Last Friday, the U.S. Securities and Exchange Commission held its annual “SEC Speaks” conference, which offers a glimpse into the prevailing trends and priorities at the Commission.  As always, the Commission devoted a significant amount of time to exploring and explaining the undertakings of its Division of Enforcement.  During the conference, some noteworthy themes and trends emerged with regard to the SEC’s enforcement priorities, which we address below.

SEC Chairman Mary Schapiro set the tone during her opening remarks at  the conference, which emphasized the Commission’s ability to “aggressively and effectively” fulfill its mandate to “protect investors and ensure the integrity of [the US] markets.”  Schapiro explained that the SEC’s Division of Enforcement has “revamped its operations, putting additional talented attorneys back on the front lines, creating specialized units, and streamlining procedures.”  According to Schapiro, “last year the SEC brought a record 735 enforcement actions” and “obtained $2.8 billion in penalties and disgorgements.”  Schapiro insisted that “there are more actions to come.” 

The SEC Whistleblower Program

Chairman Schapiro highlighted the efforts of the SEC’s new Office of the Whistleblower, noting that in 2011 the Commission “established a whistleblower program that is already providing the agency with hundreds of higher-quality tips, helping us to avoid investigatory dead-ends and – and the same time – prodding companies to enhance their internal compliance programs.” 

Sean McKessy, Chief of the SEC’s Office of the Whistleblower, offered additional insight.  He explained that the Whistleblower Office’s “number one priority” is acting as liaison between whistleblowers and the Division of Enforcement.  Other priorities for McKessy’s office include:

• Communicating with whistleblowers and their counsel, including responding to inquires about the process for submitting tips and/or claiming an award.
• Triaging tips, complaints and referrals received from whistleblowers, which the office is receiving at a rate of approximately seven per day.
• Tracking the SEC’s growing inventory of settled cases to indentify matters that might have arisen from a whistleblower complaint.
• Processing claims for awards based on settled cases.

With respect to the oft-repeated complaint that the SEC’s whistleblower rules do not require whistleblowers to report internally before submitting a tip to the Commission, McKessy underscored the Commission’s stance that the rules strike an appropriate balance between incentivizing whistleblower reports and showing consideration for corporate compliance programs.  According to McKessy, the SEC’s balanced approach is working.  In the “significant majority” of the whistleblower reports he has personally reviewed, McKessy insisted, the whistleblower did, in fact, report the potential violation internally before coming to the Commission.  In fact, he recalls only one instance in which a “serious” tip was not first reported internally. 

Enforcement Cooperation Program

David Bergers, Director of the SEC’s Boston Regional Office, highlighted several noteworthy aspects of the Commission’s Enforcement Cooperation Program.  The program, Bergers explained, is designed to encourage individuals with knowledge of wrongdoing to cooperate with the Commission early in its investigation.  Since the cooperation program was announced in January 2010, the SEC has entered into cooperation agreements with 37 individuals.  Under its cooperation agreements, the SEC often agrees to “toll prosecution” – or offers lesser sanctions – in exchange for cooperation in ongoing investigations and enforcement actions.  According to Bergers, in determining whether a cooperation agreement is appropriate, the SEC will consider the following factors: (1) the assistance provided by the individual, particularly the timing, nature, and voluntariness of the assistance; (2) the “importance” of the underlying enforcement matter; (3) the “social interest” in holding a particular individual accountable; and (4) the appropriateness of giving “cooperation credit” in light of the individual’s “profile” (e.g. whether the person is a recidivist or has accepted responsibility).

As part of the cooperation initiative, the SEC has also entered into several agreements with corporations, including one deferred prosecution agreement (DPA) and three non-prosecution agreements (NPA).  Like the agreements with individuals, the availability of DPAs and NPAs is designed to encourage corporations to cooperate in SEC investigations and enforcement actions.  While the Commission will consider a number of factors in deciding whether to enter into an agreement with a corporation, Bergers highlighted its agreements with Tenaris S.A. (a DPA) andCarter’s Inc. (an NPA) as examples of the nature and quality of cooperation the SEC expects. 

