Cooperation Credit For Prohibiting Future Violations

The SEC has long encouraged issuers to self-report, remediate and cooperate with its investigations. In return, the Commission offers the prospect of cooperation credit, that is, a sanction which is less than that which might otherwise have been imposed. Just what constitutes cooperation to yield cooperation credit in any given case is often difficult to determine. The Commission discusses the concept in its 2001 Seaboard Release, as does DOJ in its McNulty memo and the U.S. Sentencing Commission in its Guidelines. The Commission also acknowledges cooperation in its litigation and press releases. Yet, what constitutes cooperation and its impact on a case is, at best, difficult to determine and often leaves issuers to guess as to how best to obtain it.

A settled administrative proceeding filed on Tuesday, along with two earlier similar actions, sheds some light on this issue. In the Matter of First Southwest Company, Adm. Proc. File No. 3-13046 (May 27, 2008) (“First Southwest”); In the Matter of Citigroup Global Markets, Inc., successor by merger to Legg Mason Wood Walker, Inc., Adm. Pro. File No. 3-12629 (May 7, 2007) (“Legg Mason”); In the Matter of Bear, Stearns & Co., Inc., et. al., Adm. Proc. File No. 3-12310 (May 31, 2006). Each case involves the auction rates securities market. Each alleges improper conduct. In each, the Commission states that cooperation credit. In each the Commission states that it encourages firms to provide comprehensive information to the staff in industry wide investigations.

The settlements in each case can be summarized as follows:

1) First Southwest

a. The conduct: (i) Intervention in the market without adequate disclosure to prevent auctions from failing; and (ii) submitting bids to prevent the all-holder rate without adequate disclosure.

b. The sanction: (i) a censure; (ii) a C&D based on Section 17(a)(2); and (iii) a penalty of $150,000.

c. Cooperation credit: The company (i) cooperated; (ii) had a small market share; but (iii) “did not report to the Commission the practices” which are alleged to constitute violations.

2) Legg Mason

a. The conduct: Intervened in the market to prevent failed auctions without adequate disclosure.

b. The sanction: (i) a censure; (ii) a C&D based on Section 17(a)(2); and (iii) a penalty of $200,000.

c. Cooperation credit: The company (i) cooperated; (ii) had a small market share; but (iii) “reported the practices … [alleged to be violations] later than the broker-dealers in the …” [Bear Stearns settlement]

3) Bear Stearns – included 14 major firms as respondents.

a. The conduct: Each of the firms engaged in one or more of the following practices according to the Order for Proceedings (which describes each in detail): (i) completion of open or market bids: (ii) intervention in auctions; (iii) prioritization of bids; (iv) the submission or revision of bids after deadlines; (v) allocation of securities; (vi) partial orders; (vii) express or tacit understandings to provide higher returns; and (viii) price talk.

b. The sanction: Each firm agreed to the following: (i) censure; (ii) C&D based on Section 17(a)(2); and (iii) a financial penalty based on market share. Those with the largest market share consented to a $1.5 million penalty while those with a small market share consented to a $125,000 penalty.

c. Cooperation credit: According to the Commission all Respondents cooperated and voluntarily disclosed the practices they engaged in to the staff “upon the staff’s request for information.” The size of the penalties reflected investor harm and cooperation in the investigation which “mitigated the serious and widespread nature of the violative conduct. Banc of America received a penalty of $750,000 despite having a large market share because “of the quality of its self-monitoring capabilities in the auction rate securities area that it demonstrated to the Commission staff.”

Any discussion of cooperation credit begins with self-reporting. None of the firms in these cases self-reported. Yet, all were deemed cooperative by the SEC Overall, there were two key points to the cooperation: (1) acknowledging the wrongful conduct for all the firms except Southwest; and (2) cooperating with the staff’s inquiry.

The differentiating factors however, appear to have been market share and the prevention of repetition in the future. The largest fines were levied on those with the largest market share. This seems consistent with the potential investor impact of the harmful conduct.

Potential investor harm is also critical to what appears to have been the key cooperation credit factor in these cases – mitigation of possible future repetition. By demonstrating that it could “self-monitor,” presumably Banc of America demonstrated that the potential for violations in the future and thus additional investor harm is minimal. Tying cooperation credit to this factor is consistent with the Commission’s statutory mandate as reflected in it primary remedy – an injunction to prohibit future violations. Those looking for cooperation credit in the future would do well to carefully consider these cases.

Insider Trading Here And Around the Globe

A key focus of the SEC in recently is insider trading – a fact evidenced by even a quick review of the cases the agency has been filing in the past few months. The SEC, however, is not the only regulator focused on insider trading. A look around the globe suggests that regulators everywhere are struggling with the problem.

? This month, the Ontario Securities Commission began its latest insider trading prosecution. Barry Landen, formerly an executive of Agnico-Eagle, is accused of trading in advance of the release by his company of poor financial results. According to the Commission, Mr. Landen avoided a loss of about $100,000.

? In Trinidad, the government is moving forward with legislation to increase the penalties for insider trading to as much as TT$2 million or US$321,151. Under proposed legislation, corporate traders found guilty will be punished with a minimum fine equal to the profit made or the loss avoided and a maximum fine equal to the greater of double the profit made or loss avoided and a term of imprisonment up to six years. The head of the Securities and Exchange Commission Osborne Nurse noted that existing legislation in the area needs to be amended because it implies that certain kinds of insider trading are lawful.

? In Ireland, regulators are struggling with a difficulty that the U.S. SEC solved a few years back – trading in possession vs. using inside information. The Fyffes case has raised this issue. There, the Irish High Court concluded that Mr. Fyffes was not guilty of insider trading because, while he possessed inside information, he did not use it in the trading. This conclusion appears to be based on the 1990 Companies Act which prohibits taking advantage of inside information.

? In Islamabad, Pakistan the Securities and Exchange Commission has enhanced the penalty for insider trading. The new Securities Act also gives the Commission greatly enhanced powers. For example, under the Act, an authorized person may forcibly enter the premise of a licensed person to review and inspect records. The Act also contains new provisions regarding insider trading and market manipulation.

? In Japan, the Japan Securities Dealers is setting up a data base that covers the employees and executives of brokerage houses as part of a crack down on insider trading. This data base will be in addition to one covering executives of listed companies which is due to be completed next May. The data bases will permit the association to closely monitor trading by registered persons and executives.

? In Australia, survey of business executives has concluded that the securities regulator there focuses on easy targets. Likewise, many executives surveyed suggested that the market regulator had the wrong priorities. As a result the survey notes there is a lack of confidence in the integrity of he markets.

This brief survey clearly suggests that the U.S. SEC is not alone in its concerns about insider trading. At the same time, the surveys in Australia suggest that a good “cop on the beat” is essential to healthy markets.