United States: Hogan Lovells Alert: Securities Litigation Review - 7 January 2011

Summary

The Enforcement Division announced an initiative in early 2010 - paralleling Department of Justice (DOJ) policies - offering the carrot of non-prosecution agreements to encourage greater cooperation by companies and individuals. By the end of 2010, however, only one company (Carter's Inc.) had entered into a non-prosecution agreement. And the SEC continued to resort to traditional methods of encouraging cooperation, either by not charging companies with having engaged in fraud and/or not imposing financial penalties (e.g., InfoGroup, Navistar International, International Commercial Television and General Re).¹

Dodd-Frank's bounty provision promises to change the cooperation landscape. The SEC's proposed rule implementing monetary awards to whistleblowers will become final sometime during the first half of 2011. This will increase the pressure on companies to self-report conduct and cooperate with the SEC before someone blows the whistle on them. On the other hand, the SEC will be more likely to impose penalties of $1 million or greater so that whistleblowers are eligible for bounties, thus making it more difficult for companies to negotiate settlements in cases where no penalties are imposed in consideration of their cooperation and remediation efforts.

Despite economic conditions, the SEC continued to extract substantial penalties from public companies. Financial penalties ranged to $100 million (against Dell) in financial fraud cases to $150 million in one proxy disclosure case (against Bank of America), and the SEC imposed even larger penalties in other cases (the penalty of $535 million against Goldman Sachs in an investment advisory action seta new high-water mark). Aside from requiring disgorgement of profits, the SEC imposed no substantial penalties in FCPA cases, with the explanation being that the DOJ extracted substantial fines from the companies in parallel criminal actions.

The SEC's primary area of focus with regard to public companies was enforcement of the FCPA, with actions being filed against 19 companies (and some of their subsidiaries). Perhaps the most noteworthy of these were the actions against a company (Veraz Networks) whose employees made isolated and relatively small payments to foreign officials and against another company (NATCO Group) whose employees made what appears to have been facilitating payments to immigration officials. These actions create further confusion regarding what companies should do upon discovering small payments or payments for facilitating business activities.

In the area of financial misstatements, the SEC filed fraud charges against only three issuers (Diebold, Dell and Vitesse Semiconductor), while entering into a non-prosecution agreement with one company (Carter's). Charges were filed under Section 13 of the Securities Exchange Act against two other companies (Navistar International and International Commercial Television) whose officers were charged with fraud, ostensibly on account of cooperation by the companies. The SEC rewarded another cooperating company (General Re) charged with aiding and abetting the financial fraud of other companies by charging it only with having aided and abetted violations of Section 13 and imposing no financial penalty in addition to disgorgement.

The SEC filed two significant actions in regard to proxy disclosures. Its action against Bank of America is noteworthy because of the size of the civil penalty ($150 million) and the absence of charges against any officer or director, ostensibly because of outside counsel's involvement in the proxy review process. The result was quite different where the SEC charged InfoGroup's former CEO, the former CFOs, and the chair of the audit committee with violating the antifraud and proxy disclosure provisions of the Securities Exchange Act for failing to disclose substantial perquisites received by, and related party transactions with, the former CEO. There, the company consented to a cease-and-desist order that it not violate the proxy disclosure provisions, but was not required to pay a civil penalty on account of its cooperation.

Finally, with respect to Regulation FD, the SEC showed no signs of retreating following a district court's 2005 dismissal of its complaint against Siebel Systems. The SEC charged two companies (Office Depot and Presstek) and their former CEOs with having made selective disclosure of material, non-public information to an investor during the last week of a quarter. Office Depot's CEO and CFO did not speak with any analysts or investors but caused the head of investor relations to signal that the company would not meet expectations by having the director call each sell-side analyst to tell them about poor results recently announced by other companies. The CEO of Presstek made the statements during the company's self-imposed quiet period (beginning two weeks before quarter end). The clear message is that one-on-one communications with analysts and investors late in a quarter are perilous.

