by T. GormanPosted on Posted in SECActions

The Report by the Senate Finance Committee titled “The Firing of an SEC Attorney and the Investigation of Pequot Capital Management” is less than kind to the SEC and its Enforcement Division.  By all accounts, this is well deserved.  As the conclusion to the report notes:  “The investigation of Pequot Capital Management could have been an ideal opportunity for the SEC to develop expertise and visibility into the operations of a major hedge fund while deterring institutional insider trading and market manipulation through vigorous enforcement.  Instead, the SEC squandered this opportunity through a series of missteps … .”  Id. at 46. 

Regardless of the reasons, the Enforcement Staff dropped the ball on a major investigation.  The Office of the Inspector General, which conducted an internal investigation to determine what happened, did even worse.  No doubt any corporate counsel that came to the Enforcement Staff with an internal investigation of an issuer that had the difficulties of the SEC’s Pequot inquiry or that of the OIG would have received very rough treatment.  By its own standards, the Enforcement Staff deserved the same. 

The Pequot inquiry is past.  What remains are the detailed recommendations by the Senate Finance Committee for improving the Enforcement Staff.  These include standardizing investigative procedures, reallocating resources to significant and complex matters and other internal procedures designed to ensure that improper influences do not alter the course of enforcement inquiries.  As the SEC and its Enforcement Staff assess how to implement the recommendations in the Report, a key question of importance to many issuers, executives and market professionals is whether this will result in a renewed emphasis on insider trading.  After all, the Pequot inquiry was an insider trading investigation into a major hedge fund.  One result of all this could be marshalling of resources and a new emphasis on insider trading, hedge funds and market professionals. 

Last time Congress questioned the SEC about insider trading, within weeks the agency responded with a series of significant insider trading cases.  Last September for example, Congress held hearings on insider trading (see post of Sept. 27, 2006).  By early this year the SEC was bringing some of the most significant insider trading cases it had brought in years.  Coincidence?  Perhaps.  But then consider the fact that as those cases were being brought Enforcement Chief Linda Thomson noted that the once safe harbor of Rule 10b-5-1 plans used by many corporate executives might not be so safe.  The Enforcement Staff is scrutinizing the plans and the trading under them based on an academic study which suggested they were being abused.  This is, of course, precisely how the current option backdating scandal started. 

If past history is any indication, one immediate result of the Pequot debacle may be a new emphasis by the Enforcement Staff on insider trading.  A logical first target is hedge funds and other market professionals.  Next up, however, may well be corporate executives trading under the once safe harbor of a Rule 10b-5-1 plan and others with access to inside information.  This suggests that market professionals as well as corporate directors and officers should carefully examine compliance plans before trading to avoid what may well be intense scrutiny in a renewed insider trading program.  After all, the best defense is a good offense.  If the SEC did poorly in defending its investigation into insider trading at Pequot, a string of successes in insider trading investigations would be just the thing to deflect congressional critics. 

by T. GormanPosted on Posted in SECActions

Significant events last week in SEC securities litigation focused on the resolution of an old case and continued silence from the SEC on Stoneridge. 

First, the old case.  

On August 15, 2007, the SEC finally settled with former McKesson Corp. executive, Michael G. Smeraski.  Mr. Smeraski, a one time McKesson senior sales vice president, was alleged to have acted together with other senior executives and participated in a long-running financial fraud at the company.  The settlement came with a consent to a statutory injunction, baring future violations of the antifraud provisions, and an agreement to pay a civil penalty of $50,000.  While the underlying conduct here took place in 1999, this was not a case where the SEC dallied in filing suit.  Indeed, its complaint was filed in September 2001.   However, it took another six years to get the settlement, meaning that it was eight years after the events at issue before the case finally ended.  One can only wonder what took so long.  SEC v. Smeraski, Case No. C-01-3651 MJJ (N.D. Cal.).  The SEC’s Litigation Release is available at www.sec.gov/litigation/litreleases/2007/lr/20243.htm.   

The most significant event in securities litigation last week took place – or perhaps did not take place – in Stoneridge Inv. Partners, LLC. v. Scientific-Atlanta, Inc. and Motorola, Inc., No. 06-43, the case pending before the Supreme Court which will be argued in early October.  As discussed previously in this blog, Stoneridge is perhaps the most significant case to come before the Court in years concerning the construction of the antifraud provisions of the federal securities laws and private damage actions.  The question to be decided is the scope of liability under antifraud provision Section 10(b) and Rule 10b-5 thereunder – that is, whether there is “scheme liability.”  Stated differently, the question is who can be held liable under this catch-all antifraud provision if an issuer engaged in fraudulent conduct:  auditors, attorneys, vendors or others?  The resolution of this case can have an impact on the potential liability of all who deal with public companies. 

Last week, the U.S. government filed its amicus brief.  The Solicitor General sided with the defendant third party vendors and against the shareholder plaintiffs.  This is a significant filing since it eschews the usual SEC position, which typically argues that private damage actions by shareholders are a necessary supplement to its enforcement program.  The brief does, at points, attempt to harmonize the positions advocated with those previously taken by the SEC on scheme liability. 

Two groups of former SEC Commissions also filed briefs.  Former Chairman Donaldson and Levitt joined with former commissioner Goldschmid in arguing in support of the petitioners.  In contrast former Chairmen Hills, Williams and Pitt joined with former Commissioners Cox, Fleischman, Friedman, Grundfest, Hunt, Karmel, Lochner, Peters, Roberts, Unger and Wallman, arguing in favor of the respondent defendants.  In addition, Representatives John Conyers, Jr. and Barney Frank filed a brief in support of petitioners. 

In sum, what the Court and the public have is views from the parties, the government, two congressmen, a number of former SEC Commissioners and a host of interested persons.  What the Court does not have is the views of the SEC, the agency charged by Congress with administering the statutes.  Yet, it has been widely reported that the SEC wants to file a brief in support of petitioners.  In the past, when the SEC’s views did not comport with those of the Solicitor General, the agency filed a separate brief.  As I have written in the past, regardless of whether one agrees with the view the SEC would espouse, on this most important issue, the Court, the parties and the public should have the benefit of the Commission’s view.  Stifling argument is no way to argue a court case.