Pursuit of New Legal Theories

Mary Jo Gillette, Director of the SEC’s Chicago Regional Office, discussed several expanded legal theories the SEC is pursuing in enforcement matters, as well as new remedies available.  First, Gillette explained that the Dodd-Frank Act expanded the scope of aiding and abetting liability in SEC actions.  As a result of Dodd-Frank, the SEC is now authorized to assert aiding and abetting claims in new areas, including claims under the Securities Act of 1933 and the Investment Advisers Act of 1940.  Dodd-Frank also expanded the “state of mind” element required for aiding and abetting liability to include not only knowing participation, but also reckless assistance. 

Second, Gillette explained that Dodd-Frank made clear certain remedies available in control person liability cases.  Importantly, Dodd-Frank authorizes the SEC to seek injunctive relief in actions brought under Section 20(a) of the Securities Exchange Act.  The federal courts were previously split on the availability of injunctive relief in 20(a) actions; the standard for obtaining injunctive relief, however, varies among the courts. 

Gillette noted that Dodd-Frank also provides an affirmative defense to control person claims.  To wit, injunctive relief is not available against control persons who “acted in good faith and did not induce the [wrongful] conduct.  Compliance with internal controls, she says, will likely be a key consideration in relying the affirmative defense.   

Finally, Gillette emphasized that Dodd-Frank enables the Commission to seek “enhanced penalties” in cease and desist (C&D) proceedings.  The SEC is now authorized to ask for monetary penalties in C&D matters, where it was previously limited to seeking only disgorgement of ill-gotten gains.  The SEC is also empowered under Dodd-Frank to penalize secondary actors in C&D cases who caused violations of the federal securities laws, in addition to primary actors. 

Anticorruption Enforcement

The Commission now has a “cross-border group” charged with ferreting out corruption in corporations that trade on US exchanges, but are headquartered abroad.  The group is particularly interested in the accounting policies and financial disclosures of cross-border companies, many of which rely on “small US audit firms.”  As a result, the SEC is leaning on audit firms, which the SEC regards as “gatekeepers.”  To that end, the SEC issued guidance in 2010 and again in 2012, advising that they conduct risk-based analyses of their overseas clients.  According to Kara Brockmeyer, head of the SEC’s FCPA Unit, the SEC has seen a spike in Form 8-K reports of accounting irregularities, as well as a jump in Rule 10A reports.  She expects additional 10A reports to flow in through the Office of the Whistleblower. 

Brockmeyer noted that the SEC is also devoting significant resources to Foreign Corrupt Practices Act (FCPA) enforcement.  The SEC’s FCPA Unit is focusing heavily on international cooperation, teaming with regulators around the world.  She highlights the FCPA Unit’s cooperation with Switzerland, Russia, and China, each of which recently enacted anticorruption laws.  The FCPA Unit brought 20 FCPA enforcement cases 2011, including 19 against companies and one against an individual.  Brockmeyer cautioned, however, that the 2011 numbers should not be seen as a model.  Indeed, in 2012 the SEC has already charged 14 individuals with FCPA violations, compared with only five companies charged. 

Change to the SEC’s Settlement Policies

The SEC’s Chief Litigation Counsel, Matthew Martens, spoke briefly about the SEC’s settlement practices.  When the Commission elects to settle a case, he said, its policy is to accept only settlements that reflect what the Commission believes it could reasonably expect to obtain in a successful trial.  If the terms of the settlement reflect what the SEC might achieve at trial, Martens said, there is no reason to forego settlement simply because a defendant does not admit liability. 

In defense of SEC settlements, Martens noted that the agreements include great detail of the violations alleged – more information, in fact, than other agencies provide.  And importantly, while the SEC may not require an admission of guilt, it does not allow settling parties to denyguilt.  The SEC has settled more than 2,000 cases in the past three years, and the judges presiding over those matters requested additional information about the settlement less than 10 times. 

Nevertheless, Martens insisted that the SEC is committed to trying cases in appropriate circumstances, noting that the SEC has an “impressive record” in litigated matters.  The SEC has prevailed in 80% of its trials since October 2010, he says. 

* * * * *

For those that follow the ebbs and flows of SEC enforcement matters, some of these themes and trends may come as little surprise.  It is important, however, for regulated entities to track – or periodically remind themselves of – the SEC’s enforcement priorities.  

