Key Issues in InvestigationsTwo key issues that may have a significant impact on SEC investigations in 2007 and beyond are:  1) parallel proceedings, and 2) cooperation.  While these issues are not new, cases in 2006 and expected rulings and developments in 2007 may reshape how these important issues impact SEC investigations.

First, a review of recent SEC cases suggests that parallel government investigations are on the rise.  Typically, while the SEC is conducting an investigation to determine whether there has been a violation of the federal securities laws, DOJ or the local U.S. Attorney’s Office will conduct a parallel investigation into the same matters.  During the investigations, the SEC typically makes its files available to DOJ or the USAO and, on occasion, will detail one of its staff members to assist with the criminal inquiry.  Parallel investigations offer efficiencies for both government and potential defendants.  For this reason former SEC Chairman Harvey Pit noted that the SEC will continue to have a close relationship with other law enforcement agencies and use parallel proceedings.  See Remarks at DOJ Corporate Fraud Conference (Sept. 26, 2002).  For potential defendants parallel proceedings offer economies and the potential for a coordinated resolution.  Courts have held repeatedly that parallel proceedings are proper and appropriate. 

Problems can arise, however, when SEC and DOJ investigations are not parallel but merge in a manner that prejudices a defendant.  Two recent cases illustrate the point and may potentially reshape the manner in which the government conducts parallel inquiries.  Last January in U.S. v. Stringer, 408 F. Supp. 2d 1083 (D. Ore. 2006) the court dismissed a criminal indictment for government misconduct where the USAO concealed its investigation behind the SEC’s investigation and, according to findings by the court, mislead the defendants about the existence of the criminal inquiry.  On appeal the SEC has argued in an amicus brief that its standard warnings in Form 1662 are standard practice and sufficient warning of the possibility of a criminal inquiry.  Form 1662 is a standard set of warnings the SEC provides to every witness.  In part, the Form notes that information may be shared with other law enforcement agencies.  The SEC’s claims the Form is sufficient and that even where it knows there is a criminal inquiry it can rely on the Form warnings and not tell witnesses who ask about the existence of a DOJ or USAO inquiry.  This case will be decided by the Ninth Circuit later this year. 

Another parallel proceedings issue recently arose in SEC v. Reyes, (N.D. Cal. July 19, 2006).  Mr. Reyes, the former CEO of Brocade, and others are accused of securities fraud based on a stock option backdating scheme.  Similar charges are pending against Mr. Reyes in a criminal case brought by the USAO in San Francisco.  After the USAO and SEC filed their cases, the USAO moved to stay the SEC action to prevent the defendants from using the civil discovery rules to develop evidence for use in the criminal case.  The court denied the motion noting that it would be unfair to prevent the defendants from defending against the government accusations – particularly because the government brought its cases with significant fanfare, which included a press conference.  Subsequently, the defendants in the SEC case asked the court to compel the deposition testimony of several key witnesses who refused to testify and invoked their Fifth Amendment rights.  In their motion the defendants essentially argued that it was unfair for the USAO and the SEC to interview each of these witnesses in “proffer sessions” and then use that evidence when the same evidence is not available to the defendants.  Criminal prosecutors typically ask witnesses to give them a proffer or a statement of what they know when they are considering offering the witness immunity.  In this case, the USAO let the SEC join the proffer sessions so that the agency had the benefit of the evidence.  The court denied the motion as premature, noting that it did not have authority to immunize witnesses.  In ruling on the motion, however, the court cautioned the government about the unfairness of the situation and noted that if it continued as the case approaches trial, a remedy would be fashioned for the defendants.  

Stringer and Reyes may reshape the way the SEC and the DOJ interact and conduct parallel investigations.  If upheld, Stringer could require the SEC to inform witnesses when it is aware of a parallel criminal investigation.  This contrasts sharply with current practice where SEC staff may know that there is a criminal inquiry but can refuse to share that information with witnesses whose rights may be impacted significantly.  Rather the SEC enforcement staff under current practice simply point of Form 1662 or give a stock answer of “assume the worst.”  Neither response is helpful and can be misleading.   Reyes may also significantly impact SEC and DOJ investigations.  The court’s ruling makes it clear that the playing filed will be leveled prior to trial. 

