For months the standards for evaluating cooperation used by the Department of Justice in the Thompson memo and those of the SEC in the Seaboard Report have been under fire for creating a “culture of waiver” which has eroded the attorney client privilege and the work product doctrine and unduly interfered with the rights of corporations and their employees. The ABA has passed resolutions decrying the impact of the standards used by DOJ and the SEC. Organizations such as the U.S. Chamber of Commerce have issued reports heavily criticizing what it called the increasing harshness of SEC enforcement efforts. The court in U.S. v. Stein, held portions of the Thompson memo unconstitutional. Congress followed up on this with hearings in which virtually every witness, including former high ranking justice department officials, criticized DOJ and SEC cooperation policies.

Through all of this DOJ and the SEC have stood largely mute, at least implying that they stood by their policies. It was refreshing to see SEC Commissioner Paul S. Atkins address this important issue in his recent speech and suggest a review of Commission policies while noting that he would be very critical of any requests from the staff for privilege waivers. Specifically, Commissioner Atkins stated that “I strongly believe that the Commission should not view a company’s waiver of privilege as a factor that will afford cooperation credit. . . . Maybe it is time for the Commission to revisit this issue in a formal way and to clarify that waiver . . . [of] fundamental rights and protection will not result in lesser allegations and/or remedies.” The Commissioner went on to note that while waivers may make it easier for the staff — a point specifically discussed in the Thompson memo — this does not justify seeking the waiver of fundamental rights. Indeed, Commissioner Atkins noted that if internal investigations are not privileged it may undermine their effectiveness. Remarks before the Federalist Society, September 21, 2006.

Commissioner Atkin’s comments are a welcome relief from the cold silence of DOJ and the SEC on this important topic. As has been previously noted in this blog, there is no need for DOJ or the SEC to seek waivers in most cases. What the government needs when making a prosecutorial decision — which is what the Thompson memo and the Seaboard Report are suppose to be about — is the facts. A self reporting company can furnish the facts without privilege waivers. What DOJ and the SEC should be looking for as indicia of cooperation is self reporting, a full presentation of the facts to the extent known by the company including facts about persons who may be involved in the wrongful conduct being reported and the adoption of reasonable procedures which will prevent a reoccurrence in the future. If DOJ and the SEC focused on these points they should be able to assess cooperation. If DOJ and the SEC focus on encouraging cooperation rather than stripping persons of their rights they may find that their law enforcement policies are more effective. The remarks of SEC Commissioner Atkins are a welcome first step in reforming cooperation standards to do what they should be: standards which encourage cooperation and aid law enforcement in a manner which conforms with the law.

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Virtually every day there seems to be another round of disclosures about a company reviewing its stock option issuance practices or the resignation of an executive mired in the growing scandal. Backdated stock options seem to be everywhere. Yet, surely the SEC is investigating other matters.

One area that the SEC may be focusing on for a new round of investigations is insider trading. A long-time key program area for the SEC’s enforcement division, it may be that new actions are coming that could challenge backdated stock options as the “flavor of the month” scandal. Not long ago the New York Times ran an article based on a study it commissioned showing increased trading activity before the public announcement of mergers. The article suggested that such activity may be insider trading (see Blog entry of Aug. 29, 2006). Following that article, Congress began hearings on insider trading.

Now the New York Times reports on what may be another series of insider trading investigations. In an article published on October 16, 2006, the NYT reported on possible insider trading arising from the relationships between lenders and companies. Specifically, bond and debt holder of companies typically have covenants in their lending agreements that require they receive periodic financial reports from companies. Some lenders have periodic conference calls with their borrower companies in which they receive non-public information. Many of these lenders are not the traditional bank lender but are hedge funds, entities the SEC has been trying, with little success, to regulate for sometime.

As a result of their bond contracts and lending agreements hedge funds and other lenders may be receiving the material non-public information about their borrower companies. To the extent this information is material, trading by the recipients prior to its disclosure would be prohibited by insider trading rules. The information receive under the bond and lending agreements may, however, not be material. The information may be non-public but in and of itself may not be material. When that information is added to other bits of information it may become knowledge which investors seek – material information.

Piecing together bits and pieces of non-material information is the type of practice that analysts and shrewd investors are suppose to do. In fact, that type of activity contributes to the overall efficiency of the securities markets. The efficient market theory is of course the basis for much of the SEC’s regulation of corporate information. At the same time, just where the line is between what is material and what is not material and between what has become material because non-material information has been carefully compiled and totals material information can be a difficult task. The NYT article reports that the SEC is looking at these issues. It should be interesting to watch where the SEC draws the line in these cases. If the SEC is to aggressive it can deter the market efficiency that is key to much of its regulation. If it is not aggressive enough it could permit hedge funds and other lenders to have an insider trading advantage in the securities markets that can undermine investor integrity.

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