by T. GormanPosted on Posted in SECActions

Financial fraud is a traditional SEC enforcement area. Last year was no exception. The Commission brought cases focused on earnings management, revenue recognition and the misuse of reserves. One recent study of SEC financial fraud cases suggested that post-SOX the SEC has focused on larger companies. Prior to SOX, the Commission had been criticized on occasion for keying its enforcement efforts to smaller issuers. Whether the new focus on larger companies is a new trend or an aberration resulting from the recent scandals such as Enron, Global Crossing, Tyco and others remains to be seen.

Many of the corporate fraud cases focus on years-old conduct, raising questions such as those seen in SEC v. Jones, No. 07 Civ. 7044, slip op. (S.D.N.Y. Feb. 26, 2007), concerning whether the typically requested injunction is actually the equitable relief intended by Congress. Others raise questions regarding cooperation credit under Seaboard and the SEC’s policy on corporate penalties as well as Chairman Cox’s new procedures for deciding on corporate penalties. The settlements in BISYS Group, Nortel Networks, Federal Home Loan Mortgage and Cardinal Health raise illustrate these issues.

SEC v. The BISYS Group, Inc., Case No. 07-Civ-4010 (S.D.N.Y. May 23, 2007) is a settled civil injunctive action which illustrates the application of cooperation credit. Here, the Commission’s complaint alleged a variety of improper accounting techniques engaged in by senior management over a period of years to meet Wall Street expectations. For fiscal years 2001-2003, the financial results were overstated by about $180 million. Based on two restatements, pretax income was overstated 69%, 58% and 43% for fiscal years 2001-2003.

The settlement in BISYS Group reflects cooperation credit, according to the SEC. The company consented to a statutory injunction prohibiting future violations of the books and records provisions and to an order requirement the payment of $25 million in disgorgement and prejudgment interest. The fact that the settlement does not include an antifraud injunction despite allegations of a pervasive fraud or a penalty, presumably is the result of cooperation credit.

Another settlement which involved cooperation credit is SEC v. Nortel Networks, Corp., Civil Action No. 07-CV-8851 (S.D.N.Y. Oct. 15, 2007). There, the SEC’s complaint alleged that the company improperly accelerated the recognition of revenue to meet targets from 2000 to 2001. The company adopted revenue recognition policies that were not in conformity with U.S. GAAP. These actions, according to the complaint, permitted the company to inflate its fourth quarter and fiscal year 2000 revenues by about $1.4 billion. In addition, in 2002 the company improperly established and maintained reserves.

The settlement here differs from BISYS Group. Here, it includes a statutory injunction prohibiting future violations of both the antifraud and books and records provisions. In addition, the company agreed to the entry of an order requiring the payment of a civil penalty of $35 million and requiring it to report to the staff periodically on progress in resolving a material weakness in its revenue recognition procedures. Thus, despite cooperation, an antifraud injunction was required and a substantially larger fine despite the similarity of the actions.

Two other cases raise questions about the application of the Commission’s policy on corporate penalties and the new procedures for determining them instituted by Chairman Cox. SEC v. Federal Home Loan Mortgage Corp., Civil Action No 07-CV-1728 (D.D.C. Sept 27, 2007) is a financial fraud case where the Commission alleged that the company improperly smoothed earnings trends by misreporting income from 2000 to 2002. In those years, as a result of pressure from senior management and a culture which prized smooth steady earnings rather than compliance, net income was misreported by 30.5%, 23.9% and 42.9%.

To settle the action the company consented to the entry of a statutory injunction prohibiting future violations of the antifraud provisions. In addition, the company agreed to pay a penalty of $50 million.

SEC v. Cardinal Health, Inc., Case No. 07CV6709 (S.D.N.Y. July 26, 2007) is a similar financial fraud case. There, the Commission’s complaint alleged that Cardinal used a variety of practices to manage reported earnings from 2000 to 2004. The improper practices included misclassifying revenue, selectively accelerating payment of vendor invoices, improperly adjusting reserve accounts and improperly classifying expected litigation settlement proceeds to increase operating earnings.

To resolve the case, Cardinal consented to the entry of a statutory injunction prohibiting future violations of the antifraud and reporting provisions and to pay a $35 million penalty. Despite the apparent similarities in the cases and the fact that Cardinal had a parallel criminal action, that company paid a substantially smaller fine than Federal Home Loan.

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by T. GormanPosted on Posted in SECActions

The SEC and DOJ have taken an expansive view of the FCPA as part of their renewed emphasis on enforcement. Their approach here echoes that taken to the insider trading cases. Two key limitations illustrate this approach.

The first is the limitation on the antibribery provision that the payment must be to obtain or retain business. This provision was incorporated in the Act in 1978 and has remained unchanged through the 1988 amendments. It was intended to reflect the fact that not all payments to foreign officials violated the Act, but only those to obtain business or retain business. The legislative history at the time the FCPA was first passed suggests that payments regarding taxes were not within this provision, although the legislative reports from the 1988 amendments suggest to the contrary despite not changing the statutory language.

Nevertheless, both DOJ and the SEC are expanding the obtain/retain business provision to include matters relating to taxes. In two decision in U.S. v. Kay, the court of appeals has expansively read this key limitation to include payments about taxes. The first decision focused only on the adequacy of the language of the indictment while the second followed the remand and trial of the case. U.S. v. Kay, 359 F.3d 738 (5th Cir. 2004) (Kay I); U.S. v. Kay, 2007 WL 3099140 (5th Cir. Oct. 24, 2007) (Kay II). In these decisions, the court concluded that in certain instances payments regarding taxes may fall within the obtain/retain business limitation. In Kay II, the court held that since the defendants testified that payments to officials to reduce certain taxes were necessary because everyone was doing it, then those payments must in fact be necessary to obtain or retain business. As such, they are within the prohibitions of the antibribery sections.

The SEC has recently taken a similar position in a settled administrative proceeding. In the Matter of Bristow Group, Admin. Proc. File No. 3-12833, SEC Release 5633 (Sept. 26, 2007).

The second limitation concerns the payment of promotional expenses. 15 U.S.C. § 78dd-2(c)(2) permits the payment of a “reasonable and bona fide expenditure, such as travel and lodging expenses …” and the payment of expenses for “the promotion, demonstration, or explanation of products or services.”

Last year, the SEC brought two key cases involving this section. Perhaps the most significant is SEC v. Lucent Technologies, Inc., Civil Action No. 07-092301 (D.D.C. Dec. 21, 2007). In this settled civil injunctive action, the SEC’s complaint alleged that over a three year period the company paid over $10 million of about 1,000 Chinese foreign officials to travel to the U.S. According to the complaint 315 of those trips had disproportionate amounts of sightseeing, entertainment and leisure. The trips had been booked to a “factor inspection account.” The SEC also claimed that Lucent had inadequate FCPA training.

To resolve the case, Lucent consented to the entry of an injunction prohibiting future violations of the books and records provisions of the FCPA. In addition, the company agreed to pay a $1.5 million civil penalty.

To settle with DOJ, Lucent entered into a non-prosecution agreement that required the payment of a $1 million fine.

The SEC brought a similar action against Dow Chemical Company. That settled action was based on the payment of $37,000 in gifts, travel, entertainment and other items. SEC v. The Dow Chemical Co, Civil Action No. 07-00336 (D.D.C. Feb. 13, 2007).

The Department of Justice also published two rulings regarding travel and entertainment which define limitations in this area consistent with these cases. FCPA Op. Proc. Rel 2007-01; Rel 2007-02.

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