A BNA, INC. SECURITIES! REGULATION & LAW REPORT

Reproduced with permission from Securities Regula- tion & Law Report, 41 SRLR 360, 3/2/2009. Copyright ஽ 2009 by The Bureau of National Affairs, Inc. (800- 372-1033) http://www.bna.com

ENFORCEMENT

Top 10 SEC Enforcement Developments of 2008

1 BY MARC DORFMAN AND ELLEN WHEELER Madoff , as well as to the departure of the SEC’s Direc- tor of the Division of Enforcement, Linda Thomsen.2 his article highlights significant developments dur- The Madoff scandal and its fallout are the Number One ing 2008 in the enforcement program of the U.S. enforcement development of 2008. T Securities and Exchange Commission (‘‘SEC’’). Developments were selected because they may signal The SEC’s enforcement actions and investigations re- future trends or establish new legal standards. lating to auction rate securities and the subprime lend- Many commentators predicted that SEC enforcement ing market during 2008 were noteworthy, and include actions arising from the freezing of the auction rate se- the largest settlements in the history of the SEC on be- curities market or the subprime lending meltdown half of investors. While it is difficult to make any pre- would lead the list of important SEC enforcement devel- dictions in the current economic and regulatory cli- opments in 2008. Such cases have been overshadowed, mate, these proceedings provide some guidance as to however, by the unraveling of the $50 billion Ponzi the types of cases the SEC is likely to pursue in 2009. scheme allegedly perpetrated by Bernard Madoff and The SEC’s response to the freezing of the auction rate the intense scrutiny of the SEC that has followed. In- securities market is the Number Two enforcement de- deed, in the weeks following the initial Madoff disclo- velopment, while the SEC’s cases relating to the sures, the SEC has been subjected to a firestorm of criti- subprime market, including actions against mortgage cism by the media and Congress, leading to an an- brokers, is the Number Three enforcement develop- nouncement that the SEC’s Inspector General was ment, of 2008. investigating the SEC’s regulatory failures relating to The remaining Top Ten developments highlight other significant issues and trends in the SEC enforcement program: Marc Dorfman and Ellen Wheeler are mem- s bers of the Securities Enforcement & Liti- The Number Four enforcement development of gation Practice Group of Foley & Lard- 2008 is the emphasis that the SEC has placed on pursu- ner LLP. Adrian Jensen also contributed to the ing , including the highest number of in- preparation of this article. Foley & Lardner LLP represents parties who are the subject of 1 Press Release No. 2008-297 (available at http:// SEC enforcement inquiries and actions, www.sec.gov/news/press/2008/2008-297.htm). including in cases discussed in this article. 2 Press Release No. 2009-22 (available at http:// www.sec.gov/news/press/2009/2009-22.htm).

COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 0037-0665 2 sider trading cases in the SEC’s history as well as the off Securities is the world’s largest Ponzi Scheme.’’5 first Section 21(a) report since 2005. The thrust of Mr. Markopolous’s analysis was that there s Number Five is the SEC’s continued focus on vio- simply were not enough options traded in any market to lations of the Foreign Corrupt Practices Act of 1977. support the trading strategy that Madoff was allegedly s Number Six is the Ninth Circuit’s reversal of a dis- pursuing according to the materials provided to Mad- trict court opinion challenging ‘‘stealth’’ parallel pro- off’s investors. While the SEC investigated Mr. Marko- ceedings. polous’s tips, the SEC’s enforcement staff closed the s case asserting that, while the staff had found minor dis- Number Seven is the SEC’s first market manipu- closure violations, ‘‘[t]he staff found no evidence of lation case based on rumor mongering. fraud’’ and that the violations they had found ‘‘were not s Number Eight is the First Circuit’s decision poten- so serious as to warrant an enforcement action.’’6 tially expanding the scope of primary liability for mis- The SEC has been widely criticized in the media for statements contained in prospectuses. not taking earlier action on complaints against Madoff s 7 Number Nine is the Second Circuit’s decision af- and BMIS. On December 16, 2008, then Chairman Cox firming dismissal of an indictment based on the govern- issued a statement acknowledging that ‘‘credible and ment’s interference with an employer’s advancement of specific allegations’’ regarding Madoff’s conduct going legal fees to individuals. back to at least 1999 were repeatedly brought to the s Number Ten is the Eleventh Circuit’s decision up- staff’s attention, but never recommended to the Com- holding penalties and disgorgement despite the defen- mission for action.8 He further stated that he was dant’s claimed inability to pay. ‘‘gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these al- legations or at any point to seek formal authority to pur- 1. The Fallout from the Madoff Scandal sue them.’’ Cox also noted that the failure to seek a for- mal order of investigation meant that the staff relied on On December 11, 2008, the SEC filed a complaint information voluntarily produced by Madoff and BMIS, with the U.S. District Court for the Southern District of rather than using subpoena power. Cox stated that he New York against Bernard L. Madoff (‘‘Madoff’’) and had directed the SEC’s inspector general to conduct an Bernard L. Madoff Investment Securities LLC 3 investigation into ‘‘the past allegations regarding Mr. (‘‘BMIS’’). The SEC alleged that Madoff had admitted Madoff and his firm and the reasons they were not to two senior employees of BMIS that the investment found credible....’’ advisory business was ‘‘basically, a giant Ponzi scheme’’ and estimated losses from this fraud to be ap- On January 5, 2009, SEC Inspector General H. David proximately $50 billion.4 Kotz testified before the U.S. House of Representatives Committee on Financial Services and reported that his Within days of the SEC’s filing of its complaint, the office had opened an investigation and that it intended Wall Street Journal reported that a competitor of Mad- to investigate the following specific issues: (1) the off had, for almost ten years, attempted to alert the SEC SEC’s response to complaints regarding Madoff; (2) al- to Madoff’s misconduct. Harry Markopolous, then chief legations of conflicts of interest regarding relationships investment officer at Rampart Investment Management between SEC staff and members of the Madoff family; Co., even submitted a paper to the SEC entitled ‘‘The (3) the conduct of examinations and/or inspections of World’s Largest is a Fraud’’ in November BMIS and whether any red flags were overlooked; and 2005, in which he surmised that Madoff was either (4) the extent to which Madoff’s reputation, his mem- front-running his customers or, more likely, that ‘‘Mad- bership on SEC Advisory Committees, his participation on securities industry boards and panels, and his social 3 Complaint in SEC v. Bernard L. Madoff & Bernard L. and professional relationships with SEC officials may Madoff Inv. Sec. LLC, Case No. 08 CIV 10791 (available at have affected decisions regarding investigation and ex- http://www.sec.gov/litigation/complaints/2008/comp- aminations.9 Perhaps of more far-reaching conse- madoff121108.pdf). On that same day, the U.S. Attorney for quence, Inspector General Kotz also testified that his the Southern District of New York filed a criminal complaint office also ‘‘plans to consider analyzing’’ certain against Madoff based on the same allegations. See criminal broader issues, including: (1) the Division of Enforce- complaint in U.S. v. Bernard L. Madoff, Case No. 08 MAG 2735 (available at http://www.usdoj.gov/usao/nys/madoff/ ment’s complaint handling procedures; (2) the SEC’s criminalcomplaint.pdf). Office of Compliance, Inspection and Examination’s 4 SEC Complaint, at ¶ 23. 5 Available at http://online.wsj.com/documents/madoff_ SECdocs_20081217.pdf. 6 SEC Division of Enforcement Case Closing Recommenda- Note to Readers tion (available at http://online.wsj.com/public/resources/ documents/Madoff_SECRecommend_20081217.pdf). The editors of BNA’s Securities Regulation & 7 See Julie Creswell & Landon Thomas Jr., The Talented Law Report invite the submission for publica- Mr. Madoff, N.Y. Times, Jan. 24, 2009, at BU1 (‘‘Current and tion of articles of interest to practitioners. former S.E.C. regulators have come under fire, accused of fail- ing to adequately supervise Mr. Madoff and being too cozy Prospective authors should contact the Manag- with him.’’). ing Editor, BNA’s Securities Regulation & Law 8 Press Release 2008-297 (available at http://www.sec.gov/ Report, 1801 S. Bell St. Arlington, Va. 22202- news/press/2008/2008-297.htm). 4501; telephone (703) 341-3889; or e-mail to 9 H. David Kotz, Inspector General, SEC, Testimony Before [email protected]. the U.S. House of Representatives Committee on Financial Services (Jan. 5, 2009) (available at http://www.sec.gov/news/ testimony/2009/ts010509hdk.htm).

