Quarterly Securities Enforcement Briefing
- An Overview of the DOJ’s and SEC’s Recent FCPA Guidance
- Judge Sets Strict Discovery Standard for In-House Attorneys
- SEC Prevails on Aggressive Approach to Forfeiture of CEO and CFO Compensation Under SOX 304
- SEC Increases Pressure on Accounting Firms to Produce Work Papers From China
- Audit Watchdog Faults Accounting Firms for Internal Controls Work
- Supreme Court to Decide Whether SEC Can Invoke Discovery Rule in Penalty Actions
An Overview of the DOJ’s and SEC’s Recent FCPA Guidance
By Jeffrey B. Coopersmith and Jean M. Flannery
As noted in our advisory of Nov. 15, 2012, the Department of Justice (“DOJ”) and Securities and Exchange Commission (“SEC”) released their long-awaited Resource Guide to the U.S. Foreign Corrupt Practices Act (“FCPA”) on Nov. 14. The Resource Guide is a helpful though non-binding 120-page handbook that largely enshrines the government’s aggressive approach to and interpretation of the FCPA. The Resource Guide also lays out the government’s FCPA enforcement principles and what to expect after the government opens an investigation or brings charges.
For those who do not have time to read it, we have prepared this “guide to the Guide”—an outline of the Guide’s core anti-bribery content, with our own analysis included where appropriate. We hope that you will find it valuable for your FCPA compliance programs and in answering questions as they arise. We invite you to call or email us with any questions or comments.
Judge Sets Strict Discovery Standard for In-House Attorneys
By John A. Goldmark
A federal judge in Coquina Investments v. Rothstein [2012 WL 3202273 (S.D. Fla. Aug. 3, 2012, Case No. 10-60786)] levied harsh sanctions against TD Bank and its outside counsel for numerous discovery violations, including most notably, the failure to conduct an adequate internal search for documents. Coquina involved a high-profile case regarding TD Bank’s alleged assistance with a Ponzi scheme that resulted in a $67 million verdict against the bank. The judge issued a post-trial order against the bank and its counsel for negligently failing to turn over relevant documents. The ruling criticized the bank’s failure to produce documents in their native format, which led to the loss of key information in the discovery production, and the lack of coordination among its many attorneys.
The Association of Corporate General Counsel (ACC), a global bar association for in-house counsel, filed an amicus brief in support of TD Bank’s appeal, urging the 11th Circuit to reverse the sanctions as creating an “impossible standard” for in-house counsel to follow during the discovery process. The ACC argues that holding the client responsible for errors in a discovery process that involves hundreds of attorneys and a high volume of documents sets an unrealistic precedent for in-house counsel and would have a chilling effect on how they operate. The lower court’s ruling, the ACC says, demonstrates a fundamental misunderstanding of how in-house counsel work and the resources available for discovery.
This ruling is one of many recent discovery opinions throughout the country that emphasize the need for attorneys to work closely with their clients during the discovery process. It also highlights the importance of both preserving and producing documents in their native format to ensure relevant information is disclosed. Finally, it suggests that corporate counsel should actively assist outside counsel in litigation and participate in searching for and producing relevant material.
SEC Prevails on Aggressive Approach to Forfeiture of CEO and CFO Compensation Under SOX 304
By Jeffrey B. Coopersmith
On Nov. 13, 2012, the federal district court in Austin, Texas denied a motion to dismiss filed by the CEO and CFO of Arthrocare Corporation seeking to put an end to the SEC’s effort to claw back their incentive and equity-based compensation under Section 304 of the Sarbanes-Oxley Act. The case, SEC v. Baker, may portend a new, more aggressive phase in the SEC’s approach to Section 304, and underscores the need for internal corporate vigilance concerning misconduct associated with financial statements.
Section 304 gives the SEC discretion to file a lawsuit against CEOs and CFOs to claw back their incentive and equity-based compensation, as well as any trading profits, realized during the 12-month period following the issuance of a financial statement that is later restated “as a result of misconduct.” The statutory text does not require that the “misconduct” be on the part of the CEO or CFO. For years, the SEC used Section 304 sparingly, and rarely in cases that did not involve allegations of misconduct by the CEO or CFO. In Baker, however, the misconduct was committed by two senior vice presidents (both of whom were indicted), not by the CEO or CFO. Nevertheless, the SEC sought forfeiture of their SOX 304 compensation, a more aggressive approach that had been advocated by a senior counsel in the SEC’s enforcement division. See Rachael E. Schwartz, The Clawback Provision of Sarbanes-Oxley: An Underutilized Incentive to Keep the Corporate House Clean, 64 Bus. Law. 1, 34 (2008).
The court rejected the officers’ motion to dismiss the SEC’s SOX 304 claim. Federal district Judge Sam Sparks found that Congress had enacted Section 304 to create an incentive for CEOs and CFOs to police their organizations for misconduct, not simply to duplicate existing statutes giving the SEC remedies to disgorge ill-gotten gains. Following other courts that have considered the issue, Judge Sparks declined to read a scienter requirement into Section 304. He also rejected the officers’ constitutional challenges to Section 304, and a defense based on the “innocent owner” protection in the Civil Asset Forfeiture Reform Act (CAFRA).
This case underscores the importance of maintaining a robust compliance regime in connection with the preparation of financial statements. The case signals that the SEC is likely to go after incentive and equity-based compensation, and trading profits, in the wake of restatements brought on by employees’ misconduct, even where it is clear that the CEO and CFO committed no wrongdoing.
