Today we begin a series of posts reviewing 2007 SEC Enforcement trends. will periodically post this series over the next several weeks.  It will analyze the following key points: 1) An overview of the enforcement program; 2) New enforcement policy initiatives; 3) Key developments regarding investigations; 4) Significant cases in 2006; and 7) Trends and key issues for 2007.  

Enforcement Program Overview

During 2006 the number of SEC enforcement cases fell by about 9%.  Some sources have attributed this to budget restrictions.  Enforcement Chief Linda Thomsen, however, noted at a recent ABA program that the reduced number of cases was not significant.  Rather, Ms. Thomsen said that she had reviewed statistics over a number of years and that some years they go up and some years they go down.  

As in earlier years, the Enforcement Program had its critics.  In March 2006, the U.S. Chamber of Commerce published a report that reviewed the Program.  The report criticized the Enforcement Program for recent litigation set backs, attempts to shift standards of liability, misuse of penalties, and characterized it as having an increasingly harsh tone. 

The SEC of course does not agree with the findings of the report.  For example, at recent programs, such as SEC Speaks, the staff has noted that in fiscal 2006 they had a perfect 10-0 win record in district court.  No doubt, there were some significant court victories.  Those included:

SEC v. Yuen (C.D. Ca. May 8, 2006) ( in which the former Chairman and CEO of Gemstar-TV Guide was found liable and enjoined, ordered to pay over $22.3 million in disgorgement, penalties and interest and barred from being an officer or director;

SEC v. Treadway (S.D.N.Y. Oct. 26, 2006) ( in which a jury found Mr. Treadway liable for securities fraud stemming from an undisclosed market timing scheme. Subsequently, Mr. Treadway consented to a statutory injunction and an order directing the payment of $572,000 as disgorgement, interest and penalties; and

SEC v. Snyder (S.D. Tex. Feb. 1, 2006) ( in which the former CFO of Waste Management was found liable for insider trading and financial fraud and ordered to pay over $2 million in disgorgement, prejudgment interest and penalties. 

There were, however, losses prior to verdict or in administrative actions.  Those included:

SEC v. Todd (S.D.Ca. May 30, 2006) in which summary judgment was granted in favor of former Gateway executive Weitzen in a fraudulent earnings case;

SEC v. Talbot (C.D. Col. Feb. 14, 2006) in which insider trading claims were dismissed finding no duty of confidentiality against a Fidelity National director who traded in the shares of Lending Tree after he learned through Fidelity, which owned a stake in Lending Tree, of take over talks concerning Lending Tree; and

In the Matter of Flynn (Adm. Proc., Aug 2, 2006) where an ALJ dismissed aiding and abetting claims against former CIBC director Paul Flynn that claimed he aided a late-trading and market timing scheme.  This action followed the dismissal of criminal charges by former NY AG Eliot Spitzer against Mr. Flynn for the same conduct.

While we have not totaled all of the SEC’s wins and losses, the SEC can, in fact, cite to ten district court wins in fiscal 2006.  At the same time, the SEC does not have a perfect track record when the totality of its results are considered.  As the examples cited above suggest, the SEC did lose significant cases in district court on pre-trial motions.  Other losses came in administrative proceedings.  It is clear that the SEC is willing to litigate, even when the factual and legal theories are difficult, as in Talbot and Flynn.  Likewise, despite the 9% reduction in cases, the overall Enforcement Program seems alive, well, and aggressive.

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The SEC and DOJ have long coordinated when appropriate because parallel proceedings can maximize resources.  As former SEC Chairman Harvey Pitt noted:  “The SEC has had, and continues to have, a close relationship with its fellow law enforcement agencies.  Indeed, some of the most significant SEC actions over the last several months have been brought in tandem with criminal complaints and indictments.” Harvey L. Pitt, Remarks at the U.S. Department of Justice Corporate Fraud Conference (Sept. 26, 2002).  Many times parallel civil and criminal investigations are also beneficial for the defense.  Frequently, for example, parallel investigations are more efficient and offer the prospect for a coordinated resolution of a matter. 