3-2-09 COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 3 procedures, including whether there are gaps in the 2. The SEC’s Response to the Freezing of procedures relating to hedge funds that may lead to a the Auction Rate Securities Market failure to detect fraud; and (3) the relationship between different divisions and offices within the SEC and Auction Rate Securities (ARS) are securities with whether there is adequate communication and collabo- variable interest rates or dividend yields which are re- ration. set periodically through auctions. In these auctions, bid- It is too early to assess the full impact of the fallout ders submit buy bids at increasing interest or dividend from the Madoff scandal on the SEC. Early signals sug- rates to the pool of ARS holders willing to sell. The gest that the number of enforcement actions in 2009 highest rate accepted in the auction then becomes the will be much greater than in 2008—a year that wit- ARS interest or dividend rate until the next auction. The nessed the second-highest number of enforcement ac- ARS market froze in February 2008, as ARS auctions 14 tions in the SEC’s history.10 For example, in a recent began to fail in large numbers. speech, Commissioner Luis A. Aguilar complained that During 2008, the SEC reached preliminary settle- the Enforcement staff had been ‘‘coping with less staff ments with Bank of America, RBC Capital Markets and fewer resources’’ including a 10 percent reduction Corp., Wachovia, and Merrill Lynch, and reached final 15 in attorneys between 2005 and 2008.11 He stated that settlements with Citigroup and UBS. These settle- ‘‘the Commission should act quickly to rebuild and em- ments provide that up to approximately $50 billion will power the enforcement staff.’’ To do so, he urged that be provided to customers who invested in ARS before the SEC hire and staff the Enforcement Division at full the market froze. The settlements in the ARS cases are, capacity, streamline and expedite the process for ap- according to the SEC, ‘‘[t]he largest in the agency’s his- tory.’’16 proving formal orders of investigation, and ‘‘focus re- sources on cases involving the most egregious behavior The SEC’s allegations against each firm have cen- with broad market effect and to be able to clearly send tered around claims that the firms misrepresented to in- a message of deterrence.’’ Commissioner Aguilar also vestors that ARS were safe, liquid investments, despite encouraged the SEC to discontinue its policy of requir- knowing that the ARS market had been deteriorating since late 2007, and that their ability to support the mar- ing staff to seek Commission approval of a settlement ket had been impacted by the broader credit crisis. The range before initiating settlement discussions involving exact terms of the SEC settlements and settlements in a monetary penalty against a company. Shortly after principle vary from firm to firm, but share a common her appointment as SEC Chairman, Mary Schapiro an- framework. In each case, the primary objective appears nounced that such policy would be discontinued in or- to be provision of liquidity to the holders of the ARS. In der to ‘‘expedite the Commission’s enforcement efforts some cases, the settlements address individual and in- to ensure that justice is swiftly served to those public stitutional investors separately, requiring the settling companies who commit serious acts of securities firm to first cover losses from sales or purchase ARS at fraud.’’12 Additionally, in the month following the Mad- par from individual investors who purchased ARS from off filing, the SEC brought three actions against large the firm prior to the collapse in the ARS market, but re- Ponzi schemes.13 quiring only that the firm use ‘‘best efforts’’ to provide

10 SEC 2008 Report (available at http://www.sec.gov/ 14 In testimony before the House of Representatives on 2008annual/SEC_2008annual_trustp2.htm). September 18, 2008, Linda Thomsen, then the Director of the 11 Luis A. Aguilar, SEC Commissioner, Empowering the Division of Enforcement at the SEC, listed a number of pos- Markets Watchdog to Effect Real Results, Speech Address at sible factors that had resulted in the freezing of the ARS mar- the North American Securities Administrators Association’s ket, including (1) the size of the ARS market, which had grown Winter Enforcement Conference (Jan 10, 2009) (available at to $330 billion; (2) downgrades of the credit ratings for ARS http://www.sec.gov/news/speech/2009/spch011009laa.htm). On bond insurers; and (3) the larger credit crisis, which limited January 27, 2009, Senators Schumer, Shelby, Durbin, Fein- firms’ ability to make support bids in the ARS auction. Linda stein, Bayh, Tester, Graham, Sessions and Roberts introduced Chatman Thomsen, Director, Division of Enforcement, Testi- legislation to increase the number of federal law enforcement mony Before the U.S. House of Representatives Committee on officials prosecuting financial fraud by authorizing the hiring Financial Services (Sept. 18, 2008) (available at http:// of 500 additional FBI agents, 50 additional Assistant U.S. At- www.sec.gov/news/testimony/2008/ts091808lct.htm). torneys and 100 additional SEC enforcement staff members (S. 15 Press Release No. 2008-246 (Oct. 8, 2008) (available at 331, 111th Cong., 1st Sess.). http://www.sec.gov/news/press/2008/2008-246.htm) (announc- 12 Mary L. Schapiro, SEC Chairman, Address to Practising ing settlement in principle with RBC Capital Markets); Press Law Institute’s ‘‘SEC Speaks in 2009’’ Program (Feb. 6, 2009) Release No. 2008-247 (Oct. 8, 2008) (available at http:// (available at http://www.sec.gov/news/speech/2009/ www.sec.gov/news/press/2008/2008-247.htm) (announcing spch020609mls.htm). settlement in principle with Bank of America); Press Release 13 See SEC v. CRE Capital Corp., Litig. Rel. No. 20853 (Jan. No. 2008-181 (Aug. 22, 2008) (available at http://www.sec.gov/ 15, 2009) (available at http://www.sec.gov/litigation/litreleases/ news/press/2008/2008-181.htm) (announcing settlement in 2009/lr20853.htm) (action accusing CRE and its CEO and principle with Merrill Lynch); Press Release No. 2008-176 president of raising at least $25 million from 120 investors in (Aug. 15, 2008) (available at http://www.sec.gov/news/press/ Ponzi scheme); SEC v. Joseph S. Forte, Litig. Rel. No. 20847 2008/2008-176.htm) (announcing settlement in principle with (Jan. 8, 2009) (available at http://www/sec/gov/litigation/ Wachovia); SEC v. Citigroup Global Markets, Inc. and SEC v. litreleases/2009/lr20847.htm) (action accusing Forte of con- UBS Securities LLC, Litig. Rel. No. 20824 (Dec. 11, 2008) (an- ducting $50 million Ponzi scheme); SEC v. Creative Capital nouncing finalized settlements with Citigroup and UBS). On Consortium, LLC, Litig. Rel. No. 20840 (Dec. 30, 2008) (avail- February 5, 2009, the SEC announced that its settlement with able at http://www/sec/gov/litigation/litreleases/2008/ Wachovia had been finalized. Press Release No. 2009-17 (Feb. lr20840.htm) (action accusing Creative Capital of raising $23.4 5, 2009) (available at http://sec.gov/news/press/2009/2009- million from thousands of Haitian-Americans in Ponzi scheme 17.htm). consisting of a network of ‘‘investment clubs’’). 16 SEC 2008 Report, note 11 supra,at2.

