Judge Balks at SEC Settlement With IBM, Wants More Reporting

Another federal judge is challenging a settlement reached by the Securities and Exchange Commission, claiming that the SEC is letting the defendant off too easy.

On Dec. 20, U.S. District Judge Richard Leon for the District of Columbia rejected a proposed consent decree, including $10 million in disgorgement and penalties, that the SEC reached with software giant IBM in March 2011. Without admitting or denying wrongdoing, IBM resolved charges that it violated the Foreign Corrupt Practices Act by paying bribes to government officials in China and South Korea.

Leon's challenge is just the latest in a series of contested SEC settlement agreements that could potentially have profound consequences on the way that civil cases between companies and the SEC get resolved. In November 2011, U.S. District Judge Jed Rakoff rejected a $285 million settlement between the SEC and Citigroup, in part because he objected to a three-decade old SEC practice of allowing the accused to settle charges without admitting or denying guilt.

In the IBM case, the issue is whether the SEC is requiring IBM to do enough to improve its compliance practices and to prove that it will not become a repeat offender. During a public hearing, Judge Leon said the court and the SEC are at a stalemate as to what conduct should be required from IBM in the pending consent judgment. “This is not a rubber stamp court,” he stressed. “I'm not just going to roll over like the SEC has.”

Leon further remarked that he is “part of a growing number of district judges in the country who have grown increasingly concerned” about the SEC just simply signing off on consent decrees in the face of serious corporate misconduct.

The judge stipulated that he will approve the consent order only if IBM agrees to the following additional reporting requirements:

·         Submit annual reports to the SEC and the court on its FCPA compliance efforts;

·         Immediately report to the SEC and the court upon learning if there is a reasonable likelihood that the company has violated the FCPA again, including all potential accounting violations; and

·         Report within 60 days of learning that it has become the subject of any investigation or enforcement proceeding.  

Leon said that such requests are typical of what he normally requires in SEC settlements. Still, following several off-the-record discussions with the court in the 22 months the case has been under review, IBM said it would only agree to the first request.

The remaining reporting obligations should be limited to violations of the FCPA in connection with any improper payments, said Peter Barbur, a partner with law firm Cravath, Swaine & Moore who represented IBM in the case. “The books and records provisions of the FCPA, as written, would be too broad to require reporting of every potential violation,” he said.

As a general matter, the problem with making arguments based on burden, as opposed to making arguments based on the principal that the judge's actions are simply wrong, is that the court will always put the onus on the company to prove its stance, says Norman Goldberger, a partner of law firm Ballard Spahr and practice leader of the firm's securities litigation group.

“[Judge Leon] has a lot of experience—probably more than most judges—with the FCPA, and that may have influenced his views here.”

—Thomas Gorman,

Partner,

Dorsey & Whitney

That's exactly what  Leon did in this case. In particular, he questioned how tracking such data would be too burdensome for “one of the largest corporations in the world” that has a general counsel and compliance officer, each fully dedicated to monitoring IBM's litigation and compliance with the FCPA.

Barbur further argued that IBM should only have to report on “FCPA-related proceedings, litigation, and investigations,” rather than all enforcement proceedings. To that point, Judge Leon argued that granting IBM such reporting limitations would “severely limit this court's ability to assess whether the law-abiding corporate culture the defendant has allegedly put in place company-wide and the internal controls to monitor it are actually succeeding.”

The case is not IBM's first run-in with the SEC over FCPA violations. In December 2000, IBM agreed to cease and desist from violating the books and records provisions of the Securities Exchange Act, stemming from $22 million in bribery payments IBM made to foreign officials in Argentina in exchange for a government contract. In resolving the matter, IBM also was ordered to pay a $300,000 civil penalty.

Limiting reporting obligations to bribery violations “strikes me as wholly inappropriate in a case like this where the company has a history of FCPA books and records violations,” Leon said. He also expressed disdain that the SEC, “for reasons the court cannot fathom,” would agree with IBM.

Securities experts have their own take on the situation: The reason the SEC doesn't want to go along with the judge is because, if that's what starts happening in these cases, “judges are going to wind up supervising these companies, and that's not what the SEC has in mind,” says Goldberger.

Another mitigating factor in the case could have to do with Leon's former experience with the “Africa Sting” case, involving 22 individual defendants for alleged violations of the FCPA, which the Department of Justice ultimately dropped following two mistrials and three acquittals. “He has a lot of experience—probably more than most judges—with the FCPA, and that may have influenced his views here,” says Thomas Gorman, a partner at law firm Dorsey & Whitney.

Leon has given IBM and the SEC until Feb. 4, the next scheduled hearing, to prove why the disclosure obligations would be too burdensome. “I'm not interested in summary conclusory statements by lawyers,” he said. “I'm interested in data.”

