What Does Cooperation Earn?
What does a company earn for cooperation with the SEC? To be sure, being a good corporate citizen implies that the company should assist the SEC in rooting out and preventing wrong-doing. Cooperation, as defined by the SEC however, typically requires much more than that which might be expected of a good citizen and often comes at a high price for the company. Hence, the on-gong debate about the “culture of waiver” and stripping entities of fundamental rights in the name of cooperation. In return for that price, the SEC holds out the prospect of credit in the charging process. The question is: what does cooperation as defined by the SEC earn the company?
There is no clear cut answer to this question. The SEC offers little in the way of guidance either in its Enforcement Manual, Seaboard Release or the press releases which acknowledge cooperation by a settling defendant. Likewise, examination of cases where cooperation is acknowledged yields little in the way of concrete guidance. Consider for example, a settled option backdating case the SEC filed yesterday and two similar cases brought last year.
Yesterday, the Commission filed a case against Take-Two Interactive Software, Inc., the New York City based developer of interactive entertainment software games for video game consoles and personal computers. SEC v. Take-Two Interactive Software, Inc., Case No. 09 CIV 3113 (S.D.N.Y. Filed April 1, 2009). See also SEC v. Brant, Civil Action No. 1:07 CV 1075 (S.D.N.Y. Filed Feb. 14, 2007) (settled civil injunctive action against the former CEO of the company who agreed to the entry of a fraud injunction, the payment of about $4.1 million in disgorgement and a $1million civil fine).
The allegations in the complaint are similar to those in many option backdating cases. According to the SEC, between April 1997 and September 2003 the company granted backdated options without complying with its stock option plan and frequently without board or committee approval of the grant dates and exercise prices. As a result, Mr. Brant (who settled earlier) and others obtained millions of dollars worth of illicit compensation by exercising in-the-money options.
The periodic reports of Take-Two filed with the SEC were false and misleading as a result of the scheme, according to the complaint. Specifically, the company did not properly record the expenses associated with the backdated options and created the impression in its filings that the grants had been issued in accord with company procedures when in fact they were not. This caused the company to overstate net income by 13.2% in 1999, 807.4% for 2000, 19.9% for 2002, 10.7% for 2003, 5.2% for 2004 and 5.4% for 2005. The company also understated its losses for 2001 by 57.5%. Take-Two restated its financial statements for the years 1997 through 2005.
To settle the action, Take-Two consented to the entry of a permanent injunction prohibiting future violations of the antifraud provisions of the Securities Act and the Exchange Act as well as the books and records and proxy provisions of the Exchange Act. The company also agreed to pay a $3 million civil penalty. At the same time, Take-Two settled with the New York County District Attorney’s Office by agreeing to pay $300,000 to the state and continue its remedial measures.
In announcing the settlement, the SEC stated that it “acknowledges the cooperation provided by Take-Two during the course of the investigation. Take-Two currently operates under new management and a new board of directors.” There is no other definition of what constitutes cooperation or how any cooperation credit impacted the settlement.
The results in Take-Two should be compared with those in other similar cases such as Sycamore Networks and UnitedHealth. In Sycamore Networks the SEC alleged a pervasive option backdating scheme that went on for years and was covered-up with falsified documents. At the time of settlement, the SEC acknowledged the cooperation of the company and accepted a resolution under which Sycamore Networks agreed to essentially the same injunction as Take-Two. No civil penalty was imposed, however. SEC v. Sycamore Networks, Inc., Civil Action No. 1:08-CV-11166 (D. Mass. Filed July 9, 2008) discussed here.
In UnitedHealth, the SEC also alleged a significant option backdating scheme. The Commission also acknowledged the cooperation of the company with its investigation at the time of the settlement. In its release, the SEC took the unusual step of stating the steps the company undertook to cooperate: conducting an internal investigation, sharing the results with the staff and removing the officials involved. In view of that cooperation, the SEC agreed to accept in settlement a consent injunction prohibiting future violations of the books and records provisions — no fraud injunction and no penalty. SEC v. UnitedHealth Group, Inc., Case No. 08-CV-6455 (D. Minn. Filed Dec. 22, 2008) discussed here.
The reason for the significantly different settlements in these three cases is not apparent from the statements of the SEC. While the UnitedHealth release did give some specifics about the cooperation of the company which is helpful, it hardly distinguishes that case from the others. Presumably all of the companies conducted internal investigations, since that is virtually standard operating procedure under these circumstances. Presumably all of three companies made the facts from their investigation available to the SEC, since the Enforcement Manual defines cooperation in terms of making the facts available to the staff. And, the SEC releases for all three cases suggest that those involved have been replaced. So what is the difference?
In each instance, the company was accused of unlawful conduct by a government agency in a lengthy and detailed complaint — a stigma which lingers long. In each instance, the company was enjoined. In UnitedHealth however, the injunction was not for fraud, while in both Take-Two and Sycamore Systems the court order was predicated in the first instance on fraud. Only Take-Two had to pay a civil penalty. While this is hardly a scientific sample of SEC cooperation cases, they do raise a fundamental question about the value of SEC type cooperation. The Commission’s vague promise of credit and typically nondescript press releases regarding cooperation only serve to cloud the question.
To add transparency to the process and encourage companies to cooperate not just in the “good citizen” sense, but the SEC sense, the Commission should consider giving further definition to cooperation and cooperation credit in its press releases about settlements.