Q: I am chief of staff for a Senator, and I have a question about providing services to our constituents. Our office constantly receives requests from constituents to help with matters pending before federal agencies, often from campaign contributors. Sometimes it makes me uneasy to help contributors. It almost feels like bribery to use our office’s influence on behalf of people who have given money to our Senator’s campaign. On the other hand, constituent services is an important part of a Senator’s job, and it would seem arbitrary, or even political suicide, to refuse to provide services for some constituents merely because they happen to have contributed to our Senator’s campaign. Is it OK to do favors for campaign contributors?

A: Yes, it is OK to provide services to contributors. In fact, the Senate Ethics Manual encourages it. It calls assisting constituents before government agencies “an important function of congressional oversight” and says specifically that providing constituent services to contributors is “a legitimate and appropriate senatorial function.”

Senate Rule 43 confirms this. Adopted in 1992 in the aftermath of the Keating Five S&L scandal, it affirms that “a Member of the Senate, acting directly or through employees, has the right to assist petitioners before executive and independent government officials and agencies.” Under the rule, that assistance might include requesting a status report, urging prompt consideration, arranging for interviews or appointments, expressing judgments or even calling for reconsideration of an administrative response with which the Senator disagrees.

However, as the Senate Ethics Committee has acknowledged, things are a little more complicated when requests for help come from contributors. “Special issues of ethics and propriety are raised when Members intervene ... on behalf of a ... contributor to ... or fundraiser for their campaigns or other causes,” the Senate Ethics Manual says. Because a Senator must rely on numerous individuals and organizations to contribute to their campaigns, it is likely that at some point some of those individuals will seek assistance from the Senator. If a contributor has a matter that a Senator “reasonably believes he or she is obliged to press because it is in the public interest or the cause of justice or equity to do so, then the Senator’s obligation is to pursue” it.

The key is that Senators should try to treat contributors and noncontributors essentially the same. This follows from what the Senate Ethics Committee has called the “cardinal principle” in this area: The decision about whether to intervene for an individual should be made “without regard to whether the individual has contributed, or promised to contribute.” Senate Rule 43 codifies this principle. It prohibits basing the decision to assist a constituent on whether the constituent has contributed to a Senator’s campaign or causes. Given the frequency with which Senate offices receive requests for assistance, all Senate offices should be mindful of this rule.

Moreover, beyond the actual substance of the decision to help a constituent, there is also the issue of appearances. The Senate Ethics manual is full of reminders that appearances matter. The general concern is that the public’s respect for the law might decline if there is the perception that the governmental process reflects the desires of special interests rather than the public good.

The Ethics Manual provides guidance regarding how to minimize this concern when handling requests for assistance from contributors. It says that several factors warrant attention. First, there is the merit of the individual’s request. Second, there is the amount of the contribution or contributions the individual has made or raised, including whether the amount is more than the average contribution. Third, there is the history of the individual’s donations, including whether the individual has made donations in the past. Next, there is the nature of the individual’s request, including whether it would require the Senator to take an action that would deviate from normal conduct. And, finally, there is the proximity of time between an individual’s contribution and the request for assistance.

None of these factors is controlling or by itself requires or prohibits a particular course of action. In fact, the Ethics Manual makes a point of saying that, when fielding requests for help from contributors, the Ethics Committee does not endorse or require any particular procedure as it “does not seek to elevate form over substance.”

So, by all means, continue to help your constituents — contributors and noncontributors alike. I am no expert in fundraising, but I suspect that a sure way to see a drop in campaign funds is to implement a policy against helping contributors. The good news is that nothing in the ethics rules requires you to stop helping contributors. Just remember to take care while you are doing it.

Q: I am a Senate staffer with a question about the STOCK Act. I have a friend who is an attorney, and he said that one of the biggest consequences of the act is a possible expansion of the law forbidding Members and staffers from accepting gratuities from constituents. I know that this has been a tricky area for Members and staffers in the past, and we have always been very careful in our office in handling gifts from constituents. Is the gratuities law expanding?

A: Last week, by a 417-2 vote, the House approved a bill widely known as the STOCK Act. As the bill wound its way through Congress, much of the media coverage focused on the bill’s ban of “insider trading” by Members and staffers. This is understandable, given its name: the Stop Trading on Congressional Knowledge Act. Less attention has been received by some key amendments made to the bill in the Senate before it was sent to the House.