SECURITIES REGULATION & LAW REPORT ISSN 0037-0665 BNA 3-2-09 4 liquidity to institutional investors.17 The settling firms to the terms of the SEC settlements, except that fines have also been required to agree to arbitrations under a have already been assessed. In some cases, such as the new FINRA arbitration process, at individual investors’ settlements with UBS and Citigroup, the fines have option. Neither the finalized settlements nor the settle- been split evenly between New York and the other ments in principle impose penalties. However, in an- states participating in the investigation.22 nouncing the settlements in principle, the SEC stated FINRA has also pursued settlements with firms in- that it has deferred the decision to impose penalties, volved in the sale of ARS, directing their attention to and may consider imposing a financial penalty in the firms not focused on by the SEC.23 To date, settlements future based on factors including whether the indi- have been reached with SunTrust Investment Services, vidual firm has fulfilled its obligations under its settle- Inc., SunTrust Robinson Humphrey, Inc., Comerica Se- ment agreement.18 curities, Inc., First Southwest Co., WaMu Investments, The SEC staff has also indicated that, with respect to Inc., City National Securities, BNY Mellon Capital Mar- 24 the firms with which the SEC has reached settlements, kets, LLC, and Harris Investor Services. Like the SEC the focus of the investigations is shifting to the conduct and state settlements, the FINRA settlements provide a of particular individuals.19 Thus far, details of most of buyback and loss coverage guarantee for individual in- these individual investigations have not been made vestors and certain institutions with accounts up to $10 available. One ARS-related enforcement action against million, and require the settling firms to use best efforts individuals was filed on September 3, 2008, accusing to provide liquidity for those investors not covered by two brokers formerly of Credit Suisse Securities (USA) the initial buyback. The FINRA settlements also include LLC of defrauding customers by leading them mistak- fines ranging from $150,000 to $1.65 million. enly to believe that ARS purchased in their accounts The Department of Justice has also initiated criminal were backed by federally guaranteed student loans and investigations into the collapse of the ARS market, ap- that ARS ‘‘were a safe and liquid alternative to bank de- parently focusing on potential misconduct involving in- posits or money market funds.’’20 vesting client money in ARS to prop up auctions that The SEC, FINRA, and various state regulatory au- might otherwise fail, investing client money in ARS de- spite knowing the market could collapse, and insider thorities, including the NASAA and the New York At- 25 torney General (NYAG), responded to the freeze in the trading. ARS market by coordinating their activities closely, in- cluding the sharing of investigative files and proceeding 3. SEC Actions and Investigations in together in disposing of cases. State regulators, who Connection with the Subprime Lending have been a part of the SEC settlements, have also reached separate settlements with JP Morgan, Morgan Meltdown Stanley, Credit Suisse, Deutsche Bank, and Goldman Sachs.21 The terms of the state settlements are parallel The SEC’s 2008 Report stated that the Division of En- forcement had ‘‘more than 50 pending . . . investiga- tions in the subprime area . . .,’’ and, as of February 6, 17 See, e.g., Press Release No. 2008-181 (Aug. 22, 2008) 2009, Los Angeles Regional Director Rosalind Tyson re- (available at http://www.sec.gov/news/press/2008/2008- ported that the SEC had ‘‘25 very active investigations 181.htm) (establishing different timing and standards for three classes of Merrill Lynch investors: (1) individual, charitable, and small business investors with account values up to $4 mil- Headlines/9289.cfm) (announcing settlements with Credit Su- lion; (2) remaining individual and charitable investors and isse); NASAA Press Release (Aug. 21, 2008) (available at http:// small businesses with account values up to $100 million; and www.nasaa.org/NASAA_Newsroom/Current_NASAA_ (3) institutional customers and business customers with ac- Headlines/9216.cfm) (announcing settlements with Merrill counts of more than $100 million); Press Release No. 2008-176 Lynch, Goldman Sachs, and Deutsche Bank); NASAA Press (Aug. 15, 2008) (available at http://www.sec.gov/news/press/ Release (Aug. 14, 2008) (available at http://www.nasaa.org/ 2008/2008-176.htm) (establishing different deadlines and stan- NASAA_Newsroom/Current_NASAA_Headlines/9197.cfm) dards for two classes of Wachovia investors: (1) individual in- (announcing settlements with JP Morgan and Morgan Stan- vestors, small businesses and charitable organizations, and (2) ley). other Wachovia investors). 22 NYAG Press Release, Attorney General Cuomo An- 18 Press Release No. 2008-246 (Oct. 8, 2008) (available at nounces Landmark Settlement with Citigroup to Recover Bil- http://www.sec.gov/news/press/2008/2008-246.htm) (announc- lions in Auction Rate Securities for Investors Nationwide (Aug. ing settlement in principle with RBC Capital Markets); Press 7, 2008) (available at http://www.oag.state.ny.us/media_center/ Release No. 2008-247 (Oct. 8, 2008) (available at http:// 2008/aug/aug7a_08.html) (announcing $50 million in fines to www.sec.gov/news/press/2008/2008-247.htm) (announcing be paid to New York state, and $50 million in fines to NASAA); settlement in principle with Bank of America); Press Release NYAG Press Release, Attorney General Cuomo Announces No. 2008-181 (Aug. 22, 2008) (available at http://www.sec.gov/ Landmark Settlement with UBS to Recover Billions for Inves- news/press/2008/2008-181.htm) (announcing settlement in tors in Auction Rate Securities (Aug. 8, 2008) (available at principle with Merrill Lynch); Press Release No. 2008-176 http://www.oag.state.ny.us/media_center/2008/aug/aug8a_ (Aug. 15, 2008) (available at http://www.sec.gov/news/press/ 08.html) (announcing $75 million in fines to be paid to New 2008/2008-176.htm) (announcing settlement in principle with York state and $75 million in fines to NASAA). Wachovia). 23 Susan Merrill, Chief of Enforcement, FINRA, Testimony 19 Linda Chatman Thomsen, Director, Division of Enforce- before the U.S. House of Representatives Committee on Finan- ment, Testimony Before the U.S. House of Representatives cial Services (Sept. 18, 2008) (available at http:// Committee on Financial Services (Sept. 18, 2008) (available at www.finra.org/Newsroom/Speeches/Merrill/P117018). http://www.sec.gov/news/testimony/2008/ts091808lct.htm). 24 FINRA News Release (Sept. 18, 2008) (available at http:// 20 SEC v. Julian T. Tzolov, Litig. Rel. No. 20698 (Sept. 3, www.finra.org/Newsroom/NewsReleases/2008/P117019); 2008) (available at http://www.sec.gov/litigation/litreleases/ FINRA News Release (Oct. 23, 2008) (available at http:// 2008/lr20698.htm). www.finra.org/Newsroom/NewsReleases/2008/P117292). 21 NASAA Press Release (Sept. 16, 2008) (available at http:// 25 Amir Efrati, U.S. Auction-Rate Investigation Picks Up www.nasaa.org/NASAA_Newsroom/Current_NASAA_ Steam, Wall Street J., Oct. 2, 2008.