SEC Increases Pressure on Accounting Firms to Produce Work Papers From Chin
By Jeffrey B. Coopersmith and Ron Cai
On Dec. 3, 2012, the Securities and Exchange Commission ramped up its efforts to obtain documents from five Chinese affiliates of major U.S. accounting firms. The SEC has been seeking documents from the firms in connection with its investigation of PRC-based issuers traded on U.S. exchanges. The five firms are the Chinese affiliates of PricewaterhouseCoopers, KPMG, Deloitte, Ernst & Young, and BDO. Each of the accounting firms has refused to produce documents to the SEC based on the PRC’s state secrets law, which defines state secrets as “matters which, if divulged, would harm national security and interests in the areas of politics, economics, national defense, and diplomacy.” Accounting work papers created in the course of audit work could clearly fall within this definition. The SEC maintains that, notwithstanding the PRC law, the accounting firms must produce the documents pursuant to section 106 of the Sarbanes-Oxley Act, which the SEC claims requires auditors of U.S.-listed companies based abroad to provide audit work papers and other documents to the SEC. The SEC’s Dec. 3 action is in the form of an administrative order instituting proceedings to bar the Chinese affiliates of the major U.S. accounting firms from performing audits or otherwise practicing or appearing before the SEC based on the alleged failure of the firms to comply with section 106.
It is unclear how this conflict between U.S. and PRC law will be resolved. There are reports that the SEC is negotiating with Chinese securities regulators. It is unlikely that the accounting firms will comply with the SEC’s demand for documents because of the risk of severe sanctions under Chinese law. An outcome where the firms are barred from performing audit work for China-based issuers threatens to undermine the ability of Chinese companies to trade in the U.S. Under the SEC’s rules of practice, an initial decision from an SEC Administrative Law Judge is required by September 2013.
Audit Watchdog Faults Accounting Firms for Internal Controls Work
By John A. Goldmark
The Public Company Accounting Oversight Board (PCAOB), a nonprofit created to police the accounting industry, recently released a report identifying widespread problems with the internal control audits performed by the nation’s largest accounting firms. The report found that eight large accounting firms, including the Big Four, often used deficient methods in 2010 and 2011 in auditing their client’s internal controls aimed at curbing financial fraud.
The Sarbanes-Oxley Act, as amended by the Dodd-Frank Act, requires management of all companies to assess and report on the effectiveness of the company’s internal control over its financial reporting. The law also requires that independent auditors for larger companies attest to management’s disclosures about the effectiveness of that internal control. In nearly one-quarter of the audits inspected by the PCAOB in 2011, however, the accounting firm failed to obtain sufficient evidence to support its opinion approving of the client’s fraud prevention measures, a sharp increase from the flaws found in 2010. The PCAOB found “pervasive deficiencies” throughout the 2010 and 2011 audits, which frequently arose from the accountants’ failure to obtain and examine underlying documents to ensure the company was not misstating revenue or falsely valuing its assets. The watchdog cautioned that its findings did not indicate that a client’s internal controls were inadequate, but rather that the accountants frequently failed to follow proper procedures in executing their audits.
The takeaway from this report is that companies must not only maintain adequate internal controls over financial reporting but they must also provide complete and transparent records to their accountants to ensure sufficient audits over those controls.
Supreme Court to Decide Whether SEC Can Invoke Discovery Rule in Penalty Actions
By Jean M. Flannery
The Supreme Court has granted the petition for writ of certiorari to review the 2nd Circuit’s decision in SEC v. Gabelli, 653 F.3d 49 (2d Cir. 2011). The Court is expected to resolve a circuit split over whether the Securities and Exchange Commission (“SEC”) can seek civil penalties long after alleged violations took place.
In Gabelli, the SEC had accused the petitioners of, among other things, aiding and abetting violations of antifraud provisions of the Investment Advisors Act of 1940. But the SEC filed its complaint in 2008—six years after the last alleged violation. This delay prompted the district court to rule that the SEC could not seek civil penalties for the Investment Advisors Act claim because of the applicable statute of limitations (28 U.S.C. § 2462). That statute requires the SEC to commence civil penalties actions within five years of when the claim “first accrued.”
The 2nd Circuit reversed the district court, holding that the claim did not accrue until September 2003—which was when the SEC apparently discovered the alleged fraud. The Court reached its holding by applying the common law “discovery rule” to the statute of limitations. Under the discovery rule, the statute of limitations for a particular claim does not accrue until the plaintiff discovers the claim, or could have discovered it with reasonable diligence. The discovery rule traditionally applies to claims for harms that, by their very nature, remain latent during the limitations period. (The discovery rule is distinct from the equitable tolling doctrine, which prevents defendants who actively conceal their crimes from relying on the statute of limitations bar.) The 2nd Circuit held that “since fraud claims by their very nature involve self-concealing conduct, it has been long established that the discovery rule applies where, as here, a claim sounds in fraud.” Gabelli, 6543 F.3d at 59.
The petitioner and supporting amicus briefs filed with the Supreme Court criticize the 2nd Circuit for ignoring the plain language of the statute and misreading the authority it relied upon in its holding. Specifically, the briefs argue that the Supreme Court has never held that all frauds are self-concealing, and that on the contrary, the cases relied upon by the 2nd Circuit involved affirmative concealment of the fraud at issue. In addition, the briefs point out that the discovery rule is intended to protect injured parties, not a government agency like the SEC. And unlike private litigants, the SEC has broad investigatory power and tools at its disposal—arguably making application of the discovery rule to this statute of limitations inappropriate. Briefs are available here.
As highlighted in last quarter’s briefing, the 5th Circuit recently held—albeit in an unpublished opinion—that the discovery rule does not apply to § 2462. See SEC v. Bartek, No. 11-10594 (5th Cir. Aug. 7, 2012). The Supreme Court’s decision in Gabelli should resolve the 5th Circuit and 2nd Circuit split.
Oral argument in Gabelli is set for today, Jan. 8, 2013; listen to it here this Friday.