A Securities and Exchange Commission pilot program intended to strengthen the hand of its enforcement staff and speed the resolution of cases involving fines against corporations is raising concerns among defense lawyers about their ability to negotiate settlements.
As Compliance Week previously reported in April, the SEC said in some cases where a fine may be levied against a company, the SEC’s five commissioners will give the enforcement staff guidance—including advice on acceptable fines—before SEC lawyers begin settlement discussions with an issuer. That departs from decades of previous policy, where SEC lawyers negotiated with companies first and then brought settlement proposals to the commissioners for approval. Under that regime, commissioners heard little about the details of a case until a potential settlement was brought for approval.
Thomsen
Linda Chatman Thomsen, the SEC’s director of enforcement, said in an April 13 statement that the objective of the policy change was “to enhance the Commission’s negotiating power and to get to appropriate settlements with the full weight of the commission behind them.” Thomsen added that negotiated settlements “will be fast-tracked with little or no further Commission debate.”
Cox
SEC Chairman Christopher Cox plugged the new policy in an April speech, saying the approach revives what was once Commission policy for all cases. The crucial difference, he said, is that now when cases are settled within the provided range, they can be approved through the SEC’s seriatim procedure, where the commissioners vote to approve a recommendation without convening a formal closed meeting.
Legal observers say the change bolsters lawyers’ bargaining power by giving them an idea of what the commissioners deem acceptable for possible fines. That could help keep settlement talks from stalling late in the game and can also help the staff understand which issues are most important to the commissioners.
That said, defense lawyers are still skeptical that they will be able to have meaningful settlement discussions that inform the Commission’s decisions on sanctions.
Gorman
“What would concern me if I was representing a company is whether I [could] actually negotiate with the commission,” says Thomas Gorman, a partner in the law firm Porter, Wright, Morris & Arthur and former senior counsel in the Enforcement Division. “Once people make a decision, you’re not in a position of negotiating; you’re trying to talk them out of that position. “
Gorman fears the change might have a “long-term effect of making the enforcement process appear to be unfair.”
Walter Ricciardi, deputy director of the Enforcement Division, denies that possibility. He stresses that SEC lawyers can always change their recommendations if the facts of a case evolve. “A settlement will be fast-tracked if it is within the parameters already approved, but nothing is set in stone,” he says.
Cox, in his speech, did say that the new policy might lead to stiffer—although not necessarily higher or lower—fines, “because the staff lawyers negotiating them won’t have to hedge their bets, wondering whether the Commission will later on back them up, or rather cut them off at the knees.”
Waiting On Implementation
Many legal experts say the full consequences of the SEC’s policy shift won’t be known until actual cases are brought before the Commission and settled. Russell Ryan, formerly an attorney in the Enforcement Division and now a partner at the law firm King & Spalding, worries about how companies will be able to communicate their position when the enforcement staff first seeks authorization to negotiate a penalty. Without such an opportunity, Ryan says, “It will inevitably—and unfairly—have the Commission prejudging the merits of the case based solely on the staff’s version of the facts and law.”
SPEECH
Below is an excerpt of an April 13, 2007, speech by SEC Chairman Christopher Cox, where he explains the Commission’s revived policy of reviewing possible enforcement penalties.
Like you, each of the five Commissioners of the SEC shares the duty of overseeing and monitoring the operations and activities of our organization. Under procedures established long before I became Chairman, no formal investigation is initiated, no case is filed, no settlement is agreed to without Commission approval. Each of us has been appointed by the President and confirmed by the Senate with the express understanding that, like you, we will be independent in our actions and our judgments, with only the welfare of the nation's investors and markets as our special interest.
Nowhere is this more important than in the area of enforcement, where - as we saw in the mutual fund scandals of 2003 and 2004 - vigorous Commission action is necessary to ensure that a culture of ethics and compliance operates throughout a fund complex for the benefit and protection of the funds’ investors. At the same time, Commission review of enforcement actions shouldn't slow down the process. As both the Commission’s caseload and its staff have grown in recent years, that has posed a genuine tradeoff for Commissioners seeking to fulfill their fiduciary duty.