3-2-09 COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 5 in the subprime area, involving securities sellers, mort- SEC brought the highest number of insider trading gage originators, securitizers, credit rating agencies cases in its history.32 These cases include actions and others.’’26 However, the SEC brought only a few against accountants,33 senior executives of public com- enforcement actions in 2008 that directly concern panies,34 and other Wall Street professionals.35 subprime mortgage-backed securities, so it seems likely A number of recent cases involve allegations of in- that the SEC will be very active in this area in 2009. sider trading in connection with Private Investment in On June 19, 2008, the SEC charged two former port- Public Equity (‘‘PIPE’’) transactions. In late 2007 and folio managers for Asset Management early 2008, however, numerous district courts rejected 27 (‘‘BSAM’’) with securities fraud. The SEC alleged that SEC arguments that covering short positions with PIPE Ralph Cioffi and Matthew Tannin misled investors stock violates Section 5 of the Securities Act.36 In SEC about the financial state of BSAM’s two largest hedge v. Mangan, the district court subsequently entered sum- 28 funds. The SEC’s complaint alleges that Cioffi and mary judgment in favor of the defendant on the remain- Tannin misrepresented the performance of the funds ing securities fraud claims under Section 17(a) of the and the level of redemption requests. The SEC also ac- Securities Act and Section 10(b) of the Exchange Act, cused Cioffi and Tannin of misrepresenting the expo- finding that the information regarding the PIPE trans- sure of the funds to subprime mortgage-backed securi- action was not material.37 The court rejected the SEC’s ties, claiming that the exposure was about 6 to 8 per- position that the court evaluate materiality based on cent when, in fact, it was approximately 60 percent. The market reaction during a window of time prior to the SEC also alleged that Cioffi and Tannin exaggerated short sale, during which time the SEC alleged informa- their personal investment in the two funds as a selling tion about the PIPE transaction was leaked into the point to keep other investors from redeeming. The U.S. market.38 The court instead concluded that the materi- Attorney’s Office for the Eastern District of New York ality of the information concerning the PIPE transaction has also secured an indictment against Cioffi and Tan- was to be determined at the time the short sale was ex- 29 nin on conspiracy and fraud charges. ecuted and, therefore, examined the stock price move- On October 3, 2008, the SEC charged five mortgage ment from the time of the trade until the close of the brokers with securities fraud, accusing them selling un- market, during which time the price of stock was rela- suitable securities to their customers paid for by refi- nancing their fixed-rate mortgages into unaffordable 32 subprime adjustable rate mortgages.30 The SEC alleged SEC 2008 Report (available at http://www.sec.gov/ that these brokers convinced their customers—who 2008annual/SEC_2008annual_trustp2.htm). 33 See, e.g., SEC v. James E. Gansman, Litig. Rel. No. 20603 were mostly of modest means with little investment ex- (May 29, 2008) (available at http://www.sec.gov.litigation/ perience, little or no post-high school education and, in litreleases/2008/lr20603.htm) (action against former Ernst & some cases, limited or no English skills—to purchase Young partner accused of providing material, non-public infor- variable life insurance policies. In order to pay for such mation learned through his work at Ernst & Young to others policies, the brokers urged their customers to refinance who used the information to trade). their fixed-rate mortgages into subprime adjustable 34 See, e.g., SEC v. Lou L. Pai, Litig. Rel. No. 20658 (Jul. 29, rate negative amortization mortgages that they could 2008) (available at http://www.sec.gov.litigation/litreleases/ not afford. The brokers were also registered represen- 2008/lr20658.htm) (settled action against former Chairman and tatives and received commissions in connection with CEO of a division of Corp. accused of selling Enron stock on basis of material, non-public information and ordered both the refinancings and the securities purchases. to pay $30 million in disgorgement and a $1.5 million penalty). 35 See, e.g., SEC v. Matthew C. Devlin, Litig. Rel. No. 20831 4. The SEC’s Emphasis on Insider (Dec. 18, 2008) (available at http://www.sec.giv/litigation/ litreleases/2008/lr20831.htm) (action against nine defendants Trading and three relief defendants alleging that registered representa- tive of Lehman Brothers, Inc. traded on and tipped clients and Early in 2008, SEC staff members gave a number of friends with inside information about 13 impending corporate speeches in which they emphasized that insider trading transactions and was rewarded with cash and luxury items); would be an area of focus.31 And, in fact, in 2008, the SEC v. Mitchell S. Guttenberg, Litig. Rel. No. 20022 (Mar. 1, 2007) (available at http://www.sec.gov/litigation/litreleases/ 2007/lr20022.htm) (action against fourteen defendants in con- 26 SEC 2008 Report, note 11 supra, at 4; Remarks at ‘‘The nection with two alleged insider trading schemes involving in- SEC Speaks in 2009,’’ reported in Enforcement Division Re- siders at UBS Securities LLC and an attorney at Morgan Stan- ports on Past Year’s Activities, SEC Today (Feb. 11, 2009) at 1. ley & Co., Inc. provided material, non-public information in 27 SEC v. Ralph R. Cioffi & Matthew M. Tannin, Litig. Rel. exchange for kickbacks). No. 20625 (June 19, 2008) (available at http://www.sec.gov/ 36 See, e.g., SEC v. Mangan, Civ. A. No. 06-CV-531 litigation/litreleases/2008/lr20625.htm). (W.D.N.C. filed Dec. 28, 2006); SEC v. Lyon, Civ. A. No. 06-CV- 28 Id. 14338 (S.D.N.Y., filed Dec. 12, 2006); Order in SEC v. Berla- 29 Id. cher, Civ. A. No. 07-cv-3800 (ER) (E.D. Pa., Feb. 5, 2008). 30 SEC v. Ainsworth, et al., Litig. Rel. No. 20768 (Oct. 3, 37 SEC v. Mangan, 2008 WL 3925059, *5 (W.D.N.C. Aug. 2008) (available at http://www.sec.gov/litigation/litreleases/ 20, 2008). On August 18, 2008, Hilary Shane, a former hedge 2008/lr20768.htm). fund manager who had been accused of trading on inside in- 31 See, e.g., Lori Richards, Director, Office of Compliance, formation concerning the same PIPE transaction as the one at Inspections and Examinations, Address at the SIFMA Compli- issue in Mangan, agreed to a deferred prosecution agreement ance and Legal Division January General Luncheon Meeting with the Office of the U.S. Attorney for the Southern District (Jan. 17, 2008) (available at http://www.sec.gov/news/speech/ of New York. Shane had previously settled charges brought by 2008/spch011708lar.htm); Linda Chatman Thomsen, Director, the SEC and NASD in 2005. Thom Weidlich, Shane, Ex-Fund Division of Enforcement, Regulatory Key Note Address at the Manager, Won’t Face Prosecution, Bloomberg.com, Aug. 18, Second Annual Capital Markets Summit, U.S. Chamber of 2008 (available at http://www.bloomberg.com/apps/news? Commerce (Mar. 26, 2008) (available at http://www.sec.gov/ pid+emailen&refer=funds&sid=aVUZBCH8yTdU). news/speech/2008/spch032608lct.htm). 38 SEC v. Mangan, 2008 WL3925059 at *2-3.

