 27th Annual national AICPA Conference on Current SEC Developments (Dec. 7, 1999). In the years that followed the SEC brought a series of financial fraud actions involving an array of issuers such as Waste Management, WorldCom, Tyco International, Enron, Xerox Corporation and others.

In recent years, however, the number of these cases has declined. One reason may be the reforms initiated by the Sarbanes-Oxley Act of 2002. Another may be that the focus of SEC enforcement has been on market crisis cases, offering frauds and Ponzi schemes rather than difficult to develop, and time and resource consuming, financial statement fraud cases. Whatever the reason, while the world of financial reporting has become more sophisticated and complex, the root of Chairman Levitt’s concerns has not changed. The “pressure to make the numbers” is still present. This suggests that the Commission’s new task force will have much to do.

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