On the other hand, parallel proceedings may severely prejudice the defense.  In U.S. v. Stringer, 408 F. Supp. 2d 1083 (D. Ore. 2006), appeal docketed, No. 06-30100 (9th Cir. Feb. 27, 2006), the court dismissed a criminal indictment on grounds of government misconduct where securities fraud investigations by the U.S. Attorney’s office and the SEC were not parallel, but had merged.  Although the USAO decided to indict the defendants early on, it decided not to conduct an investigation and instead use the SEC to gather evidence.  The government attorneys concealed the DOJ’s involvement despite defense counsel inquiries concerning a parallel criminal investigation.  On appeal the SEC argues that its standard Form 1662 warnings are sufficient and that staff does not have to disclose the existence of a parallel criminal investigation even when it knows that one is being conducted and defense counsel makes a specific inquiry about the existence of such an investigation.

Fairness questions were also raised in SEC v. HealthSouth, 261 F. Supp. 2d 1298 (D. Ala. 2003).  There, the court denied an SEC motion to freeze assets of former HealthSouth CEO Scrushy.  The court repeatedly expressed concern about the SEC’s tactics where much of the evidence came from a parallel DOJ investigation, yet the SEC refused to make that evidence available to the defense in response to civil discovery requests claiming that it was in the possession of the U.S. Attorney’s office or the FBI. 

Likewise, in U.S. v. Scrushy, 366 F. Supp. 2d 1134 (D. Ala. 2005), the court granted a defense motion to suppress SEC testimony because the USAO and the SEC investigations had merged to where the USAO dictated questions, limited the SEC’s inquiry topics, and determined testimony location for future criminal venue without telling the defendant of the parallel inquiries.   

Now, in SEC v. Reyes, et. al., No. C 06-04435 CRB (N.D. Cal.) a key issue of fairness has been raised stemming from parallel proceedings.  To much fanfare, both agencies announced in a joint press conference the filing civil and criminal charges tied to option backdating.  Quickly, the USAO moved to stay the civil case, sending a message that the SEC did not intend to litigate immediately.  The court denied the motion noting that it is fundamentally unfair to charge persons with violations of the securities laws and then, when they wish to respond, stay the case.  Subsequently, the defense attempted to depose several witnesses, all of whom have taken the Fifth.  In a subsequent motion, the defense moved “to compel deposition testimony, for an evidentiary hearing, and for other appropriate remedies.”  The Defendants argue that the “Silent Eleven,” as they term them, have no fear of prosecution.  The Silent Eleven made proffers to the USAO that were attended by SEC staff and, according to motion papers, at least one witness has letter immunity.  See Motion of Defendants Reyes, Caova and Jesen to Compel Deposition Testimony, dated January 23, 2007.  Not surprisingly, the SEC argued procedure rather than substance, noting that the motion should be denied because it does not have authority to grant immunity, it is appropriate to conduct parallel proceedings, and if the criminal trial proceeds first many of the witnesses now invoking their constitutional right not to testify may, in fact, become available.

While the court denied the motion as premature, the Judge noted he was “sympathetic to Defendants’ argument that SEC and DOJ attorneys have selectively used their power to grant use immunity[,]” but at this point the factual record was inadequate to support the requested remedies. 

The SEC’s arguments in Reyes – as they were in HealthSouth and Stringer – were not doubt accurate, as far as they went.  But the arguments miss the point.  Government prosecutors from the DOJ and the SEC have an obligation of fundamental fairness and cannot skew the playing filed or truncate the rights of defendants in the name of law enforcement.  Such actions undercut the very system government prosecutors are suppose to serve.  These cases serve as a reminder of this crucial point.  Perhaps more importantly, in a post-Enron world where the pendulum has swung far in favor of the prosecution, perhaps these three decisions signal an appropriate swing back toward the middle.

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