SECURITIES REGULATION & LAW REPORT ISSN 0037-0665 BNA 3-2-09 6 tively stable.39 The SEC has nonetheless continued to 5. The SEC’s Continued Focus on pursue insider trading actions based on non-public in- formation concerning PIPE transactions, including Violations of the Foreign Corrupt bringing a high profile action against Mark Cuban, in Practices Act which the SEC has alleged that Cuban sold his entire position, 600,000 shares, in Mamma.com after learning Continuing a trend from 2007, in 2008 the SEC ag- of an impending PIPE offering, avoiding losses in ex- gressively pursued violations of the Foreign Corrupt cess of $750,000.40 Practices Act of 1977 (‘‘FCPA’’). Although the SEC brought fewer FCPA actions than in 2007—a record While the SEC has encountered some judicial road- year—the SEC assessed markedly higher penalties than blocks pursuing its PIPE-related insider trading actions, in prior years. Indeed, the highest penalty assessed in it won a significant victory in the Ninth Circuit in an in- 2007—$44.1 million assessed against Baker Hughes, sider trading case. In SEC v. Talbot, the SEC alleged Inc.—is dwarfed by the $800 million settlement reached that J. Thomas Talbot, a member of the board of direc- by Siemens AG (‘‘Siemens’’) with the SEC and the U.S. tors of Fidelity National Financial, Inc. (‘‘Fidelity’’) Department of Justice (‘‘DOJ’’) in December 2008.46 In- traded on confidential information about an impending deed, the Siemens settlement is by far the largest pay- acquisition of LendingTree, Inc. (‘‘LendingTree’’), ment of fines and disgorgement in the history of the which he received in his capacity as a director of Fidel- FCPA. ity.41 The district court had entered summary judgment The SEC alleged that Siemens made thousands of in favor of Talbot, holding that Talbot could only be payments totaling approximately $1.4 billion to foreign held liable if he or Fidelity owed a duty of confidential- officials around the world in connection with numerous ity to LendingTree, i.e., that Talbot, Fidelity, and Lend- contracts, including the sale of medical devices in ingTree were ‘‘linked though a continuous chain of fi- China, Russia, and Vietnam, the sale of telecommunica- duciary relationships.’’42 The Ninth Circuit reversed, tion devices in Nigeria and Bangladesh, and the sale of holding that a continuous chain of duties is not required other equipment in Venezuela, China, Israel, China, Ar- for liability under the misappropriation theory of in- 43 gentina, Russia, and Mexico. The SEC’s Director of En- sider trading. Rather, the court concluded that it was forcement at the time, Linda Thomsen, described Si- enough that Talbot breached the duty of confidentiality 44 emens’ conduct as ‘‘unprecedented in scale and geo- that he owed to Fidelity. graphic reach.’’47 The SEC also made clear in 2008 that it intends not While the SEC detailed Siemens’‘‘widespread and only to pursue those who engage in insider trading, but systematic practice of paying bribes,’’ its ineffective also public companies and other market participants system of internal controls, and a corporate culture that that fail to enact, maintain or enforce anti-insider trad- ‘‘tolerated and even rewarded’’ bribery, the SEC also ing policies and procedures. In its first Section 21(a) Re- acknowledged Siemens’ cooperation and prompt reme- port in three years, the SEC discussed its investigation dial action.48 In particular, the SEC noted that Siemens’ of whether The Retirement Systems of Alabama ‘‘massive’’ internal investigation and amnesty program (‘‘RSA’’) violated federal securities laws by purchasing were ‘‘essential in gathering facts regarding the full ex- shares of The Liberty Corporation (‘‘Liberty’’)onthe tent of Siemens’ FCPA violations.’’ basis of material, nonpublic information regarding a The DOJ’s settlement papers provide considerably prospective acquisition of Liberty by Raycom Media, 45 more detail about the magnitude of Siemens’ investiga- Inc., a company founded by RSA. RSA did not have a tion and its amnesty program. The DOJ noted, among compliance officer or any program, policy, practice or other things, that 1.6 million billable hours had been de- training to ensure compliance with federal securities voted to the internal investigation at a cost of over $850 laws, in particular insider trading laws. The SEC con- million, that over 1750 interviews and 800 informational cluded that RSA had in fact purchased stock on the ba- meetings were held, that over 100 million documents sis of material, nonpublic information, and that such had been preserved, and that 127 million accounting trading likely would not have happened had there been records had been reviewed.49 The DOJ also emphasized a ‘‘reasonable compliance program’’ in place at the time that Siemens permitted the law firm conducting the in- of the trading. The SEC stated that it was issuing its re- vestigation to do so in a completely independent fash- port in order to ‘‘emphasize the responsibilities of all in- ion, without limitations as to scope or duration, and that vestment professionals, including large public retire- Siemens stressed to all employees that they were to ment systems and other public entities, under the fed- fully cooperate in the investigation. Siemens even es- eral securities laws and to highlight the risks they undertake when they operate without a compliance pro- gram.’’ 46 SEC v. Siemens Aktiengesellschaft, Litig. Rel. No. 20829 (Dec. 15, 2008) (available at http://www.sec.gov/litigation/ litreleases/2008/lr20829.htm). This amount does not include an 39 Id.at*4. additional $569 million to be paid and $285 million previously 40 SEC v. Mark Cuban, Litig. Rel. No. 20810 (Nov. 17, 2008) paid to the Office of the Prosecutor in Munich, Germany. Id.In (available at http://www.sec.gov/litigation/litreleases/2008/ total, Siemens agreed to pay $1.6 billion to resolve the corrup- lr20810.htm). tion charges. Id. 41 530 F.3d 1085, 1087 (9th Cir. 2008). 47 Press Release No. 2008-294 (Dec. 14, 2008) (available at 42 Id. at 1089-90 (quoting SEC v. Talbot, 430 F. Supp. 2d http://www.sec.gov/news/press/2008/2008-294.htm). 1029, 1049-50 (C.D. Cal. 2006). 48 SEC v. Siemens Aktiengesellschaft, Litig. Rel. No. 20829 43 Id. at 1094. (Dec. 15, 2008). 44 Id. 49 U.S. v. Siemens Aktiengesellschaf, Department’s Sen- 45 Securities Exchange Act Rel. No. 57446 (Mar. 6, 2008) tencing Memorandum, at 18-19 (filed Dec. 12, 2008) (available (available at http://www.sec.gov/litigation/investreport/34- at http://www.usdoj.gov/opa/documents/siemens-sentencing- 57446.htm). memo.pdf).

