by T. GormanPosted on Posted in SECActions

Disgorgement and the impact of the Fifth Amendment are issues which reoccur in SEC enforcement actions. Circuit Judge Loken, in an opinion concurring in part and dissenting in part, from an order affirming a grant of summary judgment in a Commission enforcement action provides a thoughtful discussion specific of aspects of each issue. SEC v. Brown, Case no. 10-2479 (8th Cir. Oct. 13, 2011).

The case centers on an investment fund fraud. Defendant Sherwin Brown is the president and controlling shareholder of Jamerica Financial, Inc. The firm is a registered investment adviser which had under management $1.62 million from 53 clients. The funds were invested in Brawta Ventures, LLC, a private investment fund organized by defendant Brown.

The SEC’s complaint against Sherwin Brown and both entities alleged violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 204 and 206(1) and (2). It claims misrepresentations were made and that investor funds were pocketed by defendant Brown. An emergency freeze order was entered followed by a preliminary injunction.

Subsequently, a Chapter 7 proceeding was initiated by Mr. Brown. A receiver was appointed to represent Brawta and its investors. That receiver filed an adversary proceeding for the benefit of the investors. The bankruptcy court granted summary judgment in favor of the receiver and the investors.

The district court granted summary judgment in favor of the SEC in its action. In granting summary judgment the court disregarded the interrogatory answers of defendant Brown offered in opposition because Mr. Brown had invoked the Fifth Amendment precluding the SEC from taking his deposition. The court also entered a permanent injunction against Sherwin Brown and directed the payment of $869,633 as disgorgement along with prejudgment interest as requested by the SEC.

The Eight Circuit affirmed in a per curiam opinion. The court found that the district court’s adoption of the magistrate’s report on disgorgement was appropriate and that the grant of summary judgment was supported by the record.

Circuit Judge Loken concurred in affirming the grant of summary judgment but dissented from the decision to affirm the disgorgement order. First, there is no doubt that the court has broad jurisdiction under the securities laws to order the disgorgement of any ill-gotten profits. Its “purposes are to provide a remedy for fraud victims and to deprive the defendant of unjust enrichment, not to punish . . .” the Judge noted.

In this case defendant Brown diverted the amount of investor funds claimed by the SEC. The question is what remedy is proper. Equitable remedies should only issue “upon a concrete showing of need and should impose the least drastic remedy necessary to achieve the desired goals.” Here the district court did not consider the fact that a freeze order was entered, amounts recovered by the receiver or if amounts attributable to legitimate investment activities should offset the amount disgorged. The court also failed to consider if the remedy would interfere with the efforts of the victims’ to recover their losses. Rather, the district court simply accepted the SEC’s request. “On this record, the only apparent rationale for the SEC’s disgorgement request was punitive, not remedial.” Accordingly, it was an abuse of discretion to grant the Commission’s request.

Judge Loken also concluded that disregarding defendant Brown’s interrogatory answers was error although on the record here it was harmless. Here the U.S. Attorney notified defense counsel that Brown was a target of a criminal investigation after the SEC case was filed and after the interrogatory answers had been served. The district court denied a defense motion to stay the civil case and then later disregarded the interrogatory answers. It was error to do both according to Judge Loken.

Precluding evidence is an extreme remedy. While an adverse inference can be drawn from invoking the Fifth Amendment in a civil case, since “the privilege . . . is constitutionally based, the detriment to the party asserting it should be no more than is necessary to prevent unfair and unnecessary prejudice to the other side” the Judge noted, quoting SEC v. Graystone Nash, Inc., 25 F. 3d 187, 192 93rd Cir. 1994). In situations such as this case where both civil and criminal actions can be brought, courts must give “special consideration . . . to the plight of the party . .. “ asserting it. The district court has an array of remedies which include a preclusion order, barring the use of the defendant’s testimony from the civil case in the criminal proceeding or staying the civil case. Here the district court failed to consider the options.

