Today, the Federal Securities Law Blog takes a look back at the last 30 days in the world of securities-related litigation in a regular feature which appears on approximately the 15th of each month. Recent issues which the SEC has faced this month include inquiries about its now-suspended document destruction policy, upcoming reports from the Inspector General, the appeal regarding the decision to vacate Proxy Rule 14a-11, the formation of an Investment Advisory Committee, various reform recommendations and Congressional challenges to its new Whistleblower Rules. These issues, and others, are discussed in greater detail after the jump.
SEC Responds to Inquiries About Document Destruction By Suspending Policy.
As discussed here, in a letter dated August 17, 2011, Senator Chuck Grassley (R. Iowa) of the Senate’s Committee on the Judiciary, asked SEC Chairman Mary Schapiro whether the Commission had destroyed files relating to some of its more high-profile and controversial matters, such as its investigations of Bernie Madoff, Goldman Sachs, Bank of America, Lehman Brothers and others. Senator Grassley’s inquiry was based on the allegations in a letter from Darcy Flynn, a thirteen-year veteran of the staff.
The SEC responded to the inquiry by suspending the policy for now. As discussed here, the Wall Street Journal reported that "SEC General Counsel Mark Cahn issued a memo to Division of Enforcement staff telling them to stop existing record-destruction procedures for closed cases, until further notice." According to the report, Mr. Flynn, through counsel, advised the SEC that documents were still being destroyed and "that ‘we may need to seek injunctive relief’ in federal court if the SEC doesn’t freeze its document-destruction policy." The Journal confirmed the Commission’s decision to suspend the policy concerning destruction, noting that the agency was working on a new policy with the National Archives and Records Administration.
SEC Awaits Reports From Inspector General.
As also discussed here, another article in the Wall Street Journal reported that the SEC’s Inspector General is preparing several reports (expected later this month), including one concerning the document destruction issues. The Journal reported that other issues that are being considered by the Inspector General include: "alleged conflicts of interest concerning payments to Bernard Madoff victims"; the alleged "’revolving door’ between the SEC and Wall Street"; "the financial package offered Henry Hu … to head a new division … [which] included living expenses in Washington"; and "the SEC’s handling of insider-trading allegations against Dallas Mavericks owner Mark Cuban."
Meanwhile, DOJ’s Inspector General Criticized the Marshals Service’s Handling of Seized Madoff Assets.
The SEC did not have a monopoly on busy Inspector Generals. As described here, the Department of Justice’s Office of the Inspector General ("OIG") conducted an audit and prepared a 98-page report, entitled "Audit Of The United States Marshals Service Complex Asset Team Management And Oversight," which addressed, among other things, a number of issues concerning the handling of assets seized from Bernard Madoff. OIG concluded that the Complex Asset Team was using "informal valuation and disposal procedures." The OIG pointed out that "the Complex Asset Team’s informal approach to the valuation and disposal of assets undermined its perceived competency among DOJ Asset Forfeiture Program partners," and recommended that the Marshal Service "implement detailed policies outlining the circumstances in which the Complex Asset Team should employ a public process to dispose or sell assets."
The SEC Decided Not To Challenge the Ruling Vacating Proxy Rule 14a-11.
As discussed here, the SEC announced that it is not seeking rehearing of the decision by the D.C. Circuit Court of Appeals invalidating Exchange Act Rule 14a-11. That Rule allowed 3% shareholders (or larger) to use the company proxy statement to nominate directors. On Friday, July 22, 2011, the D.C. Circuit Court of Appeals issued an Opinion vacating the rule. Business Roundtable v. SEC, No. 10-1305, slip op. (D.C. Cir. Jul. 22, 2011). The SEC simultaneously announced that Exchange Act Rule 14a-8 (under which eligible shareholders are permitted to require companies to include shareholder proposals regarding proxy access procedures in company proxy materials), which had been stayed, will now go into effect. The Commission noted that "shareholders and companies have the opportunity to establish proxy access standards on a company-by-company basis – rather than a specified standard like that contained in Rule 14a-11."
The SEC Plans to Re-Establish The Investment Advisory Committee.
As discussed here, the SEC announced that it "is in the process of re-establishing an Investor Advisory Committee," while Commissioner Luis A. Aguilar expressed disappointment that the Committee was not being re-established sooner.
The SEC Begins To Tackle Reform Recommendations.
As discussed here, the Office of the Chief Operating Officer of the SEC issued its Report on the Implementation of SEC Organizational Reform Recommendations, which was mandated by Section 967 of the Dodd-Frank Act. The 25-page report was prepared to address the recommendations made in March 2011 in the Boston Consulting Group’s Report to Congress, which examined the internal operations, structure and need for reform at the SEC. The COO’s report noted the budgetary issues the SEC faces and reported on the largely organizational steps the agency has taken to begin the multi-year task of implementing the recommendations. In short, the SEC summarized that that "[w]hile the agency has made progress, the path forward is still long."
As discussed here, the Commission announced that it "will seek public comment on a plan to conduct retrospective reviews of its existing regulations." This request for comment was triggered, in part, by President Obama’s executive order to have independent regulatory agencies consider analyzing rules that might be outmoded, ineffective or burdensome. The SEC stated that it "has long had formal and informal processes in place to review its existing rules," and is "seeking public comment on the process it should use to conduct retrospective reviews, such as how often rules should be reviewed, the factors that should be considered, and ways to improve public participation in the rulemaking process." They have requested that public comments be received by October 6, 2011.
