One can only wonder where the SEC is heading.  Consider a few recent events: 

1)  Recent new articles suggest that the SEC is considering a proposal under which corporations could limit their liability in securities class actions.  The proposal would require that shareholders bring any claim they have in arbitration.  As we have previously noted in this blog on 4/18/07, the proposal seems directly contrary to the SEC’s long stated position that private damages actions are a necessary supplement to its enforcement actions.  If adopted, this would represent a change in a long held position for the SEC. 

2)  Last week the head of the Senate Judiciary Committee wrote SEC Chairman Cox asking to end the authorization that permits brokers to require customers to waive their rights to file court actions and resolve any claim from their securities trades in arbitration,  according to an article by Gretchen Morgenson in the New York Times on Sunday.  The courts of course have long upheld the position of the brokerage industry that it can require customers to waive their rights to bring actions in court in favor of mandatory arbitration.  The SEC has long agreed with this position.  In doing so, however, as Ms. Morgenson notes in her article, that the SEC has repeatedly made it clear that this position is limited to customer/broker arbitrations.  To adopt the position suggested by the Senator would be a change in a long held position for the SEC. 

3)  In light of the SEC’s brief in Tellabs, Inc. v. Makor Issues & Rights, Ltd., (No. 06-484), the private securities damage action currently pending before the Supreme Court, many SEC observers believe that the agency took a position contrary to its usual investor/shareholder focus.  That case involves pleading standards in private securities actions focused on the definition of what constitutes a “strong inference of scienter.”  In its amicus brief, the SEC took a position which many believe supports the defense.  If so, that would suggest a change in position for the agency.  

4)  At the end of March, the Supreme Court agreed to hear an appeal from the Eighth Circuit Court of Appeals in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., (No. 06-43).  That case involves a key question in private securities damage actions concerning the scope of liability.  This has been a critical issue in these cases since the Supreme Court’s 1994 decision in Central Bank, N.A. v. First Interstate Bank, N.A., 511 U.S. 164 (1994), which held that there is no aiding and abetting liability in securities fraud actions.  In Stoneridge, the question is what constitutes “scheme” liability under the antifraud provisions, Exchange Act Section 10(b) and Rule 10(b)-5 thereunder.  At stake is who can be held liable in securities class actions – only the primarily violator, such as the company involved or others who may have had some role in the challenged transaction for example accounting firms, bankers and others.  Reportedly the plaintiff’s class action bar has been heavily lobbying the SEC to take a supportive view.  The SEC has not yet taken a position in this case.  In 1995, however it obtained authority to bring cases using an aiding and abetting theory from Congress. 

5)  Reportedly the five SEC commissioners are split over the use of financial penalties against companies.  One view argues that they are a deterrent.  Another argues that they only punish shareholders who have already suffered a loss from the fraud at the company and the enforcement action brought against the firm by the SEC.  This split seems to be the moving spirit behind the new settlement procedures adopted by the agency in cases where a corporation is the potential defendant and a penalty may be imposed.  Under those new procedures the staff can no longer negotiate a settlement with a company that includes a monetary fine and submit it for Commission approval – a long used procedure.  Now the staff must first submit the case to the Commission for authority to impose a penalty and if so how much, then negotiate with the defendant and then go back to the Commission for final approval.  While Chairman Cox argued in announcing this procedure that it would speed up settlements, as we previously noted 4/19/07 that seems unlikely.  Rather, it appears to be a mechanism for the commissioners to try and coordinate their views.  In an agency that is already far to slow in most instances, these additional procedures appear to just be another impediment.  This is a change for the SEC, which will probably slow and already slow process. 

6)  In some instances the agency can move with extraordinary speed.  The SEC obtained an asset freeze in SEC v. Kan King Wong and Charlotte Ka On Wong Leung, 07 Civ. 3628 (SAS) (S.D.N.Y. filed May 8, 2007), just a week after the announcement of News Corp.’s bid for Dow Jones.  Viewed by any standard this suit was brought very quickly.  This is a welcome change from many of the agency’s traditional cases, which are brought years after the events involved.  

All of this simply leaves one wondering about the SEC’s direction and the speed at which it will proceed.  In many instances the agency moves very slowly, as in the cases involving corporate penalties.  In others it is capable of swift action in certain instances when the focus is clear, such as in the recent insider trading case.  In some key instances it seems to be changing or at least considering a change in long held positions.  Is the SEC in fact changing focus or is what we are seeing a traditionally apolitical agency caught in political and philosophical cross currents? 

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Yesterday the SEC brought another in what has become a series of cases based on claims that a company helped another falsify its financial statements.  This time the SEC brought an cease and desist action against Motorola, Inc. for entering into a “price support” agreement with Adelphia Communications Corporation.  According to the Order for Proceedings, the purpose of the arrangement was to help Adelphia artificially inflate its Earnings Before Interest, Taxes, Depreciation and Amortization by reducing operating costs.  According to the SEC the agreement involves a round-trip of cash between Motorola and Adelphia.  

In bringing the action the SEC alleged that Motorola should have realized that the agreement lacked any economic substance.  The Order for Proceedings claimed that Motorola should have seen a series of red flags, which included that fact that this was the first time a vendor had ever requested a price increase.  Motorola agreed to the entry of a C&D, and to the payment a total of $25 million in disgorgement and prejudgment interest. The action against Motorola is the latest in a series of such cases.  For example, last year the SEC brought a civil injunctive actions against: 

Scientific-America claiming that it entered into a price support agreement with Adelphia to help inflate the latter’s earnings by $43 million.  The case settled with the entry of a consent injunction and the payment of $20 million in disgorgement.  SEC v. Scientific-Atlanta, (S.D.N.Y. June 22, 2006). 

Ronald Ferguson and four other former senior executives of General Re for aiding and abetting AIG in improperly inflating its loss reserves by almost $500 million.  The case is pending as are parallel criminal charges. SEC v. Ronald Ferguson, et al., (S.D.N.Y. Feb. 2, 2006), 

Gary Bell and twelve other employees and agents of vendors to U.S. Food Services, a subsidiary of Royal Ahold, for executing false audit confirmation.   Several defendants agreed to settle for consent decrees and fines, while others are litigating with the SEC.  SEC v. Gary Bell, et al., (D.D.C. Jan 18, 2007),

All of this suggests that issuers should carefully monitor agreements and other arrangements entered into with other companies.  In conducting that due diligence it is important to follow up.  One of the “red flags” missed by Motorola is the fact that it requested a letter of assurance from Adelphia stating that the arrangement complied with all applicable laws and regulations, but the company never received one and failed to follow up on the request.

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