3-2-09 COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 7 tablished an office staffed by 16 full-time employees to dants of fundamental rights.53 According to the district facilitate interviews and document collection. With the court, shortly after the SEC began investigating the de- input of the DOJ, Siemens also designed and imple- fendants in mid-2000, the U.S. Attorney’s Office re- mented a company-wide amnesty program to facilitate quested access to SEC investigative files pursuant to the internal investigation. The program created an am- ongoing investigations by the U.S. Attorney’s Office, nesty period, during which all lower-level employees the Federal Bureau of Investigation and the Department who disclosed information regarding possible violations of Justice.54 The U.S. Attorney’s Office identified the of anticorruption regulations were protected by the defendants as potential targets and determined that company against termination or damage claims. For prosecution was likely, but asked the SEC to continue more senior employees (as well as lower-level employ- to lead the investigation, fearing that disclosure of a ees who did not volunteer information during the am- criminal investigation would alert the defendants to nesty period), the Company made individualized le- their exposure to criminal prosecution and jeopardize niency determinations. While the SEC has not indicated the opportunity to obtain information.55 that this level of cooperation and remediation is ex- Throughout the SEC’s investigation, the U.S. Attor- pected, the DOJ has stated that the ‘‘reorganization and ney’s Office remained actively involved: meeting with remediation efforts of Siemens have been extraordinary the SEC, obtaining documents, making requests and and have set a high standard for multi-national compa- even giving advice such as how best to conduct inter- nies to follow.’’ views to gather evidence.56 The involvement of the U.S. Another emerging trend in the SEC’s pursuit of FCPA Attorney’s Office, however, was concealed from the de- violations is the SEC’s efforts to hold individuals re- fendants, with, for example, the SEC instructing court sponsible for such violations. One noteworthy case in- reporters not to mention the U.S. Attorney in front of volved the former CEO of Kellogg, Brown & Root, Inc., defense counsel.57 a wholly-owned subsidiary of Halliburton Company.50 Prior to testifying before the SEC, defendants were The SEC charged that Albert Jackson Stanley, over the provided copies of SEC Form 1662, which lists among course of ten years, schemed to bribe Nigerian officials the ‘‘routine uses’’ of information provided to the SEC in order to obtain over $6 billion in construction con- the sharing of information with criminal authorities.58 tracts. Stanley consented to the entry of final judgment When defense counsel specifically inquired as to SEC permanently enjoining him from violating the anti- cooperation with criminal enforcement agencies, the bribery, record keeping and internal controls provisions SEC stated that it was its policy to not answer such of the Exchange Act. He also agreed to cooperate with questions but to refer them to the agency in question.59 the SEC’s on-going investigation. In a related criminal The district court held that the SEC failed to ad- proceeding brought by the DOJ, Stanley pleaded guilty equately warn the defendants of the extent of the SEC’s to conspiring to violate the FCPA and to commit mail cooperation with the Department of Justice, depriving and wire fraud. He faces up to seven years in prison and them of due process and Fifth Amendment rights. The a fine of $10.8 million. court further found that the prosecution abused the in- In its press release, the SEC quoted Acting Assistant vestigative process by effectively using the SEC to carry Attorney General Matthew Friedrich as saying that out its criminal investigation rather than conducting a ‘‘[t]oday’s plea demonstrates that corporate executives parallel investigation, and also by exploiting conflicts of who bribe foreign government officials in return for lu- interest between defendants and their attorney. The crative business deals can expect to face prosecu- court concluded that the government had engaged in tion.’’51 ‘‘deceit and trickery’’ to conceal the criminal investiga- tion from the defendants.60 Finding this conduct to be ‘‘so grossly shocking and so outrageous as to violate the 6. The Ninth Circuit’s Reversal of a universal sense of justice,’’ the district court dismissed District Court Opinion Challenging the indictment.61 ‘‘Stealth’’ Parallel Proceedings The Ninth Circuit vacated the dismissal of the indict- ment, holding that the SEC’s investigation was not sim- In United States v. Stringer, the Ninth Circuit vacated ply a pretext to pursue a criminal investigation, but was an Oregon federal district court’s dismissal of a crimi- a bona fide parallel investigation because the SEC’s nal indictment against three individual defendants civil investigation was opened first, led to SEC sanc- tions and was conducted pursuant to the SEC’s civil en- charged with criminal violations of federal securities 62 laws,52 confirming the fear of many targets of SEC en- forcement jurisdiction. The Ninth Circuit further held forcement investigations that undisclosed criminal that there was no bad faith on the part of the govern- prosecutions may lurk behind SEC investigations. ment or other unusual circumstances warranting dis- The district court in Stringer, in a decision which re- missal of the indictment, finding that: ceived considerable attention, dismissed a criminal in- dictment against three former executives of FLIR Sys- 53 United States v. Stringer, 408 F. Supp. 2d 1083, 1089 (D. tems, Inc., finding that the cooperation between the Or. 2006). SEC and the Department of Justice in pursuing parallel 54 Id. at 1085. civil and criminal investigations deprived the defen- 55 Id. 56 Id. at 1086. 57 Id. at 1085-88. 50 SEC v. Albert Jackson Stanley, Litig. Rel. No. 20700 58 Id. at 1086-87. (Sept. 3, 2008) (available at http://www.sec.gov/litigation/ 59 Id. at 1087. litreleases/2008/lr20700.htm). 60 Id. at 1089. 51 Press Release No. 2008-189 (available at http:// 61 Id. (quoting United States v. Smith, 924 F.2d 889, 897 www.sec.gov/news/press/2008/2008-189.htm). (9th Cir. 1991)). 52 535 F.3d 929 (9th Cir. 2008). 62 Stringer, 535 F.3d at 939.

