Significant Policy Statements
Two significant policy issues impacted the SEC’s Enforcement Program in 2006, two of which should be followed closely in 2007.  First, in January 2006, the SEC issued its Statement on Financial Penalties for Corporations,  SEC Press Rel. No. 2006-4,  For the first time the SEC articulated the points it considers in assessing penalties against issuers.  According to the Statement, the two key factors  are:  1) the presence or absence of a benefit to the corporation, and 2) the degree to which the penalty will recompense or harm the shareholders.  Other factors include deterrence, level of injury to innocent parties, pervasiveness of the violation, the level of intent and the difficulty of detection.     

Second, the SEC issued its Standards for issuing subpoenas to reporters,  The SEC issued this statement shortly after SEC Chairman Cox withdrew subpoenas issued to news organizations as part of an on-going enforcement investigation.  According to some news reports, at least one of the subpoenas had been approved by SEC Enforcement Chief Linda Thomsen.  Under the Release, before issuing investigative subpoenas to reporters or news organizations the enforcement staff is required to essentially follow a “meet and confer” type procedure, discussing the need for and scope of a potential subpoena with counsel for the new organization and/or reporter.  Any subpoena issued under the Release needs to be approved by the Director of the Division of Enforcement. 

These two statements are significant steps for the SEC.  Both represent the agency’s efforts to provide guidance and explanations about its enforcement activities.  Clearly, the statement on penalties has more day to day impact for companies.
 Despite the apparent guidance offered by the Statement on Penalties, however, its application remains elusive – particularly when considered in conjunction with the SEC’s 2001 Seaboard Release concerning cooperation.  Consider three examples:

SEC v. Tyco International (S.D.N.Y. April 17, 2006),  Here, the defendant consented to a $50 million civil penalty in what was alleged to be a $1 billion accounting scandal. 

SEC v. Fed. Nat. Mortg., (D.D.C. May 22, 2006),  In this case the defendant entered into a consent decree under which it was ordered to pay a $400 million penalty in what the complaint claimed was an $11 billion accounting scandal.  The SEC’s release did note that the defendant cooperated with its investigation. 

SEC v. AIG (S.D. N.Y. Feb. 9. 2006),  In this case AIG agreed to a consent decree under which it was ordered to pay a penalty of $100 million in a case which was claimed to involve a $700 million accounting fraud.  Again cooperation was noted. 

None of the releases explained how the factors cited in the Statement on Penalties were applied.  Although two of the cases cite to cooperation, there is no explanation of how that impacted the settlement.  While the focus of the Statement on Penalties on benefit to the company might suggest that issuers consider bringing an economist to the settlement table to evaluate any claimed benefit, the Releases concerning each case does not give any indication of how the penalty imposed relates to the factors in the policy statement. 

Similarly, a review of the Enforcement Program does nothing to alleviate criticisms of the manner in which the agency is imposing fines.  For example, the U.S. Chamber of Commerce Report on the SEC’s Enforcement Program claims that the agency’s use of financial penalties is inconsistent with the intent of congress.  Congress gave the SEC the authority to inflict financial penalties in the 1990 amendments to the securities laws, known as the Remedies Act.  According to the legislative reports, penalties were not suppose to be inflicted routinely.  Yet a review of the SEC’s Enforcement releases demonstrates that financial penalties are routinely demanded, a point consistent with recent statements by the enforcement staff. 

Furthermore, the references to cooperation in the two examples cited above only muddy the waters.  Cooperation is a sensitive topic because many charge that the current SEC cooperation standards under the Seaboard Report (similar to DOJ’s Thompson and McNulty memos) have contributed significantly to the current “culture of waiver,” where issuers are forced to waive important rights, such as the attorney-client privilege, in order to be viewed as cooperative and try and avoid prosecution.  In the cases cited above, which are typical, there is no explanation of how cooperation impacted in the determination of the penalty.  Supposedly two key SEC policy statements are interacting in the AIG and Federal National Mortgage cases to impact the outcome, but there is no explanation.  Neither Release discusses how the factors cited in the Statement on Penalties are considered.  Neither Release discusses the manner in which cooperation impacted the settlement. 

