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CLE 1 04Globalhale&Dorr FIN GLOBAL COMPLIANCE | In the Twilight Zone PARALLEL PROSECUTIONS AND THEIR COLLATERAL CONSEQUENCES Parallel criminal and SEC prosecution presents new risks for companies—and complicated questions for their general counsel. BY STEPHEN A. JONAS AND JONATHAN A. SHAPIRO resumably no one from seized documents from its execu- IN BRIEF HealthSouth was in the tives’ offices as part of an investi- PAnn Arbor lecture hall in gation that later culminated in An unprecedented spike in SEC-related November 2002, when the the first criminal prosecution for NEWSCOM.COM criminal cases demonstrates that Securities and Exchange Com- a violation of the Sarbanes-Oxley prime example—but by no parallel prosecutions may be here to mission’s enforcement chief certification requirements. The means the only one—of the stay. GCs facing such an investigation delivered the message to Univer- other shoe dropped the follow- government’s willingness to or prosecution should: sity of Michigan law professors ing day, when the SEC filed a bring parallel prosecutions: • Recognize the warning signs of a and students that “it’s a whole civil enforcement action against WorldCom, Enron, Qwest, potentially serious inquiry new ball game.” Instead of the company and then-CEO Adelphia, Rite Aid, and • Think disclosure “cajoling” criminal prosecutors Richard Scrushy, and a federal Imclone/Martha Stewart are • Assume that multiple agencies are into bringing securities cases, court entered a temporary just a few of the others. collaborating in the investigation director Stephen Cutler restraining order escrowing General counsel should expect • Understand that parallel does not explained that his Enforcement “extraordinary payments” by the the SEC and U.S. attorneys to mean simultaneous Division was “fending off calls.” company and freezing Scrushy’s continue to prosecute the • Remember that all conversations with Only the setting was academic: personal assets. To date, 15 same conduct, under the same the government are memorialized— the SEC and U.S. attorneys former HealthSouth executives or similar statutes, without and that the Fifth Amendment has now routinely prosecute public have pled guilty to various secu- any effort to divvy up investi- a downside company malfeasance with rities fraud charges, and in gations for sole prosecution by • Ensure that cooperation with the “parallel” criminal and civil November an 85-count indict- one agency or the other. government is real, not cosmetic enforcement proceedings. ment was unsealed charging The trend is not limited to • Avoid being labeled obstructionist The SEC’s message arrived Scrushy with securities fraud, headline cases: in Birmingham, Alabama, on mail and wire fraud, money • “SEC-related criminal cases” March 18, 2003. The FBI exe- laundering, conspiracy, and were filed against 259 defen- cuted a search warrant at other federal offenses. dants during fiscal year 2002. HealthSouth’s headquarters and The HealthSouth case is a The last time the commission 42 CHIEF LEGAL EXECUTIVE CHIEFLEGALEXECUTIVE. COM From left: Joel Gordon, acting chairman of the board of directors at HealthSouth; Sage Givens, an audit committee member; Phillip Watkins, former compensation committee member; Larry Striplin, former chairman of the compensa- tion committee; and Robert May, acting CEO of HealthSouth, are all sworn in prior to testifying before the House Subcommittee on Oversight and Investigation on November 5, 2003, in Washington, D.C. a broader investigation with help from the FBI, the National Association of Securities Dealers, the San Diego District Attorney, the British Columbia and Ontario Securities Commis- sions, and the Royal Canadian Mounted Police.) • The SEC has prosecuted pri- vate and public companies that engage in round-trip or side- letter deals that wind up as some- one else’s overstated revenue, reported the statistic was 1999, cops on the beat.” Smaller issuers which is what happened to a for- when, according to the annual and those accused of less egre- mer executive of Logicon (aiding report, there were just 64 indict- gious conduct may bear the and abetting securities violations ments or informations in “related General counsel should brunt of the SEC’s 800-plus by Legato Systems Inc.) and criminal proceedings.” Although additional lawyers, accountants, executives of a private company the SEC has not yet released offi- expect the SEC and U.S. and other personnel. that assisted Homestore in cial numbers for fiscal year 2003, • Since the summer, the SEC has implementing a round-trip by all indications the prosecutors attorneys to continue to aggressively prosecuted (some- transaction. Given this trend, again will break records. times in tandem with criminal counsel also may wish to moni- • Since