This Week In Securities Litigation (April 4, 2008 edition)

In the past week, critical issues regarding securities litigation and enforcement continued. The subprime crisis continued to dominate the news with regulatory reform being the topic of the day following Secretary Paulson’s speech (previously discussed here). There, the Secretary offered a blue print for regulatory reform which would essentially formalize the powers recently exercised by the Fed, merge the SEC and the CFTC in a fashion which would alter the former’s historic approach to regulation and oversight in favor of that used by the latter and federalize insurance regulation which is currently handed by the states. The Secretary’s proposals will no doubt be debated for a considerable period of time. Indeed, others in Congress are already racing to put out regulatory reform plans of their own.

At the same time the Financial Services Authority (“FSA”) in London continued its trend toward increasing regulation to cope with market manipulators and insider trading. Historically, the FSA has opted in favor of regulation rather than litigation with only a small fraction of its resources being dedicated to enforcement. While the FSA has been seeking to have powers similar to those of the SEC for years, now it appears that there will be a step forward: the FSA will be empowered to provide whistleblower protection to those who cooperate with a current market manipulation probe. While there is a debate in London as to effectiveness of such powers, at least for the moment the agency has been granted additional authority.

The options backdating scandal also continued to drag on, with perhaps a small step closer to the end. Texas-based HCC Insurance Holdings Inc received court approval of a settlement in a derivative suit based on option backdating. The only question now for the company as to option backdating is the SEC, which has an on-going inquiry. Of course, HCC is not alone in this regard since the SEC reportedly has about 80 inquiries open regarding backdated options.

Broadcom would also like to end its option backdating woes. The company is reportedly meeting with federal prosecutors in an effort to avoid criminal prosecution. Previously, former human resources executive Nancy Tullos settled option backdating claims with the SEC. SEC v. Tullos, Civil Action No. SACV 08-242 AG (C.D. CA. March 4, 2008) (discussed here). In that settlement Ms. Tullos consented to the entry of an injunction prohibiting future violations of Securities Act Section 17(a)(3) and the books and records provision of the Exchange Act. In addition she agreed to pay a $100,000 civil penalty. Last year Ms. Tullos pled guilty to one count of obstruction of justice in exchange for her cooperation (discussed previously here).

Finally, the GAO issued a follow up letter to its November 2007 report which concluded the SEC has weak internal controls. The letter contains 14 recommendations to the SEC for improvement of its controls. Letter from Jeanette M. Granzel, Director Financial Management and Assurance, GAO to The Honorable Christopher Cox, Chairman, SEC, dated April 1, 2008.

The new GAO report has, of course, a strange irony in view of the agency’s role in enforcing internal control provisions on corporate America. At the same time it is not the first call for a reform of SEC procedures.

Over the last year the SEC has received repeated calls to improve its transparency and reform its enforcement policies. For example, earlier this year the Senate Committee investigating the botched Pequot Capital investigation issued a report which was sharply critical of the agency. Its recommendations included a call for the Enforcement division to adopt formalized procedures for handling its cases. Minority Staff of S. Comm. On Finance, 110th Cong., 1st Sess., “The Firing of an SEC Attorney and the Investigation of Pequot Capital Management” at 45 (S. Prt. 110 –28 Aug. 2007). SEC Commissioner Atkins made a similar recommendation earlier this year at the SEC Speaks in 2008 Program of PLI.

Other recommendations for reform include a call for a new Wells Committee on settlement procedures, a recommendation that open file settlement procedures be used and that cooperation standards be revised. See, e.g., Remarks at the Federalist Society Lawyer’s Chapter of Dallas, Texas ( Jan. 18, 2008). The ABA and others have joined in the call for a reform of cooperation policies in the wake of court cases and congressional testimony noting that DOJ and SEC practices had created a “culture of waiver.” See, e.g., Survey by former Delaware Supreme Court Justice Norman Veasey in response to a congressional request.

To date most requests for reform have gone largely unheeded. Perhaps, the GAO will fare better with its suggestions.