This Week In Securities Litigation (January 25 to 31, 2008): Commissioner Atkins on Cooperation Credit and Two SEC Litigation Losses
This week, the SEC released the text of a speech given by Commissioner Paul Atkins at the Federalist Society Lawyers’ Chapter of Dallas, Texas on January 18, 2008. In the speech, Commissioner Atkins discussed the Supreme Court’s recent decision in Stoneridge, previously discussed here, and cooperation credit for privilege waivers.
Commissioner Atkins began by reiterating the well-reported split among the SEC Commissioners over whether to file an amicus brief supporting the Stoneridge plaintiffs. While the SEC ultimately requested permission to file such a brief based on a split vote, the Solicitor General not only refused the request, but, later argued that the Commission’s views on scheme liability were wrong. Ultimately, the Supreme Court essentially adopted the Solicitor’s views. Commissioner Atkins noted his agreement with the Court’s position, arguing that the plaintiff’s theory of scheme liability was far too expansive – a position advanced by Justice Kennedy in his opinion for the Court.
The Commissioner then returned to a topic he has addressed before – privilege waivers by corporations in exchange for cooperation credit (discussed here). As in his earlier comments, Commissioner Atkins argued that credit should not be given in exchange for cooperation because it undercuts and erodes the attorney client privilege of the corporation. The Commissioner went on to note that bargaining waivers for cooperation credit is creating a “culture of waiver.”
While Commissioner Atkins focused primarily on the loss of rights by corporations, what is perhaps more important is the impact of bartered waivers on directors, officers and employees of companies. When corporations trade their privileges and other rights for cooperation credit, it is frequently part of a strategy to do anything and everything possible to avoid or mitigate liability. While this effort is clearly understandable in view of the pressure generated by a possible charging decision – particularly in a criminal case – the gambit often has a pernicious impact on employees. As part of the barter process, corporations may decide – albeit “voluntarily,” i.e., without a specific prosecutorial request – to limit indemnification rights. This can have the impact of stripping employees of their right to counsel, since few can afford the huge cost of defending an SEC or DOJ investigation or enforcement action.
The corporate barter process may also include a decision to avoid entering into cooperation or joint defense agreements with current and former employees to avoid the appearance of “stonewalling” the SEC or DOJ inquiry. This can translate into not making corporate documents and information available to the employee for his or her defense or only providing a limit set of materials. Yet, absent access to key corporate documents the employee may not be able to adequately prepare for testimony or raise defenses. Indeed, in view of the fact that most securities cases are heavily dependent on documents, the employee may be left with no effective way to prepare for testimony or a litigation.
Finally, as Commissioner Atkins pointed out, a corporate decision to barter for cooperation credit can include pressuring employees to testify in their internal investigation. When the notes of that meeting are turned over to the SEC and DOJ, this effectively undercuts the employee’s Fifth Amendment rights. In addition, if the employee’s access to corporate materials has been curtailed, the person may not be properly prepared to testify, thus increasing the risk that any statements may be incomplete or wrong. That, in turn, increases the risk that the government will later view the statements as false and decide to charge the employee with making false statements or obstruction – a growing trend called “deputization” (i.e. the government, in effect deputizes the private lawyers conducting the internal investigation as government agents). Despite all of this (which will be detailed in an upcoming paper and series) and Commissioner Atkin’s repeated efforts to end cooperation credit, the SEC Enforcement Division and DOJ barter with corporations for cooperation credit.
Last week, the SEC also lost its third Section 5 charge in a PIPE case involving a hedge fund. SEC v. Berlacher, Case No. 073800 (E.D.Pa. Filed September 13, 2007). As in other cases, the Commission’s complaint alleged that defendant sold an issuer’s securities short in connection with a PIPE offering and later covered with the shares obtained from the resale registration statement. As in two prior cases discussed here, the court rejected the SEC’s claim regarding the Section 5 sale of unregistered securities, but not the insider trading claim. The SEC has taken a consistent position in these cases: the short sales with intent to cover with the shares obtained later form the PIPE violates Section 5. The courts have also taken a consistent position: the SEC is wrong. This issue will be discussed in detail next week.
Finally, in SEC v. Dorozhko, Case No. 1:07-cv-09606-NRB (S.D.N.Y. Filed October 29, 2007), the court rejected a request by the Commission for a preliminary injunction in the so-called “hacking and trading” case. In its complaint, the SEC the charged Mr. Dorozhko, a Ukrainian citizen, with insider trading. Specifically, the SEC claimed that the defendant used non-public information about IMS Health he obtained by hacking into Thomson’s network to purchase put options prior to an announcement of negative information about the company. Although the court initially granted the SEC’s request for a TRO and a freeze order, it denied the request for a preliminary injunction holding that Mr. Dorozhko had not breached any duty to anyone. In making its ruling, the court held that the theft of the non-public information and its subsequent use in trading is, without more, is insufficient to sustain an insider trading claim. The SEC has appealed the ruling to the Second Circuit.
In addition to discussing the Berlacher case next week, the series on Stoneridge will also continue.