Broader Implications

Leon is only one of a handful of judges in the last year to challenge proposed consent orders between the SEC and corporations. “Ever since Judge Rakoff issued his decision in Citigroup, more judges have been questioning these settlements,” says Betty Santangelo, a partner at law firm Schulte Roth & Zabel.  “If judges don't feel a settlement is appropriate, they don't want to be held responsible for approving it.”

JUDGE LEON'S SPEECH

The following excerpt of the transcript from the court's public hearing details Judge Leon's decision:

In reviewing a proposed consent judgment, a District Court has an obligation to independently determine whether the proposed consent judgment is fair, adequate and reasonable. The D.C. Circuit has additionally noted that a District Court's review of a proposed consent judgment may include consideration of the public interest.

In this case, as in a number of other SEC cases before me, I have informed the parties that I expect, as a part of my oversight responsibility in monitoring compliance with the consent judgment, that the consent judgment required the Defendant to submit to the Court and the SEC annual reports regarding its FCPA compliance efforts. This requirement will hopefully ensure that the compliance program and internal controls put into place as a condition to the consent judgment are functioning successfully and that the Defendant has remained committed to complying with the law on an ongoing basis. To date, the Defendant and the SEC are amenable to this requirement.

In addition, I have normally required the Defendant to report to the SEC and this Court immediately upon learning it is reasonably likely that the Defendant has violated the FCPA. To date, however, the Defendant has not agreed to this reporting requirement. The Defendant believes this reporting requirement should be limited to violations of the FCPA, quote, in connection with any improper payment to obtain or retain business, closed quote. That limitation strikes me, however, as wholly inappropriate in a case like this where the company has a history of FCPA books and records violations.

Next, I also normally require the Defendant to report within 60 days of learning that it is, one, the subject of any investigation or enforcement proceeding by any Federal Government agency, two, a party to any major Federal administrative proceeding, three, a party to any major civil litigation in the United States, or four, the subject of any criminal investigation by the Department of Justice. Once again, the Defendant has indicated it will only agree to these requirements if they are limited to FCPA-related proceedings, litigation and investigations. Not surprisingly, I disagree.

I believe that such a limitation would severely limit this Court's ability to assess whether the law-abiding corporate culture the Defendant has allegedly put in place company-wide and the internal controls to monitor it are actually succeeding. In sum, the Defendant balks at these reporting requirements as too burdensome to comply with. For reasons the Court the cannot fathom, the SEC appears to agree with the Defendant. I, of course, continue to disagree. To date, the parties have not demonstrated that these requirements are, in fact, too burdensome. To the contrary, I remain convinced that the requirements are necessary to protect the public interest and to ensure that Defendant's internal controls, compliance program and corporate culture have been successfully remediated.

Source: Judge Leon Speech.

In the Citigroup case, Rakoff ruled that, without any basis to find the bank in violation of the law, the proposed consent judgment was “neither fair, nor reasonable, nor adequate, nor in the public interest.” Rakoff's rejection of the settlement is currently on appeal in the U.S. Court of Appeals for the Second Circuit.

In yet another case in which a federal judge challenged the SEC's practices, Judge Rudolph Randa for the Eastern District of Wisconsin questioned the SEC about its proposed settlement with Koss Corp., stemming from charges that the audio equipment maker engaged in accounting fraud to cover up a $30 million embezzlement scheme.

Randa raised concerns as to how the settlement would stop Koss from violating securities laws again. In December 2011, he issued an order directing the SEC 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.”

Many of these cases are settled on a relatively narrow basis, Gorman explains. Yet he suggests that the settlement terms will bring a company into compliance with securities laws. “What's happening here is that judges are asking, ‘Is this really enough to ensure future compliance?'”

All three cases bring into question what role the courts should play in overseeing agreements struck between the government and a corporation. “If you're going to put more teeth into these settlements, it's going to have to come from the SEC,” says Goldberger.

Securities experts say that the extent to which more judges start to interfere in settlements between the SEC and corporations will greatly depend on the Second Circuit's ruling in the Citigroup case. “If the court comes down with a narrow ruling that judges have a very small role to play here, it could end a lot of the questions that are being raised,” says Gorman.

The Citigroup case, however, is only limited to the Second Circuit, Santangelo points out. “Although the Second Circuit is often given deference, you might have a different opinion in a different circuit,” she says.

Regardless of what the Second Circuit decides, every company that negotiates settlements with the SEC now has to worry somewhat that there may be other judges who won't simply rubber stamp these consent decrees, says Goldberger. That may encourage the SEC to reach “deals with a little more teeth, deals with a little more substance,” resulting in heftier fines and reporting obligations, he says. “It's another arrow in the quiver for the SEC.”