its inception in 2002, prosecute the same conduct, prosecutors) “other participants” tor relationships with vendors prosecutors working with the in securities fraud, who before and other business partners. President’s Corporate Fraud Task under the same or similar now were probably out of dan- Force have investigated potential ger. Enforcement actions have Making Difficult Decisions corporate fraud involving more statutes, without any effort been brought against lower-level With Limited Information than 500 individuals and compa- employees, those who may not Companies under parallel crim- nies and filed at least 169 corpo- to divvy up investigations for have benefited (at least directly) inal and civil investigations rate fraud crime cases. (See from the alleged misconduct, or are extraordinarily vulnerable “Getting the Bad Guys,” p. 37.) sole prosecution by one didn’t benefit much, as in the because decisions that bolster the • Last fall, SEC Chairman recent case against an attorney defense of one proceeding may William Donaldson told a room agency or the other. who avoided a $922.14 loss compromise or even imperil of corporate directors and their by insider trading. (The SEC their position in another. counsel that he is putting “new brought the latter case as part of Unfortunately, general counsel WINTER 2004 CHIEF LEGAL EXECUTIVE 43 GLOBAL COMPLIANCE | In the Twilight Zone Timeline: From All Sides In just two years, Homestore, the online real estate company, has faced some two dozen shareholder suits, five rounds of prosecution, and more. December 6, 2001 Resignation: Homestore CFO resigns (“personal reasons”). does “not bring any enforcement action against Homestore because December 21, 2001 Restatement: Homestore announces plan to restate of its swift, extensive, and extraordinary cooperation.” financials (extent and time period unknown) and inquiry into September–October 2002 Insurance: D&O insurer sues to rescind policies. accounting practices. Trading halted. January 9, 2003 Parallel Prosecution (Round 2): SEC and U.S. attorney December 27, 2001 Shareholder Suit: First of at least 19 class actions filed simultaneously prosecute former manager, who settles with SEC and (federal court). pleads guilty to criminal charges. January 2, 2002 Restatement: Homestore announces preliminary finding that April 23, 2003 Parallel Prosecution (Round 3): SEC and U.S. attorney simul- advertising expense in FY 2001 overstated by $54 million–$95 million. taneously prosecute three officers and directors of advertising agency January 4, 2002 Shareholder Suit: First of four derivative actions filed that did business with Homestore. (California and Delaware state courts). May–July 2003 Insurance: D&O insurers granted summary judgment; poli- January 7, 2002 Resignation: Homestore announces new CEO, CFO, and cies judged rescinded. Homestore appeals. COO. Former CEO resigns to pursue new technology venture. August 13, 2003 Shareholder Suit: Homestore settles class action for $13 January 16, 2002 Resignation: Seven more employees terminated or resign. million in cash, issuance of 20 million new shares common stock, February 22, 2002 NASDAQ: Trading resumes, but market initiates delisting and adoption of new corporate governance provisions. process for failure to timely file SEC filings. September 18, 2003 Parallel Prosecution (Round 4): SEC and U.S. attorney March 12, 2002 Restatement: Homestore announces that it overstated simultaneously prosecute three former Homestore managers; each FY 2000 revenue by $41.4 million. settles with SEC and pleads guilty to criminal charges. SEC also files April 3, 2002 Restatement: Homestore announces that it overstated enforcement proceedings against former Homestore VP and manager, FY 2001 revenue by $123 million. and against former CEO and CFO of private company that did busi- April 10, 2002 NASDAQ: Homestore announces that it will remain listed. ness with Homestore; each settles with SEC. September 25, 2002 Parallel Prosecution (Round 1): SEC and U.S. attorney September 26, 2003 Parallel Prosecution (Round 5): SEC and U.S. attorney simultaneously prosecute former CFO, former COO, and former VP; simultaneously prosecute former CFO of advertising agency that did each settles with SEC and pleads guilty to criminal charges. SEC business with Homestore. must react to SEC and other responses required. The govern- as a seemingly “routine” inquiry inquiries before they understand ment sets the calendar, providing from the SEC, a customer calling the potential magnitude of the little, if any, warning before it with a “usual course” question Unfortunately, general investigation under way, perhaps files charges and issues press that may have been prompted even without knowing their releases, which beyond creating
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