Part VII: How Corporate Officials Can Get A Good Night’s Sleep Despite Current SEC Enforcement Trends

This is the seventh in a series discussing new trends in SEC enforcement which impact corporate directors and officers and steps that can be taken to avoid future liability.

The continued criminalization of securities enforcement

Attorney General Eric Holder, in recent remarks, stressed that the government will use the “full range of parallel criminal and civil enforcement resources to combat financial fraud.” The point is efficiencies for the government. By brining together the resources of various agencies to consider a situation, enforcement officials have the benefit of added expertise and efficiency.

Parallel civil and criminal proceedings can also be beneficial for potential defendants. By having multiple agencies consider the situation at the same time the defendant has the opportunity to obtain a global resolution of a situation rather than what otherwise be fragmented approach.

The focus on parallel proceedings has spawned a number of interagency task forces. Those range from the President’s Financial Fraud Task Force to more regional models such as the Virginia Tasks Force and the Southern District of Florida Securities and Investment Initiative. The President’s Task Force is made up of a veritable alphabet soup of federal agencies, including the DOJ and the SEC. The Virginia Task Force is composed of the U.S. Attorney’s Office for the Eastern District of Virginia, the SEC and Virginia state officials while the South Florida Group includes the U.S. Attorney’s Office for that district and the SEC.

Whatever their composition, these task forces are binging together law enforcement officials in ways which while beneficial in some respects has a significant potential for overreaching. This trend toward closer cooperation contrasts sharply with the earlier approach. There the SEC would bring actions and later, if appropriate, formally refer the matter to the Department of Justice or the local U.S. Attorney’s Office for consideration. Under these circumstances the SEC would develop the law through civil enforcement. Only the more egregious cases were referred for consideration by the criminal authorities who were often reluctant to take on the burdens of a complex securities prosecution as a criminal case. Few SEC investigations had a criminal analog under this model.

Under the task force approach, however, the DOJ, the SEC and a host of others share information as it is being developed. Now 50% to perhaps as many as 60% of SEC investigations have a criminal component. This can result in a bluring of the line between civil and criminal enforcement at a time when the courts have all but made it impossible to distinguish key elements differentiating civil and criminal violations. See, e.g., U.S. v. Kaiser, No. 07-2365-cr, 2010 WL 2607140 at * 11 (2nd Cir. July 1, 2010)(defining willfulness); U.S. v. Tarallo, 380 F. 3d 11174, 1188 (9th Cir. 2004)(same); U.S. v. King, 351 F. 3d 859, 866 (8th Cir. 2004)(deliberate ignorance); Sustrand Corp. v. Sun Chem Corp., 553 F. 3d 1033, 1045 (7th Cir. 1977)(defining sscienter in a civil securities fraud suit).

This approach also has the prospect for overreaching, a point illustrated in the option backdating cases. Prior to the joint announcement by the U.S. Attorney’s Office for the Northern District of California and the SEC that each was brining an option backdating action, the law regarding the practice was largely undeveloped. The SEC had not brought enforcement actions focused on the issue. Rather, business journal publications and a series of Wall Street Journal articles spawned a civil SEC enforcement action and a criminal case charging corporate officials with violations of the law that could end in long prison terms simultaneously.

The prospect for overreach in these cases is best illustrated by the cases involving officials from California based Broadcom Corporation. There parallel criminal and civil actions were brought by the U.S. Attorney and the SEC. The criminal cases charged company co-founders Henry Samueli and Henry Nicholas as well as its former president William Rhuel. U.S. v. Samueli, Case No. 10-500024 (C.D. Cal.); U.S. v. Nicholas, Case No. 10-50005 (C.D. Cal.). Mr. Samueli pleaded guilty to obstruction and was awaiting sentencing prior to the trial of Mr. Nicholas.

When Mr. Nicholas’ trial commenced, the defense sought to call Mr. Samueli to testify. The government refused to offer him immunity. After the court granted Mr. Samueli immunity he testify for two days. Following that testimony the court concluded that there was no basis for Mr. Samueli’s guilty plea to obstruction and ordered it vacated.

Eventually the court dismissed all of the criminal charges based on prosecutorial misconduct.

The use of parallel proceedings is not the only cause of overreaching. While at one time criminal authorities were reluctant to bring charges in complex business actions because of the difficulty of proof, there is an increasing trend to criminalize such conduct. This aggressive trend also lends itself to overreaching. The prosecution of Prabhat Goyal, CFO of McAfee from 1997 through 2001, is a good illustration. Mr. Goyal was indicted and convicted of financial fraud.

The case centered on revenue recognition polices. The company adopted one policy which helped it make its quarterly numbers. The DOJ argued for an alternative treatment. Although the jury convicted Mr. Goyal, the Ninth Circuit Court of Appeals, in an unusual ruling, revered concluding that there was insufficient evidence to sustain the charges and support a conviction.

Chief Judge Kozinski concurred in the result penned what should be a cautionary note to the use of criminal charges:

this case has consumed an inordinate amount of taxpayer

resources, and has no doubt devastated the defendant’s personal

and professional life. . . . in the end, the government couldn’t

prove that the defendant engaged in any criminal conduct . . .

This is not the way criminal law is supposed to work. Civil law

often covers conduct that falls in a gray area of arguable legality.

But criminal law should clear separate conduct that is criminal from conduct that is legal . . . [it] represents the community’s sense of the

type of behavior that merits the moral condemnation of society. . .

When prosecutors have to stretch the law or the evidence to secure a conviction as they did here, it can hardly be said that such moral

judgment is warranted.

U.S. v. Goyal, No. 08-1436 (9th Cir. 2010).

Nevertheless, the trends which created the Broadcom backdating cases and the prosecution of Mr. Goyal continue. Task forces continue to multiply, the line between criminal and civil conduct continues to blur and brining criminal charges is not only popular but a priority.

Next: Whistleblowers and conclusions

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