by T. GormanPosted on Posted in SECActions

This is the fifth in a series of articles that will be published periodically analyzing the direction of SEC enforcement.

The focus of SEC enforcement in the coming months is a function of its constricted and later expanded authority. Last year that authority contracted in the wake of the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 130 S.Ct. 2869(2010). Later congress effectively overruled Morrison as to the SEC and DOJ and expanded their authority. A warning from the SEC in a Section 21(a) report in view of the congressional action may suggest a key focus for SEC enforcement in the future.

In Morrison the Supreme Court agreed with the Second Circuit that a shareholder suit based on Exchange Act Section 10(b) should be dismissed. The complaint had been brought by Australian shareholders of the bank. It alleged fraud based largely on transactions which occurred in the U.S. subsidiary that impacted the books and records of the parent company and thus the share price on the Australian exchange. The district court dismissed the complaint for lack of jurisdiction based on long standing Second Circuit jurisprudence which has been largely followed in other circuits.

While the Supreme Court agreed that the case was properly dismissed, it differed as to the rationale. Justice Scalia, writing for the Court, began by noting that the question to be resolved is not one concerning the authority of the district court to hear the case. The Exchange Act confers jurisdiction on the court to hear a securities fraud suit. Rather, the issue is whether the conduct is within the scope of Section 10(b).

In this case that question centers on whether Section 10(b) has extraterritorial reach. When considering if a U.S. statute has extraterritorial reach, the beginning point is the long standing presumption that legislation by Congress is meant to apply only within the territorial jurisdiction of the U.S. unless there is a contrary intent according to the Court. Here there is none. Accordingly, Section 10(b) is limited to conduct which occurs on U.S. exchanges and within the country.

Since Morrison delimited the reach of Section 10(b) it impacts not only private damage actions but also SEC enforcement cases. The immediate result of the decision is to limit the reach of SEC enforcement. This point is illustrated by the Moody’s Investor Services, Inc. Section 21(a) Report. Exchange Act Release No. 62802 (Aug. 31, 2010).

The Report arises out of an enforcement investigation which centered on a new model the firm developed to rate constant proportion debt obligations or CPDOs, a kind of special purpose vehicle marketed in Europe. After rating the instruments the firm discovered an error in the metrics. The firm chose not to acknowledge the error until after a May 2008 Financial Times article exposed it. By that point however Moody’s had registered with the SEC as a NRSRO. In its registration papers the firm detailed its core principles which were not followed when rating the CPDOs.

The Commission declined to bring an enforcement action, citing uncertainty regarding its jurisdiction. While the Report does not cite Morrison, it seems clear that the Court’s ruling influenced the prosecutorial decision.

The Release however concludes with a warning that in the future such conduct may result in an enforcement action: “The Commission notes that, in recently enacted legislation, Congress has provided expressly that federal district courts have jurisdiction over Commission enforcement actions alleging violations of the antifraud provisions . . . involving ‘conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States that has a foreseeable substantial effect within the United States.’”

The Commission’s warning that in the future it will scrutinize conduct is the international markets is well grounded. Dodd-Frank effectively overruled Morrison as to the SEC and the Department of Justice, giving both additional enforcement authority and perhaps a mandate. Specifically, the Act provides that the antifraud provisions extend in SEC and DOJ actions to any conduct within the U.S. that constitutes “significant steps in furtherance of the violation” even where the securities transaction is not in the U.S. and involves only foreign investors. The extension also covers any conduct outside the US. that has a foreseeable, substantial effect in the United States.

Morrison, the Moody’s Report and Dodd-Frank give definition to the scope of SEC enforcement in the near and far term. Enforcement actions stemming from pre-Morrison conduct will be limited by the Supreme Court’s decision as the Moody’s Report makes clear. In contrast, investigations and cases based on post-Dodd-Frank conduct may have the broader, more international reach consistent with the authority give to the agency by the Congress as the Moody’s Report warns.

Next: SEC Enforcement in court

by T. GormanPosted on Posted in SECActions

Maxwell Technologies, Inc. resolved FCPA violations with DOJ and the SEC. After voluntarily disclosing its violations to DOJ and the SEC the company settled all charges. Under the terms of the settlements Maxwell will pay DOJ and the SEC a total of $13.65 million, had criminal charges filed against it, entered into a deferred prosecution agreement, had an SEC complaint filed detailing its violations, consented to the entry of a permanent injunction and has undertaken to implement enhanced FCPA procedures. The investigation is continuing according to the SEC. Maxwell and its shareholders will continue to expend sums to cooperate.

The company resolved the issues with DOJ. A two count criminal information was filed, charging the company with violating the anti-bribery and books and records provisions of the FCPA. Maxwell entered into a deferred prosecution agreement. It also agreed to implement enhanced procedures and pay a criminal fine of $8 million.

In the SEC settlement the company consented to the entry of a permanent injunction prohibiting future violations of the anti-bribery and books and records and internal control provisions of the FCPA. Maxwell also agreed to pay disgorgement of $5,654,567 and prejudgment interest of $696,314. It will also be required to comply with certain undertaking regarding its FCPA compliance program. SEC v. Maxwell Technologies Inc., Case No. 1:11-cv-00258 (D.D.C. Filed Jan. 31, 2011).

According to the underlying documents, the violations at Maxwell occurred from 2002 through May 2009. The company is a manufacturer of energy storage and power delivery products. Although it is a market leader in the high-voltage capacitor business which has a high-margin, the product line among its most mature. Revenues from this product line helped offset losses on the development of new products.

During the relevant time period the company was able to market products through its Swiss subsidiary in China. Sales were made through a Chinese agent to state owned enterprises. The invoices added 20% to cover the cost of kickbacks. That amount was described as “extra amount” or “special arrangement.” The amounts were included in the books and records of the parent company as commissions. Overall the company paid $2.5 million in bribes and was awarded contracts that generated $15 million in revenue and $5.6 million in profits. U. S. company officials were aware of this long running bribery scheme according to the SEC’s complaint.

In September 2008 during an internal review of the commissions paid the Chinese agent, the management team learned that they were unusually high. Accordingly, a certificate was obtained from the agent representing that he was aware of FCPA requirements and had not violated the Act. No further action was taken.

Subsequently, in February 2009 a new Maxwell sales director learned about the kickbacks. This information was promptly transmitted to the new company CEO who notified the audit committee and outside counsel. After inquiry the company disclosed the potential FCPA issues in its Form 10-Q filing for the quarter ended March 31, 2009.

The Department of Justice “acknowledged Maxwell’s voluntary disclosure of the FCPA violations . . . “ (here). The SEC stated that “Maxwell cooperated in the investigation” (here).