Those amendments, authored by Senate Judiciary Chairman Patrick Leahy (D-Vt.) and Sen. John Cornyn (R-Texas), would significantly affect several key anti-corruption laws, including the one you mention, the law prohibiting “gratuities.” To understand the proposed changes requires a little legal history.

The so-called gratuities law is, in fact, a subsection of the statute banning bribes, which never actually mentions the word “gratuity.” The subsection that has come to be known as the gratuities law prohibits giving “anything of value” to a public official “for or because of any official act performed or to be performed by such public official.” In short, you can’t tell a Member: “Thanks for your vote on that very helpful legislation. Here’s $50,000.”

The Supreme Court clarified the scope of this law in an important 1999 decision called U.S. v. Sun-Diamond Growers of California. A lower court had convicted Sun-Diamond Growers of California of violating the gratuities law for making several gifts to the secretary of Agriculture even though no link had been established between the gifts and an official act. Sun-Diamond appealed, arguing that the court had wrongly concluded that all that is required for a conviction under the gratuities law is that a gift be given because of the recipient’s official position. The prosecution responded that the statute should apply wherever a gift is “motivated, at least in part, by the recipient’s capacity to exercise governmental power or influence in the donor’s favor.”

In a unanimous decision, the Supreme Court sided with Sun-Diamond, ruling that the gratuities law, on its face, applies to gifts given for or because of some official act. Therefore, the law does not apply to gifts that are given on the basis of the recipient’s position, even if the donor is hoping to establish good will with the recipient that might affect future official acts.

The Supreme Court noted that “peculiar results” would flow if the law were interpreted so broadly as to criminalize gifts given on the basis of the recipients’ position. For example, the court said, the statute would then criminalize token gifts such as the replica jerseys given to the president by championship sports teams each year during ceremonial White House visits. The court stated a statute “that can linguistically be interpreted to be either a meat axe or a scalpel should reasonably be taken to be the latter.”

After the Sun-Diamond decision, reform groups immediately began lobbying Congress to respond. They urged Congress to revise the gratuities law to make it a crime for someone to give a gift on the basis of the recipient’s official position. Those efforts never made much progress until this year, when the Senate passed a version of the STOCK Act with the amendments expanding the gratuities law.

Specifically, the amendments would make it a crime to give a gift worth $1,000 or more “for or because of ... the [recipient’s] official position.” This means that for prosecutors to obtain a conviction under the law, they would no longer need to establish a link between a gift and some specific official act.

The amendments do include an exception for actions taken “as provided by law, for the proper discharge of official duty, or by rule or regulation.” The amendments define “rule or regulation” in this context to include rules and regulations governing the acceptance of gifts and campaign contributions. This appears to mean that gifts made in accordance with Congressional gift rules and campaign finance regulations would, by definition, not be violations of the gratuities law.

As it turns out, the version of the bill passed by the House did not include the amendments expanding the gratuities law, meaning their fate is now up in the air. While some consider the amendments to be as good as dead, Leahy has urged that they be considered in conference, where House and Senate negotiators will work to resolve the differences between the two versions of legislation.

To return to your question, it remains unclear whether the gratuities law will expand. But, whatever the fate of the proposed amendments, Members and staffers certainly have plenty of other reasons not to accept gifts, and constituents have plenty of reasons not to give them. As you are no doubt aware, the House and Senate gift rules greatly restrict gifts to Members and staffers. And, the Honest Leadership and Open Government Act of 2007 makes it a crime for lobbyists to knowingly make a gift that violates those rules.

So, while the gratuities law might not expand, this is no reason for Members and staffers to be any less careful about gifts from constituents. Continue to proceed with care.

The Securities and Exchange Commission announced on Friday, January 6^th a significant new policy: companies that admit to criminal charges in securities fraud matters will no longer be able to settle SEC charges without admitting guilt in enforcement proceedings stemming from the same conduct.  The SEC’s Director of Enforcement, Rob Khuzami, reportedly explained:

The new policy does not require admissions or adjudications of fact beyond those already made in criminal cases, but eliminates language that may be construed as inconsistent with admissions or findings that have already been made in the criminal cases.

The Wall Street Journal’s Joe Palazzolo explains, “The policy change eliminates what had been a strange feature of parallel criminal and civil proceedings. Even when companies admitted to broad criminal violations in settlements with the Justice Department, which carry greater consequences than civil charges, they weren’t required to make an admission in their settlements with the SEC.”

