SEC Enforcement: Anxiety In The Board Room

Should there be anxiety in the boardroom concerning SEC enforcement?  Consider the following:

  • Traditionally the duties of directors have been a function of state law.  SOX changed that.  As SEC Commissioner Paul S. Atkins noted in a March 25, 2006 speech:  “Sarbanes-Oxley . . . represents. . . an unimaginable incursion of the U.S. federal government into the corporate governance arena.”
  • Gatekeepers such as corporate directors and lawyers continue to be a focus of the enforcement staff.  As Enforcement Chief Linda Thomsen noted a few months ago: “The Securities and Exchange Commission continue to look at so-called gatekeepers, such as lawyers and corporate directors . . “  Thomsen Says Lawyers, Directors Are Under SEC Enforcement’s Gaze, 38 Sec. Reg. & L. Rep. (BNA) No. 36, at 140 (Nov. 20, 2006).
  • Cases against directors have typically been based on intentional or reckless conduct.  Consider for example the complaint filed in SEC v. Collins & Aikman Corp., et al., Civil Action No. 1:07-CV-2419 (LAP)(S.D.N.Y. March 26, 2007).  That action was brought against the company, its CEO David A. Stockman and eight other former directors and officers.  The complaint alleged a financial fraud to inflate the reported income of the company. 
  • Consider also Hollinger International.  There a criminal prosecution of former Hollinger International chairman Conrad Black, who is defending criminal charges from over $60 million taken from the company with board approval is in progress.  The SEC enforcement staff issued a Wells Notice to the Hollinger audit committee noting its intent to recommend an enforcement action against each of the directors.  The crux of the case may have been summarized by former Illinois governor and Hollinger International audit committee member Jim Thompson who testified for the government at Mr. Black’s trial noting that while he only skimmed the disclosure documents for the company he read “every word” of the Wells notice.
  • Traditionally the SEC has brought actions against another gatekeeper group – attorneys – based on intentional conduct.  However in In re Weiss  a negligence standard was used.  Initially an administrative proceeding was brought against attorney Weiss for issuing an opinion stating that the interest on bonds in an offering were tax exempt which the IRS later said was wrong.  The administrative proceeding brought based on claimed violations of Securities Act, Section 17(a) and Exchange Act Section 10(b) was dismissed by the ALJ after a hearing.  On appeal the Commission reversed, finding Mr.Weiss liable under Section 17(a)(2) &(3). (Feb. 25, 2005).
  • After Weiss  directors must wonder if the standards of liability are shifting.   This is a particularly important question moving forward as the SEC considers what to do with its 140 back dated options cases and its insider trading campaign.  Directors could be key targets in each area.

  • Directors of course are typically involved in the option issuance process.  In discussing the potential liability of directors  SEC Commissioner Roel Campos cautioned in an August 15, 2006 speech:   “As yet, we have charged only officers in option backdating cases.  However, if the facts permit – and I want to emphasize that all of our Enforcement cases are very fact specific – it wouldn’t surprise me to see charges brought against outside directors.  Directors also are involved in trading the stock of their companies.  Many directors sell shares under the safe harbor of Rule 10b-5-1 plans which are suppose to insulate them from insider trading charges.  Directors however may want to recall Enforcement Chief Thomsen’s recent warning that the staff is looking hard at the safe harbor provided directors and officers who sell shares under Rule 10b-5-1 plans for insider trading.  Those remarks are based on an academic study which suggests that directors trading under these plans are doing better than the market – precisely the type of study which triggered the options backdating scandal.  Collectively, these events  represent an unprecedented federal intrusion in the board room, increased scrutiny, potentially shifting standards and huge areas of potential liability.  No wonder there is increasing anxiety in the boardroom.