Finally, an analysis of the record shows little if any prejudice to the SEC in this case. The interrogatory responses were submitted prior to any assertion of the Fifth Amendment. There was no unfair surprise from them and little if any prejudice. This is not a case where the privilege was asserted to block the SEC from obtaining the evidence it required to prevail. Preclusion was thus an error but, on the record here, harmless.

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by T. GormanPosted on Posted in SECActions

“Do they get it?” This is a question frequently asked by FCPA enforcement officials. “Do they get it” meaning does the company understand what happened, why it happened and what is required going forward. Does the company “get” the point of FCPA and anti-corruption enforcement and the laws or are their efforts little more than going through the motions. If they “get it” then a key purpose of enforcement has been served and there will be reasonable assurances against a future reoccurrence. If they don’t, clearly more needs to be done. This is where sanctions come in with the hope of bludgeoning the company until hopefully they “get it.”

Last week the SEC settled an FCPA case with Watts Water Technologies, Inc. described briefly here. This is not one of the larger or more significant cases in the sphere of anti-corruption actions. It is not about to break into the “top ten” FCPA settlements by amount with about $2.75 million paid in disgorgement along with another t $820,000 in prejudgment interest and $200,000 in civil penalties.

Nevertheless, it involves violations of the law in a high risk part of the world. The question is does the company now “get it.” The answer to the question begins with the facts detailed in the SEC’s Order for Proceedings:

Violations: The violations are payments to Chinese Design Institute employees to influence business at state owned enterprises. They stem from the sales incentive policy adopted by Watts when it acquired the subsidiary in 2006. Under that policy all sales related expenses including travel, meals, entertainment and “consulting fees” are paid by sales employees out of their commissions which equaled 7% to 7.5%. From those commissions the sale personal paid 3% to the employees of the Design Institutes. The policy was written in Chinese and never translated for Watts senior U.S. management.

Discovery: The General Counsel of Watts learned about the payments from instituting additional FCPA procedures after he learned about an SEC investigation involving payments to employees at Chinese Design Institutes. The new procedures eventually surfaced a report of the payments.

What happened? Watts retained outside counsel. An internal investigation of the sales practices at the Chinese subsidiary was conducted in conjunction with forensic accountants. The company self-reported the results to the SEC and shared them with its auditors.

What remedial steps were taken? Watts initiated a series of remedial steps including the following:

  • At the start of the internal investigation all payments were stopped to the Design Institutes;
  • Commission based compensation at the Chinese subsidiary was terminated;
  • Watts disclosed the internal investigation in a Form 10Q;
  • Additional outside counsel was retained to draft and implement enhanced anti-corruption policies and procedures including an enhanced Anti-Bribery Policy, a Business Courtesy Policy, an enhanced Travel and Entertainment Expense Reimbursement Policy for its Chinese subsidiaries and enhanced intermediary due diligence procedures;
  • A worldwide anti-corruption audit was conducted;
  • Additional FCPA and anti-corruption training for its China operations and locations in Europe was undertaken;
  • A risk assessment and anti-corruption compliance review of its international operations in Europe, China and any U.S. location with international sales was undertaken and completed;
  • Anti-corruption testing at seven international Watts sites including each of the manufacturing and sales locations in China was done; and
  • A Director of Legal Compliance, a new position that reports to the General Counsel was hired.

Seaboard is the Commission’s statement on cooperation. It has been followed by more recent initiatives regarding the use of non-prosecution and deferred prosecution agreements which were designed to spur cooperation and facilitate Commission law enforcement investigations. Under those initiatives enforcement officials continually tout the benefits of cooperating by self-reporting, conducting a full investigation, turning over all the facts to the staff, making full disclosure and implementing the necessary remedial steps to prevent a future reoccurrence.

Watts took every Seaboard step and more, much more, undoubtedly spending far more in remediation than the profits from the violations. Watts demonstrated beyond all doubt that the company “got it.” Yet it was sanctioned by the SEC although its cooperation was acknowledged. The question now is “Does the SEC get it?”

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Each year Lexis takes nominations for and selects the Top 25 Business Blogs. Last year this Blog was honored to be among those selected. If you would like to nomine a blog please use the following link here.

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