ON Securities : Securities Lawyer & Attorney for Corporate Governance & Executive Compensation Matters

The SEC has a new weapon in its enforcement proceedings, thanks to a provision in the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (848-page PDF). In an interesting article in DealBook, “Can the S.E.C. Avoid Scrutiny of its Settlements?” Professor Peter J. Henning points out that Section 929P of the Act “now allows the S.E.C. to impose a civil monetary penalty in an administrative proceeding ‘against any person’ who violates a provision of the federal securities laws.” Prior to enactment of the Act, the S.E.C. had to go to court to impose penalties against companies other than broker-dealers or investment advisors.

Professor Henning points out that this authority might have made a big difference in the SEC’s recently announced settlement of an enforcement proceeding against Citigroup over its disclosure of its exposure to subprime mortgages. Like the settlement in the Goldman Sachs proceeding, the Citigroup settlement is being delayed, as a federal district judge scrutinizes the settlement.

Under the new Dodd-Frank Act provision, Professor Henning says the SEC enforcement staff will be able to bypass the courts altogether on some types of proceedings by filing settled cases as administrative proceedings. This may allow the staff to act more quickly and impose sanctions on a greater number of companies more quickly. It’s hard to predict the impact of such a trend, however. The scrutiny of the judge in cases such as the Goldman Sachs settlement forced the SEC to get tougher in the final settlement, so the availability of administrative proceedings may make it easier for the SEC and its corporate targets to negotiate deals that are less tough than a federal judge would require. One way or another, however, the flurry of activity from the newly empowered SEC enforcement staff is sure to continue.

Show Me the Logo

Speaking of the empowered enforcement staff, the SEC obviously wants to showcase their toughness – I noticed the brand new logo that’s now prominently displayed at the upper right corner of the home page of the SEC’s website, just above a set of links to its latest high profile enforcement cases:

 

 

 

 

I’m not going to try to take any credit for the logo, but it does remind me a bit of the graphic I have used in this blog a few times:

 

 

 

 

I first used the "Busted" graphic in my post in September 2009, “’Busted’ - Don't Be Blindsided by the SEC's New Enforcement Posture,” in which I provided some tips for public companies to avoid problems with enforcement proceedings. I’ll provide an updated list of tips in an upcoming post.

Actually, one of my partners said the SEC’s new enforcement logo reminds him of another one – maybe the SEC is trying to show that its new “cops on the beat” are just as tough as the cops represented by this logo:

 

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As I have reported previously, Dodd Bill, the Restoring American Financial Stability Act of 2010 (1,600 page PDF), includes extensive governance and compensation reforms that apply to all public companies (or, in some cases, all listed companies), not just financial institutions. However, a lesser-known provision in the Dodd Bill could also have a significant impact on public companies: a program that would pay whistleblowers a bounty for reporting violations of securities law.

Under Section 922 of the Dodd Bill (starting on page 974), if a whistleblower provides information on a securities law violation that leads to monetary sanctions of more than $1 million, the SEC will be required to pay the whistleblower an amount ranging from ten percent to 30 percent of what has been collected. This bounty would apply to a wide range of securities law violations, including violations of the Foreign Corrupt Practices Act. The Frank Bill, which is being reconciled with the Dodd Bill in conference committee, contains a similar provision, without the ten percent minimum. Because the Senate and House versions are similar, it seems likely that the provision will be part of the final bill, expected to be passed this summer.

I view this provision as the “sleeper” in the Dodd Bill for public companies. It’s received less publicity than other provisions such as mandatory Say-on-Pay and a majority voting requirement for directors in listed companies. However, its impact on public companies could be even greater than those other provisions. The bounty provision may encourage employees to report perceived violations in a greater number of cases than before. Considering the recent increases in SEC enforcement staffing and activity, public companies will also be at greater risk of SEC investigations and enforcement proceedings.

In preparation for the likely passage of the bill, public companies should ensure that their whistleblower policies are up to date and that they are prepared to process a possible increase in whistleblower reports. The policies should provide clear procedures for employees to report possible violations within the company. Careful preparation may help reduce the chances of an expensive and time-consuming problem in the future.
 

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The 2010 Bowne SEC Accounting, Compliance & Legal Issues Conference held in Minneapolis last week was a major success. More than 250 public company representatives and advisors attended to hear a day-long program featuring up-to-date information on disclosure, corporate governance, executive compensation and accounting issues.