As Law360 reports, Khuzami stressed that the policy change will apply only in a minority of cases where there are parallel criminal proceedings arising from the same misconduct.  And, importantly, SEC settlements will not require companies to admit to broader misconduct than admitted in the concurrent criminal proceedings. 

Many do not view the new directive as a significant shift in SEC policy.  John Carney of CNBC, for example, insists that “the change will have very little impact on most of the cases the SEC brings.”   Carney believes most companies seeking to settle SEC matters can still avail themselves of the “neither admit nor deny” language, because “[o]nly companies that admit or are convicted in a criminal court will actually be denied those familiar words of settlement blather.” 

Still, for companies faced with parallel enforcement proceedings, the shift in policy may in fact shape their litigation strategy.  Companies in such a situation should consider, first, the timing of any settlement with the Commission.  Settlement on a “neither admit nor deny” basis may be available until the company admits guilt in the parallel criminal matter.  Thus, settling with the SEC first may present an opportunity to secure settlement on favorable terms. 

Second, for companies forced to admit guilt in an SEC settlement under the new policy, it is essential to make sure the admission covers the same conduct or elements described in the criminal matter.  While the SEC insists it will not ask companies to admit to broader misconduct, it is ultimately up to the companies to ensure any admission is sufficiently narrowly tailored. 

On November 28, 2011, SEC Chairman Mary Schapiro sent a letter to Senator Jack Reed, Chairman of the Senate Subcommittee on Securities, Insurance and Investment, requesting “statutory changes [that] would further enhance the effectiveness of the Commission’s enforcement program by expanding the Commission’s authority to seek monetary penalties for the most serious securities law violations.”  Despite “impressive” enforcement results in 2011, Schapiro says, legislative changes are needed to further deter securities laws violations.  To that end, she proposes increasing limits on civil monetary penalties and “substantially rais[ing] the financial stakes for securities law recidivists.”   

In order to deter – and in appropriate circumstances penalize – violators of the federal securities laws, Schapiro seeks to exponentially increase existing caps on civil penalties the SEC may recover in an enforcement action: from $150,000 per violation to $1 million per violation for individuals; and from $725,000 per violation to $10 million per violations for “entities.”  And in certain cases, Schapiro would like authorization to seek a penalty equal to the amount of investor losses caused by a securities law violation.   

Central to Schapiro’s request – and perhaps of more practical importance – is a proposal that would allow the SEC to prosecute more enforcement matters in administrative proceedings.  As Peter Henning of the NY Times reports:

There are a number of advantages for the S.E.C. to pursuing a case administratively, including limited discovery rights for the respondent in the action and a quicker hearing.  There is a perception among securities lawyers that the S.E.C. has something of a “home court” advantage in cases heard by an administrative law judge because the decision will be reviewed first by the full commission, which authorized filing the action, before it ever goes before a federal judge.

If approved, Henning says, the changes would allow the SEC to pursue enforcement matters outside of the federal courts, thereby “skirting the kind of scrutiny Judge Rakoff applied” in rejecting the SEC’s proposed settlement with Citigroup.  (Journalists for Bloomberg and Reuters, too, draw connections between Schapiro’s letter requests to Senator Reed and the rejected Citi settlement.)  

The requested changes, Schapiro argues, “would substantially enhance the effectiveness of the Commission’s enforcement program by addressing existing limitations that have resulted in criticism regarding the adequacy of Commission actions.”  If nothing else, the increased penalties contemplated would drastically change the stakes for regulated individuals and entities.  

Schapiro plans to prepare and submit to the Senate Subcommittee proposed language affecting the propose changes.  The fate of the draft legislation is yet to be determined, but companies should follow this space closely. 

In a rebuke to the SEC, on Monday, November 29, 2011, U.S. District Court Judge Jed Rakoff (SDNY) refused to sign a consent judgment approving a $285 million settlement between the Agency and Citigroup.  At issue is a lawsuit filed in October 2011 by the SEC alleging that Citigroup created and sold mortgage bond investments without disclosing to investors that the people assembling the deal were betting against the performance of the securities.  As a result, Citigroup allegedly reaped a $160 million profit from the sale while investors lost more than $700 billion.  On the same day the Agency filed suit, the SEC filed a consent agreement whereby Citigroup agreed to disgorge the $160 million plus $30 million in interest, pay a civil penalty of $95 million, and undertake internal measures designed to prevent recurrences of the securities fraud alleged.  Under the agreement, Citigroup neither admits nor denies the SEC’s allegations, a longstanding practice by the SEC. 

