Although the United States Securities and Exchange Commission (SEC) filed several significant enforcement actions affecting public companies during 2009, the news story of the year was that a new sheriff came to town and put in place profound process changes within the Division of Enforcement. These process changes will likely result in reshaping how future investigations are performed by staff of the Division.
Robert Khuzami, a former federal prosecutor appointed as the Division’s director in early 2009, announced several process changes, all designed to reshape the Division in the image of the United States Department of Justice (DOJ). In this same vein, former federal prosecutors were appointed as Mr. Khuzami’s Deputy and as Regional Directors in the New York and Miami offices. Under the new regime:
- Formal orders of investigation, giving the staff the authority to issue subpoenas, can now be authorized by the Director of Enforcement and his direct reports, including the eleven Regional Directors.
- Specialized units have been established to oversee investigations in five areas, including Foreign Corrupt Practices.
- Enforcement staff have been authorized to negotiate immunity agreements with individuals, a change designed to spur confessions. See Hogan & Hartson 1.20.2010 Litigation Alert.
The first of these process changes has already resulted in at least twice the number of formal orders of investigation being issued during the SEC’s fiscal year 2009 compared to 2008. This increased use of formal orders will require more public companies to give prompt consideration as to whether to publicly announce an investigation as soon as the company learns of it, given that the Staff uses such orders as authority for issuing subpoenas to third parties. It is too early to forecast the results of the other process changes, which no doubt are intended to foster confessions by corporate insiders and additional FCPA investigations by attorneys having specialized skills.
Turning to significant enforcement actions filed during 2009, the Enforcement Division, in the wake of the adverse publicity about the timeliness of its response to the Madoff fraud, devoted substantial efforts to prosecuting operators of Ponzi schemes and hedge funds, as well as individuals engaging in insider trading. As a result, and perhaps also because of the effects of Sarbanes-Oxley, the Division filed fewer significant enforcement actions relating to public companies than in past years, with most of those focused on companies in the subprime mortgage home industry. The most significant actions were:
- Accounting Fraud: General Electric, charged with four separate misapplications of GAAP, and Terex, charged with channel stuffing and failing to resolve imbalances from intercompany transactions, agreed to pay penalties of $50 million and $8 million respectively, with Terex’s penalty also being imposed on account of charges that it aided and abetted another public company that had previously settled SEC charges that it had misstated its financial statements. The SEC also filed actions against former executives of American Home Mortgage Investment and New Century Financial for understating loan loss reserves relating to mortgages or expenses related to repurchased mortgages and former AIG executives for their roles in facilitating sham reinsurance transactions.
- False/Misleading Disclosures: Although Bank of America agreed to pay a penalty of $33 million for disclosure failures relating to bonuses to be paid to Merrill Lynch employees, a federal district court judge refused to approve the settlement, questioning why shareholders, and not responsible officers and directors, should foot the bill. The SEC also charged former officers of Countrywide Financial for misleading shareholders about risks associated with loan portfolios and former officers of Quest Resource for not disclosing numerous related party transactions involving millions of dollars.
- Selective Disclosure: After a several-year hiatus following the dismissal of its second Regulation FD case against Siebel Corporation, the SEC charged the former CFO of a company with having made selective disclosure to sell-side analysts, thus signaling that FD is not a dead letter. However, for the first time since FD was adopted, the SEC decided not to charge the company, citing its extensive cooperation and prompt remedial efforts.
- Clawing Back Bonuses: In another ground-breaking case, the SEC sought, under Section 304 of Sarbanes Oxley, to recoup bonuses paid to a CEO who was not charged with any wrongdoing in connection with a restatement of his company’s financial statements.
- Foreign Corrupt Practices: The Enforcement Division continued to work closely with the DOJ, with the highlights being (1) parallel proceedings filed against Halliburton, which agreed to disgorge $177 million in the Commission’s civil action and pay a $402 million fine in the DOJ’s criminal action and (2) the SEC’s assertion of “control person” liability against officers of Nature’s Sunshine Products.
- Program Trading by Officers: The SEC filed an action against the former CEO of Countrywide for establishing three 10b-5-1 plans to sell most shares of stock that he held in three consecutive months, and later amending one such plan to sell additional shares, while in possession of material non-public information about the risks associated with the company’s loan portfolio.
Among these cases, Judge Rakoff’s rejection of the Bank of America settlement is most likely to have long-lasting effects on the Enforcement program, particularly in relation to its policy of fining public companies. Fining present shareholders for acts occurring in the past has always posed problematic issues that did not vanish following passage of the fair funds provision of Sarbanes- Oxley. It is possible that the SEC might react to the decision by taking a more conservative approach in imposing penalties on public companies, particularly where it decides that the evidence is insufficient to charge any officers, directors or employees with wrongdoing. On the other hand, the SEC might react oppositely by taking a more aggressive approach in prosecuting officers, directors and employees, thus potentially increasing fee advancement and indemnification costs for public companies.