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There was no deceit; rather, at most, there was a govern- In the press release announcing the charges, the SEC ment decision not to conduct the criminal investigation strongly emphasized that this case is indicative of the openly, a decision we hold the government was free to SEC’s future efforts to prosecute the spreading of false make. There is nothing improper about the government un- rumors. Then SEC Chairman stated dertaking simultaneous criminal and civil investigations, and nothing in the government’s actual conduct of those in- ‘‘The message of this case is simple and direct. The vestigations amounted to deceit or an affirmative misrepre- Commission will vigorously investigate and prosecute sentation justifying the rare sanction of dismissal of crimi- those who manipulate markets with this witch’s brew of 68 nal charges or suppression of evidence received in the damaging rumors and short sales.’’ course of the investigations.63 The Ninth Circuit further found that the defendants’ 8. The First Circuit’s Decision Potentially waiver of the privilege against self-incrimination were not ineffective as defendants had received sufficient no- Expanding the Scope of Primary Liability tice of their due process rights because SEC Form 1662 For Misstatements in Prospectuses ‘‘alerts SEC investigative witnesses that the information can be used in a criminal proceeding’’ and ‘‘the govern- In SEC v. Tambone, the First Circuit reversed the dis- ment’s request for information could be refused pursu- trict court’s dismissal of the SEC’s complaint against ant to the Fifth Amendment’s protection against com- two officers of an underwriter for a mutual fund family, pelled self incrimination.’’64 Moreover, the SEC advised issuing an opinion that arguably expands the scope of the defendants of their rights against self-incrimination primary liability under the antifraud provisions of the 69 prior to their testimony.65 Under these circumstances, securities laws. the court found, ‘‘the possibility of criminal investiga- The SEC’s complaint alleged that two senior execu- tion should have been well known to both the defen- tives of Columbia Funds Distributor, Inc., the principal dants and their counsel.’’66 underwriter for the Columbia Mutual Funds, had vio- lated Section 17(a)(2) of the Securities Act and Section The Ninth Circuit’s decision has undoubtedly dashed 10(b) of the Exchange Act for using false or misleading the hopes of some in the defense bar while confirming fund prospectuses to sell mutual fund shares.70 Charg- that, absent affirmative misrepresentations, the govern- ing both primary and aiding and abetting violations, the ment can simultaneously conduct civil investigations SEC alleged that these two individuals approved or while pursuing parallel behind the scenes criminal in- knowingly allowed market timing arrangements de- vestigations. spite language in the fund prospectuses prohibiting market timing.71 The district court dismissed the com- 7. The SEC’s First Market Manipulation plaint because, among other things, the false state- ments in the prospectus were not attributable to the de- Case Based on Spreading False Rumors 72 fendants. The SEC brought its first fraud and market manipu- The First Circuit reversed, holding that, as senior ex- lation case based on the intentional spreading of false ecutives of the primary underwriter for the mutual rumors. In SEC v. Paul S. Berliner, the SEC alleged that funds, the defendants had a duty to confirm the accu- racy and completeness of the prospectuses used by the Berliner, formerly a trader for Schottenfeld Group LLC, 73 disseminated a false rumor about The Blackstone distributor to sell the funds. In light of that duty, the Group’s acquisition of Alliance Data Systems court concluded that the defendants in fact made im- 67 plied statements regarding the accuracy and complete- (‘‘ADS’’). Specifically, the SEC alleged that Berliner 74 sent instant messages to a number of people, including ness of the prospectuses for purposes of Rule 10b-5. traders at brokerage firms and hedge funds, indicating The court acknowledged that Rule 10b-5 only renders it falsely that ADS’s board was meeting to consider a re- unlawful to ‘‘make’’ an untrue statement, but asserted vised proposal from Blackstone to acquire ADS at a that Rule 10b-5 must be read in conjunction with the text of Section 10(b) of the Exchange Act, which makes much lower price than previously announced. This ru- 75 mor was picked up by the media and, within 30 min- it unlawful to ‘‘use or employ’’ a deceptive device. utes, caused the price of ADS stock to drop by 17 per- Judge Selya, who dissented with respect to the ruling cent. The New York Stock Exchange temporarily halted on Rule 10b-5, described the majority’s opinion as a ‘‘radical departure’’ and an ‘‘unwarranted usurpation of trading and ADS issued a press release announcing that 76 the rumor was false. Berliner short sold ADS stock at legislative and administrative authority.’’ He was par- the same time he disseminated the rumor and covered ticularly troubled by the majority’s interpretation of the those sales as the price of stock began to decline, mak- word ‘‘make,’’ accusing the majority of ‘‘casually ing approximately $25,000 in profits. conflat[ing] this carefully chosen verb (‘make’) with a very different verb (‘use’) in order to impose primary li- Without admitting or denying liability, Berliner ability on defendants who have not ‘made’ any misstate- agreed to a consent judgment requiring that he dis- ments but, rather, are alleged to have used prospec- gorge his profits and interest ($26,129) and pay a third- tier penalty in the amount of $130,000. He also con- sented to a cease and desist order and a bar from asso- 68 Press Release No. 2008-64 (Apr. 24, 2008) (available at ciation with any broker or dealer. http://sec.gov.news/press/2008/2008-64.htm). 69 550 F.3d 106 (1st Cir. 2008) 70 Id. at 110. 63 Id. at 933. 71 Id. at 113. 64 Id. at 938. 72 Id. at 117. 65 Id. 73 Id. at 135. 66 Id. at 941. 74 Id. at 131. 67 Litig. Rel. No. 20537 (Apr. 24, 2008) (available at http:// 75 Id. at 131-32. sec.gov/litigation/litreleases/2008/lr20537.htm). 76 Id. at 150.