Judge Rakoff’s opinion is significant because the SEC has routinely sought settlements similar to this one, whereby the defendant neither admits nor denies the SEC’s allegations of wrongdoing in exchange for a fine and/or injunctive relief.  Judges have generally signed off on such agreements as a matter of course.  However, it is precisely this practice that Judge Rakoff now finds offensive.  His 15-page opinion calls the entering into such an agreement, whereby a defendant neither admits nor denies allegations, “hallowed by history, but not by reason,” and ruled that he could not sign off on such an agreement because a judge must have some facts upon which to exercise “even a modest degree of independent judgment.”  Without such independent judgment, he refused to sign the consent agreement.

Traditionally, the SEC has arranged settlements such as the agreement with Citigroup because doing so allows the Agency to declare victory without having to devote the considerable time and money it would take to take the same matter to trial.  Requiring an admission of wrongdoing, which Defendants are reluctant to do, would decrease settlements and increase the number of trials.  Thus, if Judge Rakoff’s opinion gains traction, the SEC will have to dramatically shift how it uses its resources, with broad implications for the Agency and Defendants alike. 

In the meantime, as Kevin LaCroix at the D&O Diary notes, the SEC and Citigroup will likely have to work out a deal omitting the “admits or denies” language, and Citigroup will probably have to make a greater monetary contribution before a proposed settlement passes Judge Rakoff’s scrutiny.  Meanwhile, the clock is ticking; trial is scheduled for July 16, 2012. 

Today, the SEC announced that it has entered into its first-ever Deferred Prosecution Agreement (“DPA”).  The agreement brings to light a significant resolution option that may be on the table for companies that discover potential violations of federal securities laws during internal investigations or are already the subject of an SEC investigation or enforcement action.

Last year, the Securities and Exchange Commission announced its plan to use Non-Prosecution Agreements (“NPA”) and DPAs as part of an initiative to encourage companies and individuals to cooperate in ongoing investigations and enforcement actions.  In December 2010, as reported here on Subject to Inquiry, the Commission entered into its first NPA.  The agreement with Tenaris S.A. marks the first time the Commission has made use of a DPA to “facilitate and reward cooperation in SEC investigations.” 

During a “thorough, worldwide internal review of its operations and controls,” Tenaris discovered potential violations of the Foreign Corrupt Practices (“FCPA”) involving the bribery of Uzbekistani government officials.  Tenaris informed the SEC of the violations and “took noteworthy steps [internally] to address the violations and significantly enhance its anti-corruption policies and practices to remediate weaknesses in its internal controls.”  Tenaris also agreed to cooperate with the SEC, Justice Department, and other law enforcement agencies during any related investigations. 

Under the terms of the DPA, the Commission will refrain from prosecuting Tenaris if the company undertakes to further enhance certain policies and procedures, strengthen its FCPA and anti-corruption controls, continue to cooperate with the SEC in its investigation, and report any future violations of anti-bribery or securities laws.  In addition, Tenaris must pay $5.4 million in disgorgement and prejudgment interest.

The DPA is significant to companies for several reasons.  First, it shows that the Commission will, in fact, make good on its promise to consider the use of DPAs in appropriate cases.  Second, it makes plain the importance of periodically conducting comprehensive internal investigations to identify weaknesses in corporate controls and compliance measures.  And, finally, it underscores the potential value of self-reporting in the unfortunate event that a company discovers a violation of the FCPA or securities laws during an internal investigation. 

A year ago, SEC Enforcement czar Robert Khuzami revealed several new “tools” available to Enforcement staff as part of a Commission initiative aimed at encouraging cooperation with ongoing investigations and enforcement actions.  Among Enforcement “tools,” you will now find Deferred Prosecution Agreements (“DPAs”) and Non-Prosecution Agreements (“NPAs”), pursuant to which the Commission might suspend or forego enforcement proceedings.  And Enforcement staff is making use of their new tools: As we reported earlier this month, in December 2010 the SEC entered into its first NPA since Khuzami’s announcement.  