I moderated a panel discussion on public company disclosure issues that also featured my partner, Paul Chestovich. Paul provided an update on the SEC’s new positions on climate change disclosures and non-GAAP financial measures, also the subject of a very handy article Paul wrote for the Small Public Company Forum called “Generation Non-GAAP”. We also participated in a discussion of tips for public companies to avoid disclosure problems. The SEC has beefed up its enforcement staff and enforcement activity, making compliance especially important these days, to avoid being “busted” by the SEC. Some of our disclosure and compliance tips were as follows:

• When making tough disclosure calls, remember the current public skepticism and SEC activism (business as usual may not be enough).
• Revisit forward looking disclaimers, risk factors and MD&A in light of current conditions.
• Before you have a problem, check your D&O policy – does it cover SEC investigation expenses? (Many do not.)
• Focus on process, process, process - in light of SEC scrutiny, it’s important to have consistency and proper oversight, and to be able to demonstrate that with good documentation.
• Make sure disclosure controls are formalized (written and compiled), and that the internal disclosure committee keeps proper records.
• Re-examine whistleblower policies, especially in relation to reporting of financial fraud. Note that, under the new financial reform bills, whistleblowers may receive a “bounty” for reporting financial fraud, which will encourage further activity by whistleblowers.
• Consider a formal Communications Policy to control the flow of information to analysts, media, etc. This will reduce the risk of inconsistent or misleading statements and help promote compliance with Regulation FD (prohibiting selective disclosures to analysts).
• Review the corporate website and make sure disclosures are consistent with public reports.
• Focus on your insider trading policy - make sure the policy is up to date and policed. Even the appearance of insider trading gives plaintiffs and SEC additional basis for actions, where a disclosure issue alone might not trigger a proceeding.

Our complete presentation is available here (PDF).

If you were not there, hope you can make it to the Conference next year!
 

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In a post titled “Private Securities Litigation Continues to Fall”, Broc Romanek’s theCorporateCounsel.net Blog recently summarized the results of a report by Cornerstone Research, “Securities Class Action Filings – 2009: A Year in Review” (PDF):

The latest report from Cornerstone Research shows a sharp drop-off in federal securities fraud class action filing activity in 2009. Continuing a trend that we have seen over the past few years, the 169 federal securities fraud class action filings in 2009 were off 24% from 2008, and were well below the historical average over the past ten years. Included in this big decline was a sharp retreat in credit-crisis filings, down nearly 47% from 2008 levels.

The chart on page 4 of the Cornerstone Research report shows an especially sharp decline when special cases, such as credit crisis filings and Ponzi schemes, are excluded.

Counterbalancing the drop-off in securities class action filings are the continued reports of the SEC’s efforts to beef up its enforcement efforts. In a Washington Post article, “SEC faces setbacks, skepticism in trying to reform its enforcement image”, Zachary A. Goldfarb outlines the SEC’s increased enforcement activity. He reports that SEC investigations more than doubled, from 233 in 2008 to 496 in 2009, and financial penalties increased from $1.03 billion in 2008 to $2.86 billion in 2009.

Comment: Goldfarb’s article focuses on the setbacks the SEC has encountered in beefing up its enforcement activities, which makes for interesting reading. However, the point remains that the SEC is more anxious than ever to bring enforcement proceedings. Compliance officers at public companies must continue to be vigilant to minimize exposure to disclosure-related liability. I included some tips in my previous post, “Don’t Get Caught Cheating”, and I will provide more tips in future posts.

Image: Wikimedia Commons
 

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As I reported previously, the SEC enforcement staff is "loaded for bear," stepping up its enforcement activities to go after violations of the securities laws. Some recent stories reinforce that it is more important than ever to guard against these violations: The Wall Street Journal reported on Wednesday that the SEC has greatly expanded its insider trading investigations of broker-dealers and hedge funds (subscription required to view complete article). According to the report, the staff has sent at least three dozen subpoenas in the past month, including investigating the role of Goldman Sachs bankers. The staff is using sophisticated technology to examine the webs of relationships among traders, investment bankers, attorneys and others.

Comment: There is no reason to think that the current investigations are limited to broker-dealers and hedge funds, and the trail could easily lead the SEC staff to company personnel. It is more important than ever for companies to monitor and enforce their insider trading policies.

The SEC last month reported that it entered into a consent decree with former officers and accountants at SafeNet in the first enforcement action by the Commission under Regulation G. Reg G regulates the use (and abuse) of "non-GAAP financial measures" by reporting companies. The complaint accused the personnel of engaging in a scheme to meet or exceed quarterly EPS targets through improper accounting adjustments. The company represented that it was excluding "non-recurring" expenses from its results, when in fact it was excluding recurring operating expenses to make its earnings look better.

Comment: SafeNet obviously was engaged in outright fraud, and Reg G gave the SEC staff another means to go after bad people. However, it's no coincidence that the first Reg G proceeding is in late 2009 - again, the enforcement staff is actively looking for perceived wrongdoing, in part to justify the agency's continued existence. Public companies should be more careful than ever in complying with Reg G - for example, be careful about characterizing any excluded expenses as "non-recurring," which is a real hot-button issue with the SEC staff.

Westlaw Business Currents reported last week that there has been a "noticeable uptick" in companies disclosing Wells Notices relating to enforcement proceedings.

Comment: Be careful out there. And don't get caught cheating.

No News. I keep checking the SEC calendar to see whether the Commission has scheduled a meeting to consider adoption of the new proxy disclosure rules. Nothing posted yet. It's hard to predict whether anything will be adopted this year, or whether the new rules will be effective for the 2010 proxy season.

