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Conference Panelists Review Developments in Enforcement and Corporation Finance

The second day of the Practising Law Institute's "SEC Speaks" conference featured panels on enforcement, corporation finance and ethics. Enforcement Director Linda Chatman Thompsen reviewed two recent cases, one involving El Paso Corporation for improper payments to Iraq under the U.N. oil-for-food program, and one involving an insider trading scheme in the stock of Taro Pharmaceuticals Industries, Ltd. Deputy Director Walter Ricciardi reviewed the SEC's guidelines on corporate penalties.

Deputy Director Peter Bresnan discussed hedge fund cases which typically involve either fraud on the hedge fund manager's client or fraud on the market. Bresnan acknowledged the initiative underway by the Office of Compliance Inspections and Examination regarding the alleged leaking of information by broker-dealers to favored hedge funds. Enforcement is also looking at trade leakage, he said. Bresnan urged any funds that believe someone is front-running their trades to contact the staff with specific information. The Goldstein decision, which overturned the SEC's hedge fund adviser registration rules, made the enforcement role much more important, he added, since the inspection opportunity was eliminated.

Associate Director Antonia Chion reviewed the factors the staff considers in deciding whether to bring an enforcement action for stock option backdating violations. The staff considers how bad the conduct was and how good the evidence is, she said. The staff also looks at the duration of the misconduct and the number of instances of backdating. The staff will consider the quantitative materiality of the unreported compensation expenses and whether the company is restating its financial statements.

The quality of the evidence and the presence of scienter are important, Chion said. The staff also takes into consideration the knowledge of the wrongdoing on the part of the individuals involved, including their familiarity with the accounting rules. Chion said the staff also looks for any evidence of concealment, obstruction or lying to investigators, and looks for "money in the pockets."

If the evidence is strong, a case may bring criminal interest as well, she noted, especially if the gatekeepers were involved. The investigators will look for other non-option related misconduct, she added. The staff will consider the level of cooperation and any remedial acts in deciding what action to take. If a company conducts a high quality internal investigation it can speed the process, she said.

David Bergers, the district administrator in the Boston office, said the Division is in the final stretch of its market timing cases. A number of the cases involve issues much bigger than market timing, he added, including conflicts of interests. Rose Romero, the district administrator in the Fort Worth office, reviewed microcap fraud, which continues to rise. Investors lose over $6 billion a year, much of it due to microcap fraud, which usually relies on a pump and dump scheme. Daniel Hawke, the district administrator for the Philadelphia office discussed account intrusions and said more of these cases will be brought soon.

Corporation Finance

David Lynn, the chief counsel in the Division of Corporation Finance, advised that the staff will not request that a company revise a preliminary proxy statement if it fails to include the executive and director compensation disclosure required by Regulation S-K Item 402. However, the company must include the omitted information in the definitive proxy statement. The staff does not wish to hold up the filing of definitive proxies, he said, so it is providing a certain amount of flexibility to give everyone time to get the new executive compensation disclosure right.

The Division updated the guidance in its Telephone Interpretation Manual to reflect the staff position. The omitted disclosure may not relate to matters that caused the company to file the preliminary proxy materials and may not otherwise have been made available to the public before the filing of the definitive proxy statement. John White, the director of the Division, said the staff plans to conduct an organized review of proxies in May.

Brian Breheny, the chief in the Office of Mergers and Acquisitions, said the staff has spent a lot of time on the telephone responding to questions about repricing tender offers relating to Internal Revenue Code section 409A. The staff hopes to issue guidance soon, he said, and understands the significance of the matter. Section 409A applies to stock rights where the exercise price was below the fair market value of the underlying stock on the date of grant and the rights were exercised during the employee's 2006 tax year. If employees exercised backdated stock options, they may owe an additional 20% tax, plus interest.

Paul Dudek, the chief of the Office of International Corporate Finance, said the staff has received two questions related to the proposed revisions of the foreign private issuer deregistration rules --whether a company that has already deregistered can rely on the revised rules and whether a rule 12g3-2(b) company can rely on the revised rules. Dudek said the answer to both questions is yes. Companies may maintain an exemption through Web site postings of company information.

Craig Ollinger, the Division's deputy chief accountant, reported that one of the frequent comment letters issued to companies that are using international financial reporting standards ("IFRS") relates to their failure to assert that their financial statements were prepared in accordance with IFRS as established by the IASB or with the EU-approved standards. The reconciliation requirement is still in effect and is very important, he said. The staff looks for completeness, clarity and the ability to reconstruct U.S. GAAP information.

Elizabeth Murphy, the chief in the Office of Rulemaking, reviewed the numerous extensions and exemptions granted to small companies and newly public companies with respect to their compliance with section 404. Former Commissioner Aulana Peters said she has never favored exemptions to sound rules. Internal controls are of fundamental importance, she said, and allowing companies to enter the markets without being subject to strong internal controls is inviting trouble. "The investor is not being served," she said to scattered applause from the audience.

Gerald LaPorte, the chief of the Office of Small Business Policy, said the staff continues to work through the recommendations of the Advisory Committee on Smaller Public Companies. While most of the section 404-related recommendations have been addressed, he said the staff hopes to make a recommendation soon on the non-404 items. The staff is committed to moving forward on the electronic filing of Form D, he said, and should have a proposal within the next few months.

David Lynn advised that the staff position on PIPEs offerings is alive and well. The staff has concerns with note offerings that are convertible into significant amounts of equity shares, he said, and whether certain offerings constitute a primary or secondary offering.

Additional coverage of the conference will appear in Tuesday's issue of SEC Today.

Jacquelyn Lumb