3-2-09 COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665 9 tuses that contain misstatements by others.’’77 Judge tions against businesses, such as KPMG. A company’s Selya further held that ‘‘[t]he majority’s freewheeling cooperation was included among these considerations, approach blurs the line that the Supreme Court has and the Thompson Memorandum states that prosecu- taken pains to draw between primary and secondary li- tors may consider ‘‘whether the corporation appears to ability with respect to the antifraud provisions of the se- be protecting its culpable employees and agents’’ by curities laws.’’78 promising support to such employees, including The court also concluded that the defendants’ con- through the advancing of attorneys’ fees.86 duct was actionable under Section 17(a)(2) of the Secu- KPMG adopted a policy of capping the amount of at- rities Act, which prohibits individuals from ‘‘obtaining torneys’ fees advanced to each employee under investi- money or property by means of any untrue state- gation, conditioning the advancement of fees on the ment.’’79 Acknowledging that the court had ‘‘previously employee’s cooperation with the government, and ter- analyzed section 17(a) claims identically to those made minating the fees if informed by the government that under section 10(b) and Rule 10b-5,’’ the court held that the employee was not fully cooperating, e.g., invoking such ‘‘treatment does not preclude our recognition that the Fifth Amendment privilege against self- the scope of actionable conduct under the two statutes incrimination.87 The Second Circuit described the gov- may be different.’’80 The court concluded that it was not ernment’s involvement in the formation and execution limited by the more narrow language of Section 10(b) of this policy including expressing disappointment with or Rule 10b-5 requiring that the defendant have made KPMG’s first advisory memorandum to certain of its the untrue statement; rather, liability attaches ‘‘so long employees not identified as targets which encouraged as the statement is used ‘to obtain money or property,’ the employees to cooperate with the government but regardless of its source.’’81 also advised them that it might be advantageous for The First Circuit’s decision arguably expands the them to exercise their right to counsel and that KPMG SEC’s reach by (1) extending primary liability at least to would cover reasonable fees.88 The government ac- parties who ‘‘use’’ prospectuses to sell funds if they cused the memorandum of being ‘‘one-sided’’ and de- knew or should have known of false statements in the manded that KPMG send out a supplemental memoran- prospectuses, and (2) confirming that Section 17(a)(2) dum advising that employees could deal directly with is broader than Rule 10b-5. By holding that individuals the government without counsel.89 In addition, the gov- can be liable as primary violators for making ‘‘implied ernment regularly reported to KPMG whenever an em- statements’’ through the ‘‘use’’ of others’ misstate- ployee was not fully cooperating, knowing that KPMG ments, the decision may dramatically expand the scope would pressure the employee to speak with prosecutors of primary liability in securities litigation.82 through threats of cutting off attorneys’ fees or termina- tion.90 9. The Second Circuit’s Decision The partners and employees ultimately indicted moved to dismiss the indictment based on the govern- Affirming Dismissal of Indictment Based ment’s interference with KPMG’s advancement of on Government’s Interference With fees.91 After some procedural wrangling, the district court ultimately granted the motion to dismiss, holding Employer’s Advancement of Legal Fees that the government violated the defendants’ right to substantive due process and that the prosecutors’ con- In U.S. v. Stein, the Second Circuit upheld the district 92 court’s dismissal of an indictment against 13 former duct ‘‘independently shock[s] the conscience.’’ partners and employees of KPMG, LLP (‘‘KPMG’’).83 The Second Circuit affirmed the dismissal of the in- These individuals were indicted in connection with an dictment, holding that KPMG’s policy as to advancing investigation by the U.S. Department of Justice attorneys’ fees constituted state action because it was (‘‘DOJ’’) into KPMG’s alleged involvement in creating the direct result of the government’s ‘‘overwhelming in- and marketing fraudulent tax shelters.84 The opinion fluence’’ and that ‘‘the government thus unjustifiably describes pressure placed on KPMG by the DOJ to co- interfered with defendants’ relationship with counsel and their ability to mount a defense, in violation of the operate with the investigation in accordance with the 93 factors set forth in the Thompson Memorandum, par- Sixth Amendment ....’’ ticularly as it related to advancement of attorneys’ On the same date that the Second Circuit issued its fees.85 opinion in U.S. v. Stein, Deputy Attorney General Mark The Thompson Memorandum had set forth a number Filip issued a statement announcing that the DOJ had of principles governing the DOJ’s decisions to bring ac- substantially revised its policies with regard to charging corporations with crimes, and expressly revoking the policies with regard to advances of attorneys’ fees to 77 Id. employees at issue in Stein.94 78 Id. at 151. 79 Id. at 125-26. 80 Id. at 127. 86 Id. at 136. 81 Id. 87 Id. at 138-39. 82 On February 23, 2009, the First Circuit denied panel re- 88 Id. at 138. hearing of the decision, but asked the SEC, interested amici 89 Id. and the defendants to submit briefs on whether rehearing en 90 Id. at 138-39. banc should be granted on the issue of the scope of liability for 91 Id. at 140. implied statements under Section 10(b), including specifically 92 Id. at 142 (quoting U.S. v. Stein, 495 F. Supp. 2d 390, whether the panel decision would apply to private actions for 412-15 (S.D.N.Y. 2007)). damages. 93 Id. at 136. 83 541 F.3d 130, 135-36 (2d Cir. 2008) 94 Mark R. Filip, Deputy Attorney General, Remarks Pre- 84 Id. at 137. pared for Delivery at Press Conference Announcing Revisions 85 Id. at 137-39. to Corporate Charging Guidelines (Aug. 28, 2008) (available at

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10. The Eleventh Circuit’s Decision to the amount of liability.99 The district court granted summary judgment for the SEC and ordered disgorge- Upholding Penalties and Disgorgement ment in the amount of $6.4 million, pre-judgment inter- Despite Defendant’s Claimed Inability to est in the amount of approximately $1.99 million, and a Pay $75,000 penalty.100 The defendant argued that the SEC had acted in bad In SEC v. Warren, the Eleventh Circuit affirmed a dis- faith by not waiving penalties and that summary judg- trict court’s decision granting summary judgment in fa- ment was not warranted because there were questions vor of the SEC as to the amount of a civil penalty and of fact as to his inability to pay and the SEC’s good disgorgement, notwithstanding the defendants’ claimed faith.101 Rejecting defendant’s arguments in their en- inability to pay.95 tirety, the Eleventh Circuit issued a per curiam opinion The defendant had entered into a consent order with affirming the district court’s decision, and holding that the SEC which stipulated that Warren would pay a civil a defendant’s inability to pay is at most a factor to be penalty, disgorgement, and pre-judgment interest, but considered in imposing a penalty, but ‘‘nothing in the did not stipulate as to the amount of liability, which was securities laws expressly prohibits a court from impos- to be determined by the court.96 The consent order fur- ing penalties or disgorgement in excess of a violator’s ther provided that if Warren furnished a sworn state- ability to pay.’’102 The court noted that, even if inability ment that he was unable to pay, the SEC could elect to to pay was decisive, the defendant’s financial statement waive his liability.97 Warren subsequently submitted fi- showed that he had some assets and regular income nancial statements, showing that he had over $150,000 and therefore could pay a substantial judgment.103 The in real estate equity and approximately $10,000 in court held that such a financial statement established monthly income.98 The SEC did not elect to waive the that the SEC had a good faith basis for not waiving pen- liability and, instead, moved for summary judgment as alties.104 http://www.justice.gov/archive/dag/speeches/2008/dag-speech- 99 Id. 0808286.html). 100 Id. 95 534 F.3d 1368, 1370 (11th Cir. 2008). 101 Id. 96 Id. at 1369. 102 Id. at 1370. 97 Id. 103 Id. 98 Id. 104 Id.

3-2-09 COPYRIGHT ஽ 2009 BY THE BUREAU OF NATIONAL AFFAIRS, INC. SRLR ISSN 0037-0665