New Series: Self-reporting And Cooperation: Key Issues

Today begins a new occasional series on self-reporting and cooperation, a critical issue faced by many discovering a possible malfeasance. Almost immediately upon making this discovery the business organization is confronted with critical questions regarding self-reporting, cooperation, privilege waivers and others, all of which can have far reaching and significant consequences. Yet many of these questions must be at least tentatively resolved while the facts and circumstances about the situation are only beginning to unfold.

The Securities and Exchange Commission (“SEC”) and the Department of Justice (“DOJ”) have long encouraged business organizations to self-report conduct which may be a violation of law and fully cooperate with any ensuing law enforcement inquiry. To encourage business organizations to take these steps, the SEC and DOJ offer the prospect cooperation credit in the charging decision in the form of amnesty or some lesser charge or sanction than might otherwise be imposed.

Despite SEC and DOJ encouragement and releases discussing these questions, the issues for the company and its advisors are often ill-defined, guided only by vague standards which reduce decision-making to guessing and projecting the consequences to speculation. In a few instances, there is a clear duty to self report. In others, the legal framework may encourage and virtually compel such a decision. Assessing the potential consequences however, is hazardous in view of virtually open ended organizational liability, broad prosecutorial charging discretion and vague cooperation standards which reserve all discretion to the SEC and DOJ.

Yet, it is critical for any organization confronted with the question of self- reporting to carefully assess its options and the potential consequences prior to making the initial decisions. To analyze the questions a business organization must consider when confronted with questions of self-reporting and cooperation, this series will consider four key points: (1) the obligation to self report; (2) prosecutorial charging and cooperation standards; (3) the potential impact of cooperation credit; and (4) cross currents which undercut offers of cooperation credit. The final segment of the series will analyze the collective impact of these considerations.

The SEC Files Another Insider Trading Case Based On International Trading

Trading in the U.S. markets through foreign accounts does not shield the trader from SEC scrutiny and potential liability. On Friday, the SEC reaffirmed this point, filing another insider trading case based on international trading. SEC v. One or More Unknown Purchasers of the Call Options for the Common Stock of DRS Technologies, Inc., Civil Action No. 08-cv-6609 (S.D.N.Y. Filed July 25, 2008). This case is based on trading in advance of the announcement of the merger talks between DRS Technologies, Inc. and Finmeccanica S.p.A., the same takeover transaction which is the predicate for an earlier insider trading case. SEC v. De Colli, Civil Action No. 08-civ-4520 (S.D.N.Y. May 15, 2008), discussed here.

The emergency action filed Friday froze assets related to option trading in the shares of DRS Technologies. The complaint also alleges insider trading in options of American Power Conversion Corp, two years earlier. The trading was through an account at UBS AG.

As to the DRS options, the complaint claims that an unknown purchaser acquired 1,820 out of the money and soon to expire call options for over $456,200. Immediately following a May 8th Wall Street Journal article reporting advanced merger negotiations between Finmeccanica and DRA, the unknown purchaser liquidated all of the options, making an illegal profit of about $1.6 million. Subsequently, on May 12, 2008, the merger of the two companies was announced. The allegations here are similar to those made in the De Colli case filed earlier this year.

The complaint also alleges that the unknown purchaser traded on inside information when acquiring 2,830 American Power call options at a cost of about $343,000 in September and October 2006. On October 30, 2006 Schneider Electric SA announced the acquisition of American Power for $31 per share. The unknown purchaser subsequently liquidated the options at a profit of about $1.7 million.

This case is another example of the SEC working closely with other regulators to quickly bring an insider trading case that involved international trading. In filing this action, the SEC worked with the Swiss Federal Banking Commission, the Department of Justice and the Chicago Board of Options Exchange.