Significant Enforcement Actions Filed in 2009
SEC v. General Electric Co., Lit. Release 21166 (Aug. 4, 2009). The SEC filed a consented-to injunctive action against GE for violating the antifraud and other provisions of the Securities and Securities Exchange Acts on account of four separate instances of allegedly improper accounting in 2002 and 2003 relating to not expensing certain costs relating to its hedging of commercial paper and interest-rate swaps, along with prematurely recognizing revenues from sales of locomotives and improperly recognizing revenues from changing the methodology for calculating margins on sales of spare parts for aircraft engines. As a result, net earnings were inflated by about $600 million in each year. GE agreed to $50 million pay a civil penalty and consent to entry of injunctive relief. Although the SEC’s complaint indicated that GE acted “primarily through senior corporate accountants,” the accountants were charged with any violations of the securities laws.
SEC v. Terex Corp., Lit. Release 21177 (Aug. 12, 2009). The SEC filed a consented-to injunctive action against Terex for violating the antifraud and other provisions of the Securities Exchange Act on accounting of its premature recognition of about $35 million from transactions at year ends 2000 and 2001 with United Rentals, Inc. The SEC’s complaint also charged Terex with aiding-andabetting United Rentals violations of the antifraud provisions because of actions by Terex’s former CFO in connection with two sale-leaseback transactions between the companies. Terex agreed to pay a $8 million civil penalty and consent to entry of injunctive relief. In 2007, the SEC had filed fraud charges against the former CFO of Terex relating to the same alleged misconduct.
SEC v. Strauss. Hozie and Bernstein. Lit. Release 21014 (April 28, 2009). The SEC charged the former CEO and former CFO of American Home Mortgage Investment Corporation with fraudulently understating the Company’s loan loss reserves in one quarter and with making misleading statements about the risk associated with its mortgage portfolio. The SEC also charged the two, and the former Controller, with misleading the Company’s auditor. Reserves were understated by $38 million. The former CEO consented to entry of an order enjoining him from violations of Section 10(b) of the Securities Exchange Act, requiring disgorgement of $2.2 million, and imposing a 5-year officer and director bar and a $250,000 civil penalty. No charges have yet been filed against the Company.
SEC v. Rand, Lit. Release 21114 (July 1, 2009). The SEC charged the former chief accounting officer of Beazer Homes USA, Inc. with setting up improper “cookie jar” reserves and then reversing the reserves latter to boost earnings, as well as using secret side agreements to avoid detection of improper recognition of revenues from sale/leaseback transactions involving model homes. The improper reserves understated net income by about $63 million and the reversal of the reserves and recognition of revenues on the sale/leaseback transactions overstated net income by about $47 million in subsequent periods. The Complaint seeks injunctive relief, disgorgement, a civil penalty and an officer-and-director bar for the alleged violations of Section 10(b) and other provisions of the Securities Exchange Act. In 2008, Beazer Homes consented to entry of a ceaseand- desist order containing similar allegations and citing the Company’s cooperation.
SEC v. Greenberg and Smith, Lit. Release 21170 (Aug. 6, 2009). The SEC charged the former CEO and former CFO of American International Group as control persons with regard to AIG’s accounting for sham reinsurance and other transactions in violation of the antifraud and other provisions of the federal securities laws. The CFO was also charged with direct violations of the same provisions. Both consented to entry to relief, with the former CEO agreeing to disgorge $7.5 million, pay a civil penalty of $7.5 million, and entry of an injunction that he not violate the antifraud and control-person provisions and the former CFO consenting to similar injunctive relief and to disgorge $750,000 and pay a civil penalty of $750,000. The former CFO also agreed to a 5-year suspension of his right to practice as an accountant before the Commission. In 2007, AIG settled charges filed by the SEC relating to the same transactions.
SEC v. Silva and Bjorkstrom, Lit. Release 21302 (Nov. 17,2009). The SEC charged the former Vice President of Worldwide Sales of Tvia, Inc., a semiconductor manufacturer, with having made side deals with customers and Tvia’s former CFO with having allowed current recognition of revenue regarding such customers despite being aware of red flags concerning the VP’s conduct. As a result, Tvia’s revenues were overstated by about $5 million over four quarters. The former CFO settled, agreeing to the entry of injunctive relief that she not violate subsections 17(a)(2) and (3) of the Securities Act and various subsections of Section 13 of the Securities Exchange Act, pay a $20,000 civil penalty and to a two-year bar under Rule 102(e) from practicing before the Commission. The former VP was charged, among other things, with violating Section 10(b) of the Exchange Act in connection with the improper revenue recognition by Tvia and selling shares while in possession of information that Tvia’s financial statements were false. No charges have yet been filed against the Company.
SEC v. Morrice, Dodge and Kenneally, Lit. Release 21327 (Dec. 7, 2009). The SEC charged the former CEO, former CFO, and former Controller of New Century Financial Corporation, a subprime mortgage lender, with having fraudulently misstated the Company’s financial results by understating expenses related to bad loans and thus overstating net income by over $100 million during two quarters. The SEC also charged all three with making false statements that the Company was not at risk despite circulating contrary information, including in a weekly missive titled “Storm Watch”. The Complaints seeks injunctive relief, civil penalties, disgorgement and officer and director bars. Separately, the SEC seeks to claw back bonuses and other incentive compensation paid to the former CEO and CFO. No charges have yet been filed against the Company.
