Two settled administrative proceedings filed yesterday that relate to the previously settled actions brought against PNC Financial Services and accounting giant AIG reflect contrasting remedies in financial fraud actions.  Both actions are based on the SEC’s investigation along with the Federal Reserve into the use of special purpose entities sold by AIG to PNC. 

In PNC, the SEC brought a cease and desist action against the financial services company for a false quarterly filing made in 2001.  Specifically, the Order for Proceedings as to PNC claimed that the company entered into an arrangement with AIG to create special purpose entities used to remove approximately $762 million in loan and venture capital assets from its books.  The SEC claimed that these “transactions were an effort to eliminate PNC’s risk of loss on the transferred loans and other assets while allowing it to benefit from any long-term improvement in their values.  Had PNC continued to include these transferred assets in its financial statements, it would have been required to reflect in its financial statements any losses incurred and the benefit of any improvement in the value of these assets.”  Instead, the company transferred the assets to SPEs under an arrangement, which permitted it to book any long term increase but avoid the losses.  According to the SEC, under the arrangements although AIG invested 3% or more in the entities as required by GAAP, in fact its fees exceeded this amount so that its net investment was less than required.  Thus, the arrangements did not comply with GAAP.  According to the Order for Proceedings, during the third quarter of 2001 the Federal Reserve had “incomplete” communications with PNC in which it raised questions concerning the propriety of the arrangements.  Nevertheless, PNC continued with the improper arrangements, incorporating the false financial statements in registration statements filed with the SEC.  PNC also issued a press release in January 2002 that incorporated the false financial data despite the fact that it knew it would have to restate the results. 

PNC consented to the entry of an order directing that it cease and desist from violations of the antifraud provision of the Securities Act, Sections 17(a)(2) & (3) and various Exchange Act books and records provisions.  PNC also entered into an extensive supervisory agreement with the Board of Governors of the Federal Reserve. Release No. 33-8112 http://sec.gov/litigation/admin/33-8112.htm; SEC v. American International Group, Inc., No. 1:04CV02070 (GK) (D.D.C. judgment entered Dec. 7, 2004. 

Yesterday, Thomas Garbe consented to the entry of an order directing him to cease and desist from causing violations of the reporting provisions of the Exchange Act. Release No. 34-54906 http://sec.gov/litigation/admin/2006/34-54906.pdf. Mr. Garbe is a CPA who was PNC’s director of Accounting Policy at the time the false quarterly reports were prepared and filed with the SEC.  According to the Order for Proceedings, Mr. Garbe participated in meetings about the proposed SPE transactions with AIG and researched and analyzed the accounting issues involved with the accounting treatment:  “During 2001, Garbe was the head of PNC’s Accounting Policy department, and, as such, had responsibility for ensuring that PNC’s accounting for each of the . . .[SPE transactions] was in conformity with GAAP.”  In January 2002, Mr. Garbe became director of Financial Accounting for PNC.  

In another action filed yesterday, former EY partner Michael Joseph consented to the entry of an order directing that he cease and desist from causing violations of the books and records provisions of the Exchange Act and the antifraud provisions of the Securities Act, Sections 17(a)(2) & (3) and an order under Rule 102(e) denying him the right to practice before the SEC but permitting an application for a right of reentry after three years.  Mr. Joseph was a partner in the national office of EY and helped develop and market the accounting product AIG sold to PNC and used to improperly remove assets from its books.  Not only should Mr. Joseph have known that the product did not conform to GAAP but, according to the Order, he violated auditor independence standards by advising PNC during its audits on the appropriateness of the accounting for the product he helped develop and market. Release No. 33-8759, http://sec.gov/litigation/admin/2006/33-8759.pdf  

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Senator Specter introduced the Attorney-Client Privilege Protection Act of 2006 (ACPPA) in the Senate yesterday.  Thus, the so-called “culture of waiver” created by the Justice Department’s Thompson Memo and the SEC’s Seaboard Releases – both of which in practice have forced corporate privilege waivers and denied employees of fundamental rights – could be about to end.   

 As noted in this space on November 21, the draft text of that bill includes provisions that effectively rewrite key provisions of the Justice Department’s Thompson Memo and the SEC’s Seaboard Release on the waiver of the attorney-client privilege and other key rights in the name of cooperation.  Specifically, the draft bill would preclude federal investigators in either a civil or criminal matter from in any manner requesting a waiver of the attorney-client privilege or work product doctrine. 

In addition, the proposed legislation directs that federal investigators not “condition a civil or criminal charging decision relating to a organization, or person affiliated with that organization, on, or use as a factor in . . .” assessing cooperation any valid assertion of privilege, the payment of legal fees for employees, the sharing of information under joint defense agreements or otherwise or the failure to terminate employees for the assertion of constitutional rights.  The bill would not preclude a voluntary waiver of privilege.  

 This proposed legislation seems to echo the comments of Senator Specter at the September Senate hearings on this issue.  During those hearings, Senator Specter reportedly told the Justice Department that he would introduce legislation on to preserve these privileges and rights unless the Thompson Memo was redrafted. Deputy Attorney General Paul McNulty, who testified at those hearings, reportedly told senators that the Department would revisit the Memo, although no representation was made that the provisions the private bar finds troubling and claim create the “culture of waiver” would be eliminated.  

To date the Justice Department has not amended or redrafted the Thompson Memo.  Recent press reports, however, suggest that the Department is reconsidering the Thompson Memo and that changes will be forth coming.  Those reports follow a recent speech by Larry Thompson, author of the Memo, noting that it was not intended to be applied in the manner which many claim has created a “culture of waiver.”  Similarly, the SEC has not taken any steps to amend the Seaboard Report.  SEC Commissioner Paul Atkins did state in a September 2006 speech that waiver should not be considered in assessing cooperation. See Remarks before the Federalist Society, September 21, 2006.
http://www.sec.gov/news/speech/2006/spch092106psa.htm Linda Thomson, SEC Enforcement Director, noted in a recent conversation at the ABA Business Section meetings that waiver is the exception and not typically sought, echoing earlier staff comments.  Similar claims by the Justice Department were rejected as not credible by Judge Kaplan in U.S. v. Stein. 

In any event, introducing a bill is a long way from having it signed into law.   We will just have to wait and see whether the “culture of waiver” is about to end because the bill is pushed through Congress or if the Justice Department and the SEC will finally amend their respective directives, or if the stalemate continues.

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