Developments Regarding Whistleblower Rules.
As discussed here, the Commodity Futures Trading Commission has adopted its Final Rules to implement a whistleblower program mandated by the Dodd-Frank Act. In considering the proposed rules, the CFTC stated that it considered the SEC’s recently adopted rules and "[w]here appropriate and consistent with the underlying statutory mandate in Section 23 of the [Commodity Exchange Act], the Commission has endeavored to harmonize its whistleblower rules with those of the SEC." One of the "significant" issues the CFTC considered was "the impact of the whistleblower program on company systems for internal reporting of potential misconduct." The Commission determined that "it is inappropriate to require whistleblowers to report violations internally to be eligible for an award," but recognized the importance of internal compliance and reporting systems and "does not want to discourage employees from using such systems when they are in place." The Rules provide that, when determining the amount of the award, the Commission will consider whether the whistleblower provided information to the company or interfered with internal systems.
However, as discussed here, there are on-going Congressional efforts to roll back the impact of the Whistleblower Rules and other elements of the Dodd–Frank Act. The Whistleblower Improvement Act of 2011 (H.R. 2483) provides that, expect under limited circumstances, the whistleblower must internally report the matter to the employer and then may report to the agency within 180 days.
SEC Enforcement – Insider Trading.
As discussed here, the SEC announced its latest result in its case relating to Galleon Management, this time obtaining a default judgment against Deep Shah, a former lodging industry analyst at Moody’s. The Court entered a permanent injunction from future violations of Section 10(b) and Rules 10b-5, and disgorgement, prejudgment interest and civil penalty totaling over $34.5 million. The events involving Galleon Management, which had previously resulted in the criminal convictions of Raj Rajaratnam and Zvi Goffer, has also led to a number of settlements with the SEC.
SEC Enforcement – Clawback Cases.
As discussed here, the SEC announced it had settled a case with James O’Leary, the former CFO of Beazer Homes USA under Section 304 of the Sarbanes-Oxley Act. Section 304’s "clawback" provision requires the reimbursement of compensation from executives under certain circumstances when their companies were in material non-compliance of financial reporting requirements due to misconduct. In Mr. O’Leary’s case, although he was not charged with any misconduct, he has agreed to reimburse $1.4 million he received after fraudulent financial statements were filed.
As discussed here, the SEC remains in litigation with Maynard L. Jenkins, the former chief executive officer of CSK Auto Corporation, seeking reimbursement of more than $4 million that he received in bonuses and stock sale profits while CSK Auto was the committing accounting fraud. At the time it sued Mr. Jenkins, the SEC described the case as the first clawback case under the Sarbanes-Oxley Act against an individual who was not alleged to have otherwise violated the securities laws. The SEC Enforcement Staff had recommended a settlement of that matter for less than half the amount the SEC originally sought. The Commissioners rejected that settlement, with some Commissioners believing the amount of the settlement was too low and others taking the position that the case should not have been brought at all. The case against Mr. Jenkins is now scheduled for trial on August 17, 2012, although the Court has ordered a settlement conference, scheduled for September 27, 2011.
Criminal Case – Non-Prosecution Agreement Relating to Corporate Earnings Manipulation.
In a cased related to the SEC’s action against Mr. Jenkins, the Department of Justice announced that it had entered into a Non-Prosecution Agreement with CSK Auto to settle a criminal investigation into alleged securities law violations stemming from a corporate earnings manipulation and double-billing scheme (as also discussed here). Under the terms of the agreement, CSK Auto will pay a $20.9 million penalty. DOJ stated that the agreement not to prosecute the company (or O’Reilly Automotive Inc., the company which subsequently acquired CSK Auto) was based on CSK Auto’s "timely, voluntary and complete disclosure of the illegal conduct;" CSK Auto’s and O’Reilly’s "thorough cooperation with the government’s investigation;" and their "extensive remedial efforts pertaining to … internal training, compliance and reporting."
Criminal Case – FCPA.
As discussed here, the Government filed a Motion with Ninth Circuit Court of Appeals stating that it was dropping its appeal of the decision of District Court Judge George Wu to sentence Gerald and Patricia Green to only six months in prison following their conviction on FCPA charges. The Government had originally requested that the couple be sentenced to "a significant number of years" years, but later lowered its request to ten years. The couple has already served their six month sentences. The lengthy sentence sought against Gerald Green (who was 78 years old, and according to his counsel, in poor health when convicted) was one example of the Government’s efforts to aggressively enforce violations of the FCPA. Although the Government has not offered an explanation as to why it abandoned the appeal, the abandonment of the appeal is a step in a different direction during this "new era of FCPA enforcement."
Mortgage-Backed Securities Enforcement Proceedings.
As discussed here, the Federal Housing Finance Agency, as conservator for Fannie Mae and Freddie Mac, filed lawsuits in state and federal court in New York and Connecticut against 17 different financial institutions (including Bank of America, Citigroup, Credit Suisse, Deutsche Bank, Morgan Stanley and JP Morgan), certain of their officers and various underwriters, alleging violations of the federal securities laws and common law relating to the sale of mortgage-backed securities. In its news release, the FHFA claimed alleged that "the loans had different and more risky characteristics than the descriptions contained in the marketing and sales materials provided to" Fannie Mae and Freddie Mac.