Now that the Commission is officially in the DPA/NPA business, what new features can we expect to see on the enforcement landscape?  One strong possibility is the use of independent corporate monitors in an SEC investigatory and/or enforcement context. 

Khuzami is a former federal prosecutor so he is well aware of the Justice Department’s established practice of imposing corporate monitorships in connection with DPAs and NPAs.  Since the Arthur Andersen scandal, the DOJ has made increasingly frequent use of independent monitors in its deferred and non-prosecution arrangements.  Roughly 30% of the DPAs and NPAs entered into by the DOJ require the creation of an independent corporate monitor who is responsible for identifying existing compliance issues, creating or beefing up compliance and ethics programs, and reforming corporate culture to help avoid future compliance issues.

While the SEC’s proposed use of DPAs and NPAs came about as part of a program designed to foster cooperation, there are clues in the SEC’s December 2010 NPA that would seem to suggest that Enforcement staff is pursuing the DOJ model.  In its press release announcing the NPA, the Commission listed the corporation’s substantial remedial actions among the reasons for non-prosecution.  It looks, therefore, like the Commission is heading down the road to exchanging remedial compliance measures for non-prosecution.   

And independent corporate monitors may be the next logical step.  Corporate monitorships would serve the same function in enforcement matters that they do in a criminal context: facilitating and encouraging corporate compliance with federal securities laws. 

Companies should take note that corporate monitors may be on the horizon in the SEC’s new DPA/NPA era.  Corporate monitorships have become “slightly controversial in recent years,” according to a Main Justice report.  This is principally because they can be costly, lengthy affairs in which a company cedes control over internal compliance measures to a third party.  As a result, some federal judges, including Judge Ellen S. Huvelle, have vigorously questioned the expediency of imposing corporate monitorships.  

Still, according to Charles Duross, chief lieutenant of the DOJ’s FCPA team, “Corporate monitors are not going away.”  We will have to wait and see whether the SEC chooses to pursue its compliance objectives by swapping DPAs and NPAs for corporate monitorships. 

A recent litigation release reveals the SEC’s continued determination to use Section 304 of the Sarbanes-Oxley Act of 2002 to compel CEOs and CFOs of companies required to restate their financial statements to repay bonuses and other forms of compensation.  The SEC has sought to force the return of such executive compensation without alleging and proving fraud or other misconduct by the CEOs or CFOs.

Diebold, Inc., a manufacturer and seller of ATMs, bank security systems, and electronic voting machines, was required to restate its financial statements for 2003 and additional reporting years after allegedly engaging in accounting fraud and other misconduct (pdf).  Under Section 304, once an issuer is required to restate its financials due to material misstatements or omissions, the CEO and CFO of the issuer must reimburse the issuer for any bonus or other incentive-based or equity-based compensation received during the 12-month period following the issuance of the financial document (and the profits realized from the sale of securities of the issuer during the same 12-month period). 

The SEC alleged that former CEO Walden O’Dell violated Section 304 after failing to reimburse Diebold (pdf) for the $470,016 in cash bonuses, 30,000 shares of Diebold stock, and stock options for an additional 85,000 shares of stock he received during the 12-month period following the restated Form 10-K for 2003.  Based on the fact that O’Dell was the CEO of Diebold during the restatement period, and without any allegation of personal misconduct on the part of O’Dell, the SEC determined that a violation of Section 304 of SOX occurred and that O’Dell was responsible for reimbursing Diebold.  According to the SEC’s website, O’Dell, without admitting or denying the allegations, agreed to consent to an order requiring that he reimburse Diebold for his bonus and other incentive/equity-based compensation.

The SEC’s confidence in using the SOX “clawback” against CEOs and CFOs without any proof of fraud or other misconduct has been bolstered by two recent judicial opinions.  First, on June 9, 2010, in SEC v. Jenkins, a federal district court in Arizona ruled in favor of the SEC to allow the recovery of compensation from CEOs and CFOs without showing incidents of misconduct or fraud.  Second, on June 28, 2009, in Free Enterprise Fund v. Public Company Accounting Oversight Board (pdf), the Supreme Court upheld SOX as “fully operative as law.”  With these recent successes, we can only foresee additional use of the clawback provision by the SEC.