SEC v. Bank of America Corp., Lit. Release 21164 (Aug. 3, 2009). The SEC filed a consented-to injunctive action against Bank of America alleging that the Company misleadingly told shareholders in its solicitation of proxies for its proposed acquisition of Merrill Lynch that Merrill Lynch had agreed not to pay bonuses. Bank of America, however, had agreed to allow Merrill to pay bonuses totaling %.8 million. In addition to consenting to be enjoined from violating Section 14(a) of the Securities Exchange Act and Rule 14a-9, Bank of America agreed to pay a $33 million civil penalty. As noted above, Judge Rakoff rejected the settlement. In January 2010, the SEC filed a separate action against Bank of America charging an additional violation of Section 14 (a) and Rule 14a-9 for failing to disclose prior to the December 5, 2008 shareholder vote that Merrill had lost $4.5 billion in October 2008 and projected a loss of billions of dollars in November 2008 as well. Bank of America has agreed to pay a $150 million civil penalty to settle both cases, pending approval by Judge Rakoff.
SEC v. Mozilo, Sambol and Sieracki, Lit. Release 21068A (June 4, 2009). The SEC charged the former CEO, former COO, and former CFO of Countrywide Financial with misleading investors by signing off on annual reports that stated it had a portfolio of quality mortgages at the same time that they internally were discussing the significant credit risks being taken by the Company in underwriting and purchasing certain mortgages. The CEO was also charged with insider trading even though he had established stock sale plans under Rule 10b-5-1, alleging that the plans and an amendment to one of the plans were made while he was in possession of material, nonpublic information about the credit risks being faced by the Company and thus realized $140 million in illgotten profits. No charges have yet been filed against the Company.
SEC v. Cash and Grose, Lit. Release 21087 (June 17, 2009). The SEC charged the former CEO and the former CEO of Quest Energy Partners with violating the antifraud provisions by failing to disclose numerous related party transactions and falsely certifying in periodic filings that they knew of no fraud by management. In particulars, the SEC alleged that, over a period of five years, the former CEO embezzled about $10 million by insisting on kickbacks form vendors, among other things. No charges have yet been filed against the Company.
SEC v. CellCyte Genetics Corp. and Berninger; SEC v. Reys, Lit. Release 21200 (Sept. 8, 2009). The SEC filed a consented-to injunctive action against CellCyte and its former Chief Scientific Officer for making false statements in public filings and other materials about the success of the Company’s stem cell technology. Both agreed to entry of injunctions that they not violate the antifraud provisions of the federal securities laws and the former officer agreed to pay a $50,000 civil penalty and to a 5-year officer and director bar. The SEC filed a separate action against the Company’s former CEO on the same grounds and seeking similar relief, including an officer and director bar.
See SEC v. Morrice, Dodge and Kenneally, supra.
In the Matter of Black, Exchange Act Release 60715 (Sept. 24, 2009). The SEC filed a consentedto cease-and-desist order against the former CFO of American Commercial Lines for making a selective disclosure in violation of Section 13(a) of the Exchange Act and Regulation FD. The former CFO had sent an email from his home computer to just the sell-side analysts covering the Company amending the Company’s guidance for the quarter by saying that it would likely be a “dime below” what the Company had announced publicly. The former CFO agreed, in a parallel civil action, to pay a $25,000 civil penalty.
Clawing Back Bonuses
SEC v. Jenkins, Lit . Release 21149A (July 23, 2009). The SEC filed a civil action pursuant to Section 304 of Sarbanes-Oxley seeking to have the former CEO of CSK Auto Corporation reimburse the Company for the more than $4 million in bonuses and stock sale profits he earned while the Company was committing accounting fraud. This is a ground-breaking case because the SEC does not assert that the CEO in any way participated in or caused the Company’s violations that led to the restatement of its financial results.
Foreign Corrupt Practices
SEC v. Halliburton Company and KBR, Inc., Lit. Release 20897A (Feb. 11, 2009). The SEC filed a civil action charging that Halliburton’s KBR subsidiary had violated the FCPA by bribing Nigerian officials for a decade to obtain construction contracts. KBR and Halliburton agreed to pay $177 in disgorgement, in addition to a $422 million criminal fine to settle parallel criminal charges.
SEC v. Nature’s Sunshine Products, Inc., Douglas Faggioli, and Craig D. Huff, Lit. Release 21162 (July 31, 2009). The SEC filed a civil action charging the company and its CEO and former CFO with violating the FCPA by making payments to Brazilian customs officials. The two officers were charged with control personal liability only. The company agreed to pay a $600,00 civil penalty and the officers $25,000 each.
Program Trading By Officers See SEC v. Mozilo, et alia, supra.