At the same time the SEC staff has defended Seaboard and the use of penalties.  There is no indication at the moment that the SEC will reconsider Seaboard despite the criticism of the standards and a recent letter to Chairman Cox from the ABA  proposing revisions although SEC Commissioner Cox has called for a review of the Release.  The staff has  stated repeatedly that it will continue to seek penalties as in the past.  In view of the criticism of both policies, as the enforcement program moves forward it would seem appropriate for a further clarification of the use of penalties and a revision of Seaboard to eliminate the culture of waiver.
Next:  Key issues in SEC investigations.

Today we begin a series of posts reviewing 2007 SEC Enforcement trends. will periodically post this series over the next several weeks.  It will analyze the following key points: 1) An overview of the enforcement program; 2) New enforcement policy initiatives; 3) Key developments regarding investigations; 4) Significant cases in 2006; and 7) Trends and key issues for 2007.  

Enforcement Program Overview

During 2006 the number of SEC enforcement cases fell by about 9%.  Some sources have attributed this to budget restrictions.  Enforcement Chief Linda Thomsen, however, noted at a recent ABA program that the reduced number of cases was not significant.  Rather, Ms. Thomsen said that she had reviewed statistics over a number of years and that some years they go up and some years they go down.  

As in earlier years, the Enforcement Program had its critics.  In March 2006, the U.S. Chamber of Commerce published a report that reviewed the Program.  The report criticized the Enforcement Program for recent litigation set backs, attempts to shift standards of liability, misuse of penalties, and characterized it as having an increasingly harsh tone. 

The SEC of course does not agree with the findings of the report.  For example, at recent programs, such as SEC Speaks, the staff has noted that in fiscal 2006 they had a perfect 10-0 win record in district court.  No doubt, there were some significant court victories.  Those included:

SEC v. Yuen (C.D. Ca. May 8, 2006) ( in which the former Chairman and CEO of Gemstar-TV Guide was found liable and enjoined, ordered to pay over $22.3 million in disgorgement, penalties and interest and barred from being an officer or director;

SEC v. Treadway (S.D.N.Y. Oct. 26, 2006) ( in which a jury found Mr. Treadway liable for securities fraud stemming from an undisclosed market timing scheme. Subsequently, Mr. Treadway consented to a statutory injunction and an order directing the payment of $572,000 as disgorgement, interest and penalties; and

SEC v. Snyder (S.D. Tex. Feb. 1, 2006) ( in which the former CFO of Waste Management was found liable for insider trading and financial fraud and ordered to pay over $2 million in disgorgement, prejudgment interest and penalties. 

There were, however, losses prior to verdict or in administrative actions.  Those included:

SEC v. Todd (S.D.Ca. May 30, 2006) in which summary judgment was granted in favor of former Gateway executive Weitzen in a fraudulent earnings case;

SEC v. Talbot (C.D. Col. Feb. 14, 2006) in which insider trading claims were dismissed finding no duty of confidentiality against a Fidelity National director who traded in the shares of Lending Tree after he learned through Fidelity, which owned a stake in Lending Tree, of take over talks concerning Lending Tree; and

In the Matter of Flynn (Adm. Proc., Aug 2, 2006) where an ALJ dismissed aiding and abetting claims against former CIBC director Paul Flynn that claimed he aided a late-trading and market timing scheme.  This action followed the dismissal of criminal charges by former NY AG Eliot Spitzer against Mr. Flynn for the same conduct.

While we have not totaled all of the SEC’s wins and losses, the SEC can, in fact, cite to ten district court wins in fiscal 2006.  At the same time, the SEC does not have a perfect track record when the totality of its results are considered.  As the examples cited above suggest, the SEC did lose significant cases in district court on pre-trial motions.  Other losses came in administrative proceedings.  It is clear that the SEC is willing to litigate, even when the factual and legal theories are difficult, as in Talbot and Flynn.  Likewise, despite the 9% reduction in cases, the overall Enforcement Program seems alive, well, and aggressive.