What full Commission review should provide is a guarantee of fairness and of horizontal equity in a nationwide program. And it should be the wind at the backs of our staff across the country as they seek to obtain the best possible results for America’s investors. When enforcement lawyers in settlement discussions sit eye-to-eye across the table from counsel for the defense, we want them to know they have the full backing of the Commission. Our staff will have the strongest negotiating position, of course, if the Commission has reviewed the proposed range of outcomes before the offers in settlement are made. So in a handful of cases where the need for national consistency is greatest, we're reviving what had been a long standing policy of the SEC for all cases for many years - that Commission approval be obtained before settlement discussions are commenced. But we'll do so with a difference: When cases are settled within the range of guidance provided by the Commission, they will be eligible for summary approval through the Commission's seriatim procedure. And I and each of the Commissioners are committed to seeing to it that this procedure works to speed up, not slow down, our cases.
The category of cases we’ve selected consists of those in which a monetary penalty against a company might be involved. As you know, very recently the Commission adopted new guidelines for cases of this kind, and we are anxious to ensure that in the early days of its implementation, the precedents we establish are clear, consistent, and in accordance with the instructions of Congress in the Remedies Act. Already, there’s been speculation whether this procedural change portends a shift to higher or lower penalties. It is, of course, designed to do neither, but rather to ensure that the laws are vigorously enforced with the benefit of full Commission review.
But if I had to hazard a guess, it would be that if anything, the penalties you will see imposed in future cases will be stiffer - because the staff lawyers negotiating them won't have to hedge their bets, wondering whether the Commission will later on back them up, or rather cut them off at the knees. We should never put our staff in such a position. They are America's finest, and every Commissioner is extremely proud of the work they do. We're confident that this new approach will give them more flexibility and better tools to do their jobs more effectively and more quickly. It will also give each of the Commissioners a better opportunity to do our jobs, which require of us the same oversight responsibilities that each of you must constantly exercise as independent directors.
Source
Securities and Exchange Commission (April 13, 2007)
On the other hand, Ryan adds, “If a company at this early stage is given an opportunity, through the Wells process [to alert companies and people that they are under investigation] or otherwise, to argue why either no charges should be brought or why no penalty is appropriate, this new policy has a good chance of improving the fairness of the process and the results reached.”
Gorman says the new policy may also result in more unity among the commissioners about penalties. Critics, including some commissioners over the years, have long said fines achieve little other than taking still more money away from investors who already have suffered losses from whatever got their companies in trouble in the first place.
“We’re seeing some settlements just sit for long periods of time,” Gorman says. “This may be an attempt to bring unity among the five commissioners before the staff goes out with a settlement offer.”
For example, disputes over fines delayed a settlement in the SEC’s case against Brocade Communications Systems, which was charged last year in connection with accounting wrongdoings that resulted in financial restatements. The company reserved $7 million in the first quarter of fiscal 2006 that it said was for a proposed settlement based on an offer made to the SEC staff. The deal then lingered for months, and was only closed last Thursday. (The charges were not related to Brocade’s stock-option backdating, which resulted in still more charges against Brocade executives last July.)
Doty
Former SEC general counsel James Doty, now a partner in the law firm Baker Botts, says any suggestions that the policy “is trimming the wings” of the enforcement division “are incorrect.” He sees the change as an attempt to bring uniformity in corporate penalties given the large number of stock options backdating cases currently underway. The Commission is believed to be currently investigating or negotiating with more than 100 companies over backdated stock options.
“I think this is an attempt to develop a structure for dealing with them, rather than having a patchwork of results with no explainable reason for why one company was treated one away and another treated another way,” Doty says.
In many backdating cases, Doty adds, the SEC hasn’t done any investigation at all; rather, the company has done its own internal investigation and handed over the results to SEC lawyers. In those cases, he says, it may make sense for the Commissioners to look at a case at the front end, since the investigations “give a sense of what the fact patterns are.”
Doty admits that defense lawyers’ fears of prejudgment in cases are “valid,” but stresses that, “It’s only a concern, not a demonstrated result.”
“The prejudgment issue imposes on the Commission and the staff a duty to make it clear that they are listening and giving due consideration to the submissions of counsel,” he adds.
Still, some question why only cases involving fines against corporate issuers are being carved out. “There doesn’t appear to be a particular need or reason to carve out only this kind of settlement,” Gorman says.
Similarly, Ryan says, “If it’s a good idea to have the Commissioners involved earlier in the process, it seems to me that it ought to be a good idea in most other cases, too.”
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