Reyes is not the first case in which the SEC has had access to information developed by criminal prosecutors that is not available to the defendants in an SEC enforcement action.  A ruling in Reyes, coupled with the ruling in Stringer, may go far to level the playing filed for defendants.  Second, there may be significant developments on the question of cooperation that will impact SEC investigations.  Cooperation is a key topic because it can shape the prosecution or mitigate a penalty for a company facing a potential securities law action by the SEC or the DOJ.  The SEC’s standards in its Seaboard Release, No. 34-44969, 2001 WL 1301408 (Oct. 23, 2001) have been heavily criticized along with those of the DOJ by the ABA, in testimony before congress, by business groups and even by former high ranking justice department officials as causing a “culture of waiver,” which requires companies to waive their attorney-client privilege, work product protections and often the rights of its employees in the hope of being viewed as cooperative.  While the SEC staff and the DOJ prosecutors disclaim responsibility for creating the so-called “culture of waiver” there is no doubt that many companies strip themselves of key rights and even perhaps impede their ability to obtain legal advice important to conforming their conduct to legal requirements in an effort to be viewed as cooperative.  Indeed, Senator Specter has even offered legislation, tiled the Attorney Client Protection Act of 2007, to attempt to remedy the situation.  While DOJ has taken some steps to amend its policies, the SEC has yet to respond to its critics, other than in sporadic denials.  In February, however, SEC Commissioner Atkins noted that Seaboard should be reviewed – a reiteration of comments he made last year.  Similarly, last month the ABA sent SEC Chairman Cox a letter requesting that Seaboard be revised.  In view of the continued pressure on the SEC to revise its cooperation policies, there may be movement on this issue later this year.  A revision of Seaboard to eliminate the “culture of waiver” by, for example, providing a bright-line test for cooperation or adopting the suggestion of Commissioner Atkins that waivers not be counted toward cooperation credit, would be a key step in reforming cooperation standards.  Reforms in this area, coupled with the pending ruling in Stringer and potential developments in Reyes, may have a significant impact on how the SEC conducts its investigations in the future. Next, significant case trends. 

Print Friendly, PDF & Email

In Part I of our series on SEC Enforcement Trends (see post of February 23, 2007) we noted that some commentators have questioned the vitality of the enforcement program. Three recent cases reflect on this question:

First, in SEC v. Blue Bottle et al., Civil Action No. 07Civ.01-CV-1380 (CSH)(KNF)(S.D.N.Y.)(February 26, 2007) the SEC was successful in obtaining a temporary retraining order prohibiting future violations of the antifraud provisions of the federal securities laws as well as an order directing that certain funds be repatriated from overseas bank accounts in an insider trading case. Specifically, the SEC claims that Blue Bottle, a Hong Kong company and defendant Matthew Charles Stokes, a citizen of Guernsey, repeatedly traded in the securities of twelve different companies immediately prior to the publication of news releases about those entities. According to the complaint the defendants realized profits of over $2.7 million. The information about the twelve companies was obtained, according to the agency, through fraudulent means which included hacking into computer networks. The brokerage accounts used to execute the trades were opened with fake documents and false information.

Second, in SEC v. Thomas W. Jones et al., Civil Action No. 05Civ. 7044(RCC)(S.D.N.Y. February 26, 2007) the court entered summary judgment against the SEC and in favor of the defendants. The agency alleged defendants, employees of Citigroup Asset Management, a business unit of Citigroup that provides investment advisor and management services to Citigroup sponsored mutual funds, aided and abetted violations of Section 206 of the Investment Advisors Act. Specifically, the complaint alleged that defendants profited at the expense of mutual fund investors through a deal to hire a bank-affiliated fund transfer agent which had an undisclosed side deal. The SEC sought an injunction, penalties and disgorgement. The court began by dismissing the claim for penalties as time bared under 28 U.S.C. Section 2462 which provides for a five year statute of limitations in suits where a civil fine, penalty or forfeiture is sought. In reaching its conclusion the court rejected an SEC claim that the statute should be tolled because of fraud, finding that the agency failed to present any facts demonstrating that the claimed misrepresentations or omissions were unknowable. The court also concluded that the SEC’s request for injunctive relief was time barred because the there was no showing that the requested relief was necessary to prevent future harm beyond the claim of a past violation. Accordingly, the injunction was more in the nature of a penalty and thus subject to the five year statute of limitations which had run. Finally, while disgorgement is an equitable remedy not subject to the statute of limitations, the SEC failed to present evidence demonstrating the amount which should be ordered.

Finally, U.S. v. Reyes, Civil Action No. C06-04435 (CRB) (N.D. Cal July 19, 2006)(the Brocade stock option backdating case) is reportedly set for trial in June. While the allegations in the criminal case and the SEC’s complaint paint a picture of clear fraud, problems may be arising for the government. As reported earlier (post of February 20, 2007) parallel proceedings issues have been raised in the SEC’s civil case. While those have currently been resolved in favor of the SEC, the court cautioned the agency’s lawyers that if problems persist a remedy for the defendants would be fashioned. Now in the criminal case evidence is appearing which may call into question government claims. BusinesWeek Online reports in a story dated March 5, 2007 (but now available) that former CEO Reyes has vowed to fight the case. Documents which are coming out appear to undercut the very clear cut claims made by the government. Specifically, it appears that an operations manual specified that the options clerk pick the lowest stock price since the previous option grant when preparing new options paper work for Mr. Reyes to sign. Unlike other option backdating cases, apparently Mr. Reyers was not involved in the dating process. These facts may prove to be significant in a case which focuses on an intentional and concealed fraud. While the government started this case with a great deal of fanfare last year, press releases are one thing, proof in court, as the Jones case cited above suggests, is another.

Next: Part III of the Series on SEC Enforcement Trends

Print Friendly, PDF & Email