Brief descriptions of significant enforcement actions

Foreign corrupt practices

SEC v. NATCO Group, Inc., 34 Act Release 61325 (11 January 2010). The SEC charged the company with having violated the books-and-records and internal control provisions by creating false documentation regarding payments made to Kazakhstan prosecutors to satisfy demands for immigration fines or by a consultant to immigration officials for temporary work visas. It is unclear whether the SEC would have charged the company with any violation of the FCPA had the approximately $125,000 in payments been accurately reported, as they arguably were facilitating payments. The company agreed to pay a $65,000 penalty imposed in a separate civil action. No parallel DOJ action was filed.

SEC v. Daimler AG, Press Release 2010-51 (1 April 2010). The SEC charged the company with making at least $56 million in improper payments to foreign officials in at least 22 countries over the course of at least 10 years. The company agreed to disgorge $91.4 million and separately paid a criminal fine of $93.6 million to settle charges filed by the DOJ.

SEC v. Technip, Lit. Release 21578 (28 June 2010) and SEC v. ENI, S.p.A. and Snamprogetti Netherlands, B.V., Press Release 2010-19 (7 July 2010). The SEC charged these companies, along with KBR and Halliburton who were charged in 2009, with having made improper payments over several years to government officials in Nigeria to facilitate construction of a LNG facility.

• Technip agreed to disgorge $98 million and to pay a $240 million criminal fine, and
• ENI and its subsidiary Snamprogetti agreed to disgorge $125 million and to pay a $240 million criminal fine.

SEC v.Veraz Networks, Inc., Press Release 2010-115 (June 29, 2010). The SEC charged the company with making improper payments to government officials in China and Vietnam to obtain business from government-controlled telecommunications companies there. The company obtained no business in China because it declined a contract worth about $230,000 after discovering that a consultant had made gifts valued at approximately $40,000 to government officials there. In Vietnam, the company sold products to the government controlled company during periods in which an employee made or offered payments, entertainment and gifts to officials (the payments were not being quantified in the SEC's complaint, which specifies only flowers sent to the wife of one official). The company agreed to pay a civil monet penalty of $300,000. No parallel criminal action was filed by the DOJ.

SEC v. Universal Corp. and SEC v. Alliance One, Lit. Release 21618 (6 August 2010). The SEC charged two tobacco companies with paying more than $5 million in bribes to government officials in Thailand, China, Greece, Indonesia, Kyrgyzstan, Malawi, and Mozambique.

• Universal agreed to disgorge $4.5 million and pay a criminal fine of $4.4 million, and
• Alliance agreed to disgorge $10 million and pay a criminal fine of $9.45 million.

SEC v. Panalpina, Inc., SEC v. Pride International, Inc., SEC v. Tidewater, Inc., SEC v. Transocean, Inc., SEC v. Global Santa Fe Corp., SEC v. Noble Corp. and In the Matter of Royal Dutch Shell plc, Press Release 2010-24 (4 November 2010). In its first sweep of an industrial sector, the SEC filed injunctive actions against six oil services companies, and administrative proceedings against a seventh charging them with bribing custom officials in 10 countries to avoid duties, expedite importation of goods and equipment, extend drilling contracts, and lower tax assessments.

• Panalpina agreed to disgorge $23.5 million and to pay criminal fine of $70.56 million,
• Pride International agreed to disgorge $23.5 million and to pay criminal fine of $32.625 million,
• Tidewater agreed to disgorge $1 million and pay $217,000 civil penalty as well as criminal fine of $7.35 million,
• Transocean agreed to disgorge $7.3 million and pay criminal fine of $13.44 million,
• Global Santa Fe agreed to disgorge $3.8 million and pay $2.1 million civil penalty,
• Noble agreed to disgorge $5.6 million and pay criminal fine of $2.59 million, and
• Royal Dutch Shell agreed to disgorge $18.1 million and pay criminal fine of $30 million.

SEC v. RAE Systems, Inc., Press Release 2010-242 (10 December 2010). The SEC charged the company with making $400,000 in payments to Chinese officials to obtain significant government contracts through two joint ventures for the purchase of gas and chemical detection products. Such contracts resulted in revenues of $3 million and profits of $1.1 million. The company agreed to disgorge all profits. No parallel DOJ action was filed.

