PLI Panelists Review Policy Changes in Enforcement

Among the topics discussed by panelists at the Practising Law Institute’s recent conference on securities litigation and enforcement were the controversies surrounding the SEC’s policies on civil penalties against issuers. Peter Bresnan with Simpson Thacher & Bartlett LLP said the SEC sought more civil penalties from corporate issuers after the Fair Funds legislation enabled it to return funds to injured shareholders rather than turn it over to the Treasury Department. The average amounts of the penalties dropped after the SEC adopted a new penalty framework in 2006. He said the number of cases increased but the average penalty amounts declined between 2007 and 2008.

Bresnan said the recent decrease in penalty amounts was partly due to the types of cases the SEC brought. There were no big blockbusters, he said. Another reason was a change at the Commission where certain commissioners believed that large penalties posed competitive harm abroad and also injured shareholders for a second time. SEC Chair Mary Schapiro did away with a pilot penalty program upon her arrival. Bresnan said that nobody liked that program.

The panelists questioned the formula the SEC uses in arriving at a penalty amount. Carmen Lawrence with Fried, Frank, Harris, Shriver & Jacobson LLP said there was a time when one could figure out the range of a penalty, but that is no longer the case. Mark Schonfeld with Gibson, Dunn & Crutcher LLP noted that the penalty guidelines that were adopted in 2006 are still in effect.

The SEC’s Scott Friestad confirmed that the penalty guidelines are still in effect. The focus is on the harm done to shareholders and the benefit obtained by a company through its misconduct. Some of the commissioners believe that the other factors outlined in the guidelines have been underemphasized such as deterrence, the egregiousness of the misconduct and the company’s cooperation. Friestad believes these other factors will receive greater focus.

The panelists discussed Judge Rakoff’s decision in the Bank of America case and its impact on future penalties. Rakoff called the SEC’s penalty trivial in light of the size of the transaction that was at stake. Rakoff sent the message that the SEC should have pursued the individuals involved in the failure to disclose the bonus payout that had been approved. Schonfeld noted that almost all cases against individuals are being litigated. The BoA case raises questions about whether the SEC will settle future cases without naming individuals, he said.

The panelists also discussed the CSK Auto Corporation clawback case in which the SEC sought the return of over $4 million of the former CEO’s bonuses and stock sale profits which he received while the company was committing accounting fraud. It was the first action seeking reimbursement under Sarbanes-Oxley Act Section 304 from an individual who was not alleged to have violated the securities laws.

For years, the SEC used the clawback provision only against those being charged with other securities violations. This was a very big case, according to Schonfeld. Friestad said that clawbacks are a remedy that Congress gave to the SEC and there will be more cases like CSK.

In a discussion about whether the SEC should be able to pay for tips other than the currently authorized insider trading payments, Friestad noted that the SEC only receives one or two insider trading tips a year. Colleen Mahoney with Skadden, Arps, Slate, Meagher & Flom LLP, noted that the option of paying for tips makes it more likely that the tipper will identify him or herself. The person’s identify gives the staff a perspective on any axes they may have to grind.

Friestad said that in order to make a whistleblower plan work, the SEC would have to be able to offer some kind of immunity because most tippers do not have clean hands. They are often involved in the misconduct. However, the idea of immunity goes against the staff’s inclinations, he said.

The panelists talked about the increased frequency of the use of deferred prosecutions which were rare until the post-Enron era when Arthur Andersen failed after negotiations with the government broke down. Deferred prosecutions increased in order to prevent putting more companies out of business. There were 35 deferred prosecution agreements entered in 2008.

Mahoney said that deferred prosecutions are a positive outcome for companies, but they often involve an admission of wrongdoing and a stipulation to facts that can feed private litigation. The imposition of a monitor is a common element to the agreement, some of whom have played very active roles in the companies they oversee.

Wayne Carlin of Wachtell, Lipton, Rosen & Katz reviewed SEC investigations. There is no such thing as “no big deal,” even if the inquiry is informal, he said. The informal stage is known as a matter under inquiry and the threshold for opening an MUI is very low. There is no need for any proof that a violation has occurred. At this stage, the staff does not have subpoena power and relies on the voluntary submission of documents.

Carlin said the staff tries to figure out within two to three months whether an investigation needs to be upgraded to a formal investigation. It may act faster in cases such as insider trading where it must obtain access to phone records and other documents that require subpoenas. The process for issuing formal orders of investigation has changed under Schapiro, he said. She has delegated the Commission’s authority to Enforcement Director Robert Khuzami who has subdelegated the authority to other staff.

Friestad noted that in some cases, the staff will still go to the Commission for a formal order of investigation, particularly if it is high profile or controversial. At a minimum, the staff will notify the duty officer in those instances, he said.