(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

SEC Enforcement Studies Submitted to Congress Under Sarbanes-Oxley

The SEC has completed two studies of enforcement mandated by the Sarbanes-Oxley Act and, as a result what the Commission found, has recommended additional legislation to strengthen aspects of its enforcement regime. As required by Section 308(c) of the act, the SEC staff conducted an analysis of its enforcement actions over the last five years to identify how such proceedings may best be utilized to provide restitution for injured investors. Section 308(a) of the act, the "fair fund" provision, authorizes the Commission to take civil penalties collected in enforcement cases and add them to disgorgement funds for the benefit of victims of securities law violations. In an effort to augment the fair fund statute, the SEC has asked Congress to give it the power to employ private collection attorneys and to grant securities cases an exclusion from state homestead exemptions.

A separate study, ordered by Section 704 of the Sarbanes-Oxley Act, reviewed enforcement actions in an effort to identify areas of corporate financial reporting that are most susceptible to fraud, inappropriate manipulation, or inappropriate earnings management. The results of that study have lead the Commission to ask Congress for, among other things, nationwide service of process in federal court civil securities actions.

The Section 308 report revealed that temporary restraining orders and asset freezes can limit investor losses and increase the chances of returning investor funds in almost all types of cases, particularly when the Commission receives early notice of the misconduct. It was similarly found that the appointment of a receiver, where appropriate, enhances the SEC's ability to maximize investor recovery. The SEC also concluded, however, that there are still practical and legal obstacles to providing compensation to injured investors, including disgorgement collection difficulties, evidentiary burdens in enforcement actions, and costs to create and administer distribution plans. Compensating injured investors is especially difficult with corporate financial fraud violations because they may cause huge investor losses that dwarf, by several orders of magnitude, any profit that the violators may have made.

Ultimately, the Commission believes that additional legislation may help fulfill the investor compensation goals of the fair fund provision and enhance the agency's ability to collect disgorgement and penalty monies owed by securities violators. With this in mind, the SEC asked Congress to amend the fair fund provision to allow penalty monies ordered in a particular matter to be distributed to injured investors in that matter regardless of whether disgorgement was ordered. In addition, the SEC seeks express authority to directly hire private debt collection attorneys, who would be paid on a contingency fee basis. It is envisioned that the contract attorneys would appear in court proceedings where they would file liens and other papers, and would represent the Commission in settlement and compromise negotiations. Authority to approve any settlement, however, would remain with the Commission.

The SEC also recommended legislation to exclude securities cases from state law property exemptions, such as homestead exemptions. The Commission emphasized that the exclusion of securities judgments and administrative orders from state law property exemptions would increase available assets for recovery to investors and obviate the need for protracted contempt litigation to recover disgorgement. The Section 704 study identified several areas that have been particularly susceptible to fraud and other improper conduct, including improper accounting in connection with business combinations, inadequate disclosures in management's discussion and analysis, and failure to disclose related party transactions. The SEC also found improper accounting for foreign payments in violation of the Foreign Corrupt Practices Act and improper use of non-GAAP financial measures.

The SEC focused on the fact that there is currently no single mechanism for a company to file its restated financial statements, making it difficult for investors to determine when and where financial statements have been restated. To address this situation, the SEC plans to propose the addition of a line item to Form 8-K requiring the company to disclose what was restated and why, and include a link to the Form 10-K or 10-Q containing the restated financial statements. In addition, the Commission proposes adding a box to the Form 10-K or 10-Q to be checked if the filing contains restated financial statements.

On the legislative front, the Commission seeks an amendment to the Exchange Act to allow parties who choose to produce privileged or protected material to do so without fear that their production to the Commission will be deemed to waive privilege or protection as to anyone else. The SEC emphasized that this amendment would enhance its access to significant, otherwise unobtainable, information. The Commission also wants Congress to authorize the Department of Justice, subject to judicial approval, to share grand jury information with the Commission in more circumstances and at an earlier stage than is currently permissible.

Finally, the Commission recommends legislation to make nationwide service of process available in civil securities actions filed in federal courts. Currently, the SEC enjoys nationwide service of process only in administrative proceedings. The SEC believes that nationwide service of subpoenas will provide substantial advantages, including significant savings in terms of travel costs and staff time through the elimination of duplicative depositions.