SEC v. Alcatel-Lucent, S.A., Lit. Release 21795 (27 December 2010). The SEC charged the company with making payments over a period of almost five years to government officials in Costa Rica, Honduras, Malaysia, and Taiwan to obtain telecommunications contracts - approximately $7 million to officials in Costa Rica. According to the complaint, the leaders of several subsidiaries knew or should have know of the payments. The company agreed to disgorge $45.372 million and to pay a criminal fine of $92 million.

False/misleading financial statements

SEC v. Diebold, Inc., Lit. Release 21543 (2 June 2010). The SEC charged the company with fraud for having manipulated revenues, understated expenses, and taken other improper accounting actions. The complaint pointed to the company's use of an "opportunities list" to find items to close the gap between the company's results and analyst's consensus estimates. The company agreed to pay a $25 million civil money penalty. The former CEO, who was not charged with wrongdoing, agreed to disgorge bonuses, salary, and stock options under Section 304 of Sarbanes-Oxley.

In the Matter of Navistar International Corporation, Lit. Release 21616 (5 August 2010). The SEC filed administrative proceedings against the company and officers for the $137 million overstatement of the company's net income over five years through the premature recovery of income from several rebates and the improper accounting for certain revenues and deferred expenses. Although the SEC charged certain officers with fraud and five paid civil penalties totaling $362,500, Navistar consented to charges that it violated Section 13 of the Securities Exchange Act only and was not required to pay a civil penalty on account of its cooperation.

SEC v. Dell, Inc., Dell, Rollins, Schneider, Jackson and Dunning, Lit. Release 21599 (22 July 2010). The SEC charged the company with fraud for using improperly established "cookie jar" reserves to cover revenue shortfalls over four years and misleading investors by not disclosing substantial exclusivity payments from Intel. The company agreed to pay a civil penalty of $100 million. The CEO and former CEO agreed to consent to entry of injunctions that they not violate Sections 17(a)(2) and (3) of the Securities Act in connection with the misleading disclosures and to pay civil penalties of $4 million apiece. The former CFO agreed to consent to fraud charges and pay a penalty of $3 million.

SEC v. International Commercial Television, Inc., Lit. Release 21622 (9 August 2010). The SEC charged the company with violating Section 13 of the Securities Exchange Act for overstating revenues for two years. The SEC separately charged the company's former CFO with fraud. The company consented to an injunction but no financial penalty was imposed, presumably on account of its cooperation.

SEC v. Vitesse Semiconductor Corp., Tomasetta, Hovanec, Mody and Kaplan, Lit. Release 21769 (10 December 2010). The SEC charged the company with financial fraud for having engaged in channel stuffing for approximately five years and having failed to recognize compensation expenses on backdated stock options. The company agreed to pay a $3 million civil penalty. The former controller and Director of Finance also agreed to settle by disgorging certain compensation received.

SEC v. Elles, Lit. Release 21784 (20 December 2010). The SEC filed an injunctive action charging a former Carters, Inc. EVP for Sales with fraud for understating expenses for six years by manipulating the amounts of discounts given to Carter's largest wholesale sustainer, which discounts were deferred until later quarters. The EVP was also charged with insider trading on this information. The SEC entered into its first non-prosecution agreement with a company, citing Carter's extensive cooperation.

Aiding and abetting false financial statements filed by other companies

SEC v. General Re Corp., Lit. Release 21384 (20 January 2010). The SEC charged the company with having structured sham reinsurance transactions so as to facilitate misstatements of AIG's and Prudential's financial results. General Re consented to entry of an injunction that it not aid and abet violations of Section 13 of the Securities Exchange Act and to the disgorgement of about $12 million in profits, but was not fined or charged with more serious violations on account of its cooperation.

False/misleading proxy disclosures

SEC v. Bank of America Corp., Lit. Release 21377 (12 January 2010). The SEC charged the company with having misled shareholders in soliciting proxies relating to the acquisition of Merrill Lynch by failing to disclose substantial losses (most particularly $4.8 billion in October 2009 alone) sustained by Merrill Lynch just prior to the acquisition. In addition to consenting to be enjoined from violating Section 14(a) of the Securities Exchange Act and Rule 14a-9, the company agreed to pay a $150 million civil penalty to resolve the matters alleged in the complaint and a complaint filed in August 2009 alleging that it had mislead shareholders regarding bonuses to be paid to Merrill Lynch employees.

