by T. GormanPosted on Posted in SECActions

The SEC Enforcement Staff has been back in the archives again.  Last week, they dusted off another accounting fraud from 1999 and charged IBM employee Kevin Collins with assisting Dollar General in cooking the books.  As a result, a settled civil injunctive action containing the usual remedies was filed, as well as a related administrative proceeding.  Perhaps the markets are now safe since the SEC has dug back in history and obtained orders precluding future violations of the federal securities laws by Mr. Collins based on the ancient conduct alleged in the enforcement proceedings.  The SEC’s Litigation Release on this matter can be viewed at http://www.sec.gov/litigation/litreleases/2007/lr20166.htm. 

This is not the first time comments have been made in this space questioning whether the current enforcement staff should be reassigned to the SEC historical society.  A post on March 28, 2007 raised the same question when the SEC filed two settled cases focused in 1999, 2000 and 2001.  That post also recounted the fact that earlier this year, one District Court had refused to enter the statutory injunction the SEC sought viewing it as punitive time barred since the five year statute of limitations had expired, while another Court dismissed a Commission enforcement action seeking an injunctive relief for want of prosecution (the case had been brought after the statute of limitation for penalties had run).  

Despite these court rulings the Collins case filed last week demonstrates the apparent resolve of the SEC and its enforcement staff to continue bringing years old enforcement cases.  For what reason?  The SEC is supposed to police the capital markets and keep them safe for all.  The remedies given to the SEC by Congress reflect this serious mission.  Those remedies are largely equitable and remedial.  Their focus is on halting on-going conduct and preventing future violations.  SEC enforcement actions – save perhaps the current debate over financial penalties which will be the subject of another post – has never been about punishment or being punitive.  It has always been about being remedial and ensuring the integrity of the markets for the future.  

Bringing years-old enforcement actions, however, has little to do with the mission of the SEC or its traditional remedies.  Demanding a statutory injunction against future violations based on events that took place eight years ago has little, if anything, to do with preventing future violations.  It is difficult at best to claim such a demand is remedial.  The market reaction to the filing of this action reflects this fact – it had no discernable impact on the share price of IBM or Dollar General.  The reason – no investor was made to feel more safe from this action.  

Rather, Judge Casey in SEC v. Jones, No. 07 Civ 7044 (S.D.N.Y Feb. 26, 2007) was right when he held that a request for a statutory injunction under circumstances similar to those in the Collins case was not remedial, but punitive, and thus subject to the statute of limitations.  To ensure that the SEC focuses on policing the markets rather that shuffling through the archives, it is time to for Congress to pass a statute of limitations setting a time limit within which the SEC must bring an action or be time barred.  At the same time, perhaps more Courts will follow the lead of Judge Casey and start denying injunctions where no remedial purpose can be served by entering such an order other than to permit the SEC to claim what is surly a hollow victory that does little to implement its important statutory mandate. 

by T. GormanPosted on Posted in SECActions

A second test for determining who is a primary violator began with a decision of the Tenth Circuit Court of Appeals and evolved through subsequent decisions by the Second, Fifth and Eleventh Circuits. In its 1996 decision in Anixter v. Home-Stake Prod. Co., 77 F.3d 1215 (10th Cir. 1996), the Tenth Circuit rejected the holding of In re Software Toolworks, Inc., 50 F.3d 615 (9th Cir. 1994) as mere aiding and abetting.  The case involved a securities law suit against an auditor who had issued false opinions regarding a failed ponzi scheme.  After reviewing the allegations, the Court noted that “the critical element separating primary from aiding and abetting … [is] a representation … by the defendant, that is relied upon … .”  The speaker – here, the auditor – need not communicate the statement himself.  It is sufficient, the Court stated, if the auditor knew or should have know that the representation would be communicated to shareholders.  The Court noted that this test provides more guidance than the “substantial participation” or other similar tests.  

The next year the Second Circuit decided the first of two cases following the Anixter approach.  First, in Shapiro v. Cantor, 123 F.3d 717 (2nd Cir. 1997), the Court reviewed the sufficiency of securities fraud claims against the auditors of a failed video chain.  Plaintiffs contended that the auditors failed to disclose a prior felony conviction of the chain owner and that financial projections prepared by the firm were circulated in offering memos.  The Court rejected the claims as insufficient.  As to the conviction, the Court held that the auditors had no duty to disclose.  As to the financial projections, the court noted that preparing such materials is “consistent with the role of an accountant.”  

Second, in Wright v. Ernst & Young, 152 F.3d 169 (2nd Cir. 1998), the Court followed Anixter in rejecting Software Toolworks, while noting that in Shapiro it had followed what now known as the “bright line” test.  Here, the Court rejected claims that an auditor orally approved release of financial data and results included in a press release which stated that the data was not audited.  The Court held that “if Central Bank is to have any real meaning, a defendant must actually make a false or misleading statement … .”  In a second key portion of its opinion, the Court held that “[a] secondary actor cannot incur primary liability … for a statement not attributed to that actor at the time of its dissemination.”  

The Eleventh Circuit followed the same approach in Ziemba v. Cascade Int’l. Inc., 256 F.3d 1194 (2001).  There, the complaint alleged securities fraud claims against a company and its auditors and law firm.  The law firm, the complaint claimed, participated in drafting false letters and press releases later issued by the company.  The auditors were alleged to have given incorrect advice on consolidating subsidiaries of the company and failed to have issued a “going concern” limitation as to a sub.  The Court rejected the claims and, after reviewing the split in the Circuits, elected to follow Wright.  A “misstatement or omission upon which a plaintiff relied must have been publicly attributed to the defendant” at the time of the investment decision, the court held.  Here, the law firm did not make a misstatement because it had no duty to speak.  The auditors did not make a misstatement because no opinion was ever disseminated to investors. 

Finally, the Fifth Circuit also adopted this position in the Enron litigation, Regents of the Univ. of Cal. v. Credit Suisse First Bank (USA), Inc., 482 F.3d 372 (5th Cir. 2007).  A petition for certiorari is pending in this case.  Thus, the case may be heard with Stoneridge. 

In Credit Suisse a securities fraud complaint was brought against a group of banks who were claimed to have assisted Enron in falsifying its financial statements.  Essentially, the banks entered into business arrangements that permitted Enron to either improperly book revenue or keep liabilities off its books according to plaintiffs.  The complaint claims that each bank knew Enron was engaged in long-term financial fraud.  

The District Court adopted a position on scheme liability advocated by the SEC and refused to dismiss the complaint.  Subsequently the District Court certified the class. 

The Circuit Court, reviewing the case on an appeal of the certification ruling, reversed.  The Fifth Circuit held that the banks had not made a misrepresentation because they had no duty to Enron’s shareholders to disclose.  While Enron committed fraud the banks were, at most, aiders and abettors.  The Court went on to note that it is inappropriate to impose liability for securities fraud on one party to a business deal.  

Next:  Scheme liability