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I attended a compelling legal education program this week, taught by Egil "Bud" Krogh. Political junkies know that Krogh was a young assistant White House counsel in the Nixon years. As a leader of the "Plumbers" unit, he authorized the 1971 break-in of the offices of Daniel Ellsberg's psychiatrist after the leak of the Pentagon Papers. After the break-in came to light in the Watergate hearings, Krogh pleaded guilty, served time in prison, was disbarred and later reinstated.

Bud now lectures on the topic of legal ethics, based on his recent book, Integrity: Good People, Bad Choices, and Life Lessons from the White House. His premise: in a pressure-filled environment such as the White House, intense loyalty to individuals can blind you to your higher principles. This is compounded by fear, inexperience, pride and other factors.

Krogh's description of an environment that can put pressure on decision-making is familiar to anyone called on to say yes or no to any proposal by a corporate officer. Whether the proponent is the client of an outside attorney or the boss of an in-house attorney, there is a lot of pressure just to nod approval, as Bud Krogh nodded to Howard Hunt when the Plumbers break-in was discussed. I think the situation is especially acute for in-house attorneys. Of course, most proposed actions are legal, and the advice is often about the level of risk involved in two alternatives. And most in-house attorneys do a great job of balancing the competing pressures of giving sound advice while also being part of the team. But how do some decisions, even decisions by good people, go astray?

A great example can be found in the options backdating scandals. An article in the Financial Times in November 2006 reported that the backdating scandals had resulted in at least twelve major US companies replacing their general counsel, and a March 2008 speech by the SEC's Director of Enforcement reported that at least seven former general counsel had been charged by the SEC in connection with the scandals. Backdating, even though not necessarily illegal in itself, in these cases represented falsification of documents and involved misleading accounting and tax fraud. I know many attorneys said "no" to the practice, but these counsel simply nodded as backdating was pushed by other corporate officers. It might not have seemed like such a big deal at the time.

I asked Krogh how to advise an attorney (maybe a younger in-house attorney) how to avoid the pitfalls of losing perspective in a pressure-filled situation. He steered me toward a Top Ten List provided by Hank Shea, a former Assistant U.S. Attorney in Minnesota who teaches ethical leadership at the University of St. Thomas Law School, including the following two lessons learned from the misconduct of others:

When faced with a right versus a wrong decision, guard against that first intentional misstep.

When faced with an ethical dilemma, seek advice and counsel from others.

After an interesting program, Bud entertained us with a great Nixon impression, including, at the request of one of my colleagues, the famous phrase "I am not a crook". Bud proved that we can all learn lessons about how to be able to make that statement, and mean it.

It's Just An IP Thriller - One More Comment

Bud Krogh also told a great story about Elvis, the King of Rock and Roll, who came to visit President Nixon in a meeting engineered by Bud. I just saw a great film about another King - the King of Pop. "This Is It" chronicles the rehearsals for Michael Jackson's planned comeback concert tour. I recommend it to anyone who wants to see the combination of pure genius and meticulous attention to detail shown by MJ. If you didn't see it before, it's worth reading my previous post, reporting that Jackson was actually one of the named inventors in an issued patent.

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I spoke this week at a Minnesota CLE Conference on the topic of how public companies can avoid liability for their disclosures. In preparing my remarks, it struck me that the SEC is "loaded for bear" in going after public companies and their officers with investigations and enforcement proceedings. The SEC has increased and reorganized its enforcement staff and is trying to raise its profile - really, an attempt to justify the agency's continued existence. Recent examples, just during July and August of 2009:

A recent accounting fraud case against General Electric, where GE agreed to pay a $50 million fine.

The SEC's $33 million settlement with Bank of America for failure to disclose the approval of Merrill Lynch bonus payments in the merger proxy statement. The District Court is considering rejecting the settlement as too lenient, which the SEC is disputing.

The SEC's "clawback" action to recover $4 million in incentive compensation from the CEO of CSK Auto, reported here. It's not clear whether the SEC will be successful in this case. However, clearly, the SEC is trying to send a message to corporate officers that, if the officers are not vigilant to preventing accounting fraud and disclosure violations, their own compensation may be at risk.

This is all happening at a time when private lawsuits for securities fraud are getting more difficult for plaintiffs' attorneys to bring - a point of agreement for the plaintiffs' attorneys and defense attorneys on the panel. This does not mean company officials can relax, due to the increased scrutiny from the SEC and, probably, increased skepticism from judges and juries about public company practices. As I said in this prior post, this atmosphere should lead public companies to carefully consider their disclosure processes, including the disclosure controls and procedures required under SOX.

In other words, once again, "Don't Get Caught Cheating." Or, make sure you're not "BUSTED" by the SEC.

If you would like a copy of my PowerPoint presentation from this week, send me an e-mail. If you have any tips on disclosure procedures, or just want to weigh in on the SEC's newly found "mojo", post a comment below.

Have a great Labor Day weekend!

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