SEC v. American Equity Investment Life Holding Co., Noble, and Waugaman, Lit. Release 21431 (3 March 2010). The SEC charged the company with violating the proxy disclosure provision of the Securities Exchange Act by making misleading disclosures about a related-party transaction with its former CEO. The company disclosed that it bought an entity controlled by the former CEO for $1 but failed to disclose that it had a large deficit largely as a result of having made a $2.5 million distribution to the former CEO just prior to the sale. The proxy statement was also misleading in that it indicated that the former CEO was being compensated modestly given that it was clear that the purchase of the entity he controlled was intended to compensate him for his services to the company. The company consented to an injunction but was not fined. The former and present CEOs agreed to pay civil money penalties of $900,000 and $130,000 respectively.

SEC v. Gupta, Raval, Dean and Daz, Lit. Release 21451 (15 March 2010). The SEC charged the former CEO, former Chair of the Audit Committee, and two former CFOs of InfoGroup, Inc. with violating the antifraud and proxy disclosure provisions by understating the amount of perquisites provided to the former CEO and failing to disclose all related-party transactions involving the CEO - each by about $10 million over several years. The former CEO and Audit Committee Chair settled, agreeing not to violate the antifraud and proxy disclosure provisions of the federal securities laws, to pay civil money penalties of $2,240,700 and $50,000, and to the imposition of officer-and-director bars – permanent for the former CEO and 5 years for the former Audit Committee chair. The former CEO also agreed to pay the company $5 million in addition to a disgorgement settlement negotiated by the board a couple of years earlier. The company separately consented to entry of a cease-and-desist order charging it with violations of Sections 13 and 14 of the Securities Exchange Act, and no penalty was imposed on the company because of its extensive cooperation and remedial efforts.

Other false/misleading disclosures

SEC v. Citigroup, Inc., Lit. Release 21605 (29 July 2010). The SEC charged the company with misleading investors in public filings and earnings calls about the extent of its holdings of subprime mortgages by representing that such holdings were $13 billion instead of more than $50 billion. The company agreed to pay a $75 million civil penalty.

Selective disclosures

SEC v. Presstek, Inc. and Marino, Lit. Release 21443 (9 March 2010). The SEC filed an injunctive action against the company and its former CEO who made seemingly vague statements, in response to questions from a large institutional investor during the last week of the Company's third quarter, that the Company's sales had not been "vibrant" during the summer and that its financial results would be "mixed." The institutional investor promptly liquidated most of his stock holdings, leading to a price decline of 19%. The complaint noted that the former CEO violated the company's self-imposed quiet period that began mid-month during the last month of each quarter. The company consented to entry of an order that it not violate Section 13(a) of the Exchange Act and Regulation FD and pay a $400,000 civil money penalty while litigation with the former CEO is ongoing.

In the Matters of Office Depot, Inc., Stephen A. Odland and Patricia McKay, Lit. Release 21703 (21 October 2010). The SEC filed settled administrative proceedings charging the company, its CEO, and its former CFO with violations of Regulation FD. During the last week of the second quarter of 2007, the CEO and former CFO directed the head of investor relations to call all sell-side analysts to remind them what the company had said earlier in the quarter about the effects of the economy and to point them to the poor results just announced by three other companies. This, the SEC alleged, was "signaling" prohibited by Regulation FD. The company, which was also charged with having violated the periodic filing, books-and-records-and internal control provisions of the Securities Exchange Act, paid a $1 million civil penalty. Each of the officers paid a $50,000 civil penalty.

Footnotes

1. Similarly, with regard to individuals, the SEC on one occasion declined to impose a civil penalty on a corporate officer (David P. Turner of Innospec on August 5) charged with aiding and abetting his company's violations of the FCPA, and no doubt, as in past years, exercised its prosecutorial discretion on countless occasions by not charging potentially culpable individuals who cooperated during an investigation.

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