On Tuesday, January 24, 2012, the SEC filed a Memorandum which defended the proposed settlement with Koss Corporation ("Koss") and its CEO. The Commission’s Memorandum was filed after a Wisconsin federal judge, Rudolph Randa, issued a letter order on December 20, 2011, directing the Commission to "provide a written factual predicate for why it believes the Court should find that the proposed final judgments are fair, reasonable, adequate, and in the public interest," citing Judge Rakoff’s November 28, 2011 order in SEC v. Citigroup Global Markets, Inc. (discussed here). The issues in the Koss Corporation litigation do not include the "neither-admit-nor-deny" policy at the hear of Citigroup Global Markets, but focus on specific language in the proposed Judgments. The SEC’s Memorandum defends the provisions, while arguing that the language (which is similar to that used in other judgments) should not be changed.
On October 24, 2011, the SEC announced that it had brought an action against and settled charges against Koss and its CEO and former CFO, Michael J. Koss. The Commission alleged that the company’s former Principal Accounting Officer, Secretary, and Vice-President of Finance Sujata Sachdeva and former Senior Accountant Julie Mulvaney engaged in a wide-ranging accounting fraud to cover up Ms. Sachdeva’s embezzlement of over $30 million from Koss. The SEC alleged, in part, that the two were able hide the substantial embezzlements in Koss’s financial records in part because Koss and Mr. Koss failed to adequately maintain internal controls to assure the accuracy and reliability of financial reporting. The SEC’s Complaint charged Koss and Mr. Koss with preparing materially inaccurate financial statements, book and records, and lacking adequate internal controls.
In settling, Koss and Mr. Koss consented to the entry of an injunctive order without admitting or denying the allegations in the Commission’s complaint. The proposed settlement would enjoin the company and Mr. Koss from future violations and order Mr. Koss to reimburse Koss $242,419 in cash and 160,000 of options pursuant to Section 304 of the Sarbanes-Oxley Act (Mr. Koss had previously voluntarily reimbursed $208,895 in bonuses to Koss). The SEC submitted a motion, along with Consents signed both by Koss and Mr. Koss, along with proposed judgments (again, one for Koss and one for Mr. Koss).
On December 20, 2011, Judge Rudolph Randa issued the letter directing the SEC to explain why the proposed settlements were "fair, reasonable, adequate, and in the public interest." Judge Randa raised certain specific issues.
• Judge Randa was concerned with the adequacy of two parts of the injunctive relief in the proposed final judgments to prevent future violations of the federal securities laws, and for enforcement of their terms through the Court’s contempt powers or otherwise. He noted that the Court has an independent duty to assure that injunctions comply with the directive of Fed. R. Civ. P. 65(d) (which requires specificity). However, Judge Randa was concerned that if enforcement became necessary, the terms in the proposed judgment were too vague, which would make enforcement difficult for the Court.
• Judge Randa was also concerned that the language of the Judgments incorporated the terms of the Consents entered into by Koss and Mr. Koss. Judge Randa noted that "the consent documents may be interpreted as containing injunctive relief, those injunctions are also vague and could pose enforcement issues in the future," and said that "additional injunctive relief must be expressly stated in the final judgments."
• Judge Randa requested that the Commission address the adequacy of the SEC’s proposed final judgment provision regarding disgorgement by Mr. Koss (whose family owns 70% of Koss), pointing out that he could not assess the fairness of the provision without any factual predicate for how those disgorgement terms were determined.
• Finally, Judge Randa was concerned that the proposed judgments are not final judgments because they do not expressly state dispose of the claims against the parties (such as dismissing the claims without prejudice, while including a provision for retaining jurisdiction over the enforcement of the settlement).
The SEC’s Memorandum, filed on January 24, 2012, addressed each of these questions. As an initial matter, the SEC argued that "the Court must only find that the judgments are fair, adequate and reasonable," and claimed that the Court should not, as Judge Rakoff suggested, add "a requirement that a reviewing court also find such judgments to be in the public interest." Nonetheless, the SEC argued that the proposed settlement in Koss Corporation was in the public interest.
• In responding to the Court’s inquiries regarding whether the provisions of the two proposed Judgments contained sufficient detail as required under the rules, the SEC pointed out that "the proposed consent judgments are similar in form and substance to consent judgments in Commission enforcement actions entered by district courts in similar cases in this Circuit and elsewhere." The Commission asserted that "the books and records and internal controls provisions that are the subject of the injunctions against Koss and [Mr. Koss], as written, are well-tailored to prescribe what an issuer such as Koss must do to comply." The SEC argued that the Judgment does not include additional details raised by the Court because the defendants had already taken remedial action to address those issues.
• With respect to the question of whether incorporating the terms of the Consents into the Judgments rendered them vague, the Commission argued that "the consents are tailored to achieve important public policy objectives," but said that, if the Court found it necessary, it would submit revised proposed judgments that contained the language from the consents.
• With respect to the Court’s request that the SEC address the adequacy of the proposed final judgment provision regarding disgorgement by Mr. Koss, the Commission argued that it was not seeking disgorgement, but instead are seeking reimbursement under Sarbanes-Oxley Section 304(a) and laid out how the amount was calculated. The Commission also argued that it considered seeking reimbursement for additional years, but, after weighing the risk of litigating those years (Koss’s financial statements were not restated), elected to not do so.
• With respect to the concern as to whether the judgments were final, the Commission argued that "so long as the language of the judgment makes clear that the district court is finished with the case, there is no requirement that a judgment contain language specifically disposing of the claims against the parties – e.g., dismissing the complaint or awarding judgment in favor in favor of one party or another – in order for the judgment to be rendered final." The Commission argued that the proposed Judgments against Koss and Mr. Koss satisfied that standard.
Although Judge Randa’s questions in Koss Corporation cited Judge Rakoff’s order, the issues are different. For example, the SEC’s policy of settling on a neither-admit-nor-deny basis does not appear to be at issue. In Citigroup Global Markets, the SEC is so concerned with the precedent set by Judge Rakoff’s ruling on that issue that it has appealed the case, obtained a temporary stay in the Court of Appeals and taken steps which caused Judge Rakoff to accuse the Commission of filing "materially misleading" papers. The SEC’s Memorandum in Koss Corporation seems low-key in comparison to the answers the SEC provided to the Judge’s questions in Citigroup Global Markets.
Still, Judge Randa is the latest Judge to question how the SEC does things, focusing on the language of the Judgment – language which is similar (if not identical) to the language which it has used for years. The SEC could satisfy Judge Randa by amending the language, but seems reluctant to do so (other than adding language from the consents, which is also similar, if not identical, to language used in other consents).
The question Judge Randa must consider is whether the language is, as stated by Judge Rakoff, "hallowed by history, but not by reason." In other words, should the Commission continue using the same language because that is the way it decided it should be written and it is the language the SEC has always used (which does promote consistency in the SEC’s cases) or should the Judge in each case that signs the Final Judgment have some input into its terms?