Well, it depends.  In December, we noted that the SEC had “not made a decision” concerning such cases, according to senior members of the enforcement staff.  This is not surprising, given the difficult nature of the issue.  For example, in July 2006, SEC Commissioner Paul Atkins commented in a speech before the International Corporate Governance Network, that spring-loading stock options (i.e., choosing an option’s grant date and exercise price at a time shortly before the release of positive corporate news; or in the case of negative news, “bullet-dodging”) does not fall within the parameters of insider trading.  “Boards, in the exercise of their business judgment, should use all the information that they have at hand to make option-grant decisions,” Mr. Atkins said. “An insider-trading theory falls flat in this context, where there is no counterparty who could be harmed by an options grant. The counterparty here is the corporation — and thus the shareholders.”  Mr. Atkins even went so far to comment that spring-loading options is an efficient low-cost way to compensate executives.  The SEC’s Office of the Chief Accountant recently noted that spring-loading is not an accounting issue, but is a disclosure issue.  While in some senses this may not seem fair, insider trading is not based on fairness or parity of information.  Rather, it is based on an abuse of position in the form of a breach of duty or a misappropriation, it would seem difficult, at best, to sustain a claim of insider trading where the company approves the option grant to take advantage of a news event.  As Mr. Floyd Norris noted in his October 6, 2006, NYT article “They Deceived Shareholders. Who Cares?,” various professors and former SEC staff believe that the SEC will have a tough time bringing such a case.  

Supporters of an insider trading theory, however, point to cases where executives were granted or exercised options when the board was unaware of the pending positive or negative corporate news.  More than 40 years ago, executives at Texas Gulf Sulphur, aware of a significant mineral discovery, bought stock and options and accepted company options while they, and not the authorizing board, were aware of the discovery.  The Second Circuit held that the executives’ conduct was illegal. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968).  Recently, the SEC settled a two-year old case where an executive, David Willey, who was the only person in the corporation who knew the Federal Review Board was going to downgrade the company, used the information to trade stock and exercise his options.  http://www.sec.gov/litigation/litreleases/2006/lr19918.htm

These cases are distinguishable from those where the Boards of Directors knew about the company information or ratified the option grants thereafter.  Where is the misappropriation or breach of fiduciary duty when both sides of the stock transaction, the Board and the executive, have the same material information?  While the SEC may be investigating instances of spring-loading or bullet-dodging, it will be interesting to see what type of cases it elects to bring.  It could elect to litigate the issue by bringing a case where the entire board was aware of the information.  On the other hand, it may elect to seek a case where there are other more clear cut securities law violations and add in the spring-loading/bullet-dodging theory.  Based on past history, the latter seems more probable.

This week the SEC announced more enforcement actions and settlements in its action involving Royal Ahold (Koninklijke Ahold N.V.) and its subsidiary, U.S. Foodservice. http://sec.gov/litigation/litreleases/2007/lr19975.htm.  Thirteen additional individuals were charged in the massive financial fraud and several agreed to settle for consent decrees and fines, while others are litigating with the SEC.  These actions bring the total number of individuals charged by the SEC in this fraud to 30 along with the company.   The complaints in these actions all focus on a massive financial fraud at U.S. Foodservice to ensure that the reported earnings were equal to or greater than targeted regardless of the company’s true performance.  In essence, the scheme involved U.S. Foodservice personnel contacting vendors and securing false audit confirmation letters.  In some instances the vendors were simply urged to falsify confirmations while in others they were coerced.  The confirmation letters provided that they were for the outside auditors.  Defendants in the various actions included the senior management of the company, including the CEO, CFO, and an executive vice president, and several others.  In some instances, the vendors who participated in the scheme engaged in insider trading.  Generally, individuals who settled agreed to the entry of a consent decree enjoining them from future violations of the antifraud provisions.  Officers agreed to an officer director bar and, in many instances, fines.  

What is interesting about the case is not the claims themselves, but the settlement with the company and the statements of the SEC about cooperation.  These recent settlements make clear that this case involved a massive fraud which pervaded senior management of the company and implicated many others.  The company settled in October 2004 by agreeing to the entry of a consent decree and statutory injunctions prohibiting future violations of the antifraud and books and records provisions of the securities laws.  http://sec.gov/litigation/litreleases/lr18929.htm.  The SEC did not seek a fine for several reasons, including that criminal prosecutors investigating the case in The Netherlands requested them not to seek fines to avoid potential double jeopardy issues.  In September 2006, the DOJ entered into a non-prosecution agreement with the company.  http://www.corporatecrimereporter.com/documents/ahold.pdf 

At the time of settlement, the SEC cited Ahold’s extensive cooperation.  That cooperation included:  1) self-reporting; 2) an extensive internal investigation; 3) voluntarily expanding the investigation to cover a number of other areas; 4) promptly providing the staff with the internal investigation reports and the supporting information; 5) waiving the attorney-client privilege and work product protection with respect to the internal investigations; 6) making its current personnel available for interviews or testimony; 7) significantly assisting the staff in arranging interviews or testimony from former personnel in the U.S. and abroad; and 8) promptly taking remedial steps, including revising internal controls and terminating employees responsible for the wrongdoing.  According to the Release it is clear that Ahold took every imaginable step to be cooperative.

Contrast this case with the example of cooperation in the Seaboard Release.  There, a relatively isolated fraud took place in a subsidiary.  The SEC cited the cooperation of the company as the basis for its decision not to prosecute the organization and pointed to the actions of the company as an example of cooperation in the Release.  That cooperation consisted of 1) self-reporting; 2) promptly notifying the SEC; 3) conducting a complete internal investigation; 4) making the investigation report available to the staff; 5) not asserting privilege; and 6) terminating those responsible. 

Comparing the facts and the results in the two cases is instructive in assessing the definition of cooperation under Seaboard and its impact on the SEC’s prosecutorial judgment.  Ahold is, by all accounts, a massive fraud.  With thirty individuals named, the SEC’s investigation is still on-going.  The fraud involved the entire top of the company and included a former audit committee member.  Nevertheless, once discovered by the company, every possible action was taken to cooperate with the SEC beginning with self-reporting and including privilege waivers.  Ahold, however, was required to settle for a full statutory injunction that included fraud claims.  Penalties were not imposed because of the requests of Dutch prosecutors, although the SEC also noted that it considered the cooperation of the company in reaching that decision.  In contrast, Seaboard was an isolated fraud where cooperation yielded no prosecution based on essentially the same steps taken by Ahold.  In both cases, the companies waived the attorney client privilege.  The difference seems to be that pervasive fraud equals at least an enforcement action and maybe penalties (absent a request from the criminal prosecutors) while an isolated fraud does not.  In either case, however, privilege waivers seem necessary.