SEC Update—Ninth Circuit Permits Simultaneous Civil & Criminal Investigations; Bush Nominates Two Democrats to Fill Vacancies on SEC; SEC Successfully Uses Sarbanes-Oxley Escrow Provision to Avoid Pending Executive Bonus; SEC Proposes Short Sale Rule: S
Circuit Court Supports SEC & U.S. Attorney Actions – Permits Simultaneous Civil & Criminal Investigations
On April 4, the Circuit Court of Appeals for the Ninth Circuit issued its much-anticipated opinion in United States v. Stringer,1 supporting the actions of the Securities and Exchange Commission and the U.S. Attorney’s Office in conducting simultaneous civil and criminal investigations and reversing the lower court’s decision which held that the government’s actions violated the defendants’ rights to due process and against self-incrimination. This decision validates the government’s use of simultaneous, parallel investigations and also clarifies the limits on permissible government conduct that the courts would consider acceptable and not violative of a defendant’s constitutional rights.
The Stringer case called into question parallel and simultaneous investigations, which are frequently utilized by federal regulatory agencies working in conjunction with law enforcement agencies. In Stringer, the Ninth Circuit Court reversed the district court ruling dismissing the criminal indictments against certain former officers of FLIR Systems, Inc. (“FLIR”) on charges of securities, mail and wire fraud. The court determined that the government had not violated the defendants’ Fifth Amendment due process rights by simultaneously pursuing civil and criminal investigations of the defendants. The Circuit Court’s decision rests on the fact that the SEC disclosed to the defendants in a form that accompanied the subpoena the possibility that information received in the course of its investigation could be used in a later criminal proceeding. The Circuit Court also rejected the district court’s finding that the government obtained certain evidence in violation of the defendants’ Fourth Amendment rights against unlawful searches and seizures.
In the Stringer case, the SEC initiated an investigation of FLIR and its officers and later met with the local U.S. Attorney’s Office in
The District Court in Stringer found that federal prosecutors, working together with the SEC, violated the defendants’ due process rights by not advising them of the investigation by the U.S. Attorney’s Office and the potential criminal prosecution.2 In addition, the District Court held that the government violated the defendants’ Fourth Amendment rights by not mentioning the involvement of the U.S. Attorney’s Office and as a result, engaged in an unreasonable search and seizure. As a result, the District Court concluded that any information obtained through the SEC subpoenas should be suppressed in the event of a criminal trial.
In reversing the District Court decision, the Ninth Circuit stated that simultaneous civil and criminal investigations are permissible and not a violation of the defendants’ right against self-incrimination since the form attached to the SEC’s subpoena provided sufficient notice of a possible criminal prosecution and the fact that information gathered by the SEC could be used in a criminal proceeding. The Circuit Court clarified that although the government may not intentionally mislead criminal defendants, there is no legal duty on the part of the government to disclose the existence of the criminal investigation. In addition, the Circuit Court rejected the District Court’s finding that the government violated the Circuit Court rejected the District Court’s finding that the government violated the defendants’ due process rights by using the civil investigation solely for the purpose of obtaining evidence for a subsequent criminal prosecution. Since the SEC began its civil investigation before the U.S. Attorney’s Office investigation, the Circuit Court concluded that the SEC’s interviewing of defendants did not constitute a due process violation because the SEC was conducting its own bona fide civil investigation.
This decision will undoubtedly be chalked up as a “big win” for the government and result in the continued use of concurrent, parallel investigations by government entities. As a result of the ruling in this case, public companies and their officers need to have a coordinated approach to respond to SEC inquiries that appear routine in nature, including consultations with the company’s SEC’s counsel. Companies also should seek counsel that is experienced in criminal and “white collar” investigations. In addition, the company and individuals involved in an SEC investigation should assume that a criminal investigation may be initiated, and that any information supplied to the SEC may be provided to criminal prosecutors and utilized in the criminal investigation.
Two Democrats Nominated to Fill Vacant SEC Positions
On March 28, two Democrats, Luis A Aguilar and Elisse B. Walter, were nominated by the Bush Administration to fill the vacancies on the SEC. If their nominations are approved by the Senate, Ms. Walter and Mr. Aguilar will serve for terms expiring in 2012 and 2010, respectively. The three current Commissioners are Republicans. The President’s party is limited to a maximum of three seats on the Commission.
Mr. Aguilar is a partner with the
SEC Successfully Uses Sarbanes-Oxley Escrow Provision to Avoid
Pending Executive Bonus
On April 9, the SEC announced that $29.5 million in previously frozen funds that had been earmarked as a bonus to be paid to Henry C. Yuen, the former chief executive officer of Gemstar-TV Guide International, would be returned to the company and its shareholders. The funds had been previously set aside in 2003 under Section 1103 of the Sarbanes-Oxley Act of 2002 - a little-known provision of the massive securities and corporate reform law that has provided substantial relief to companies and their defrauded investors.
Under Section 1103 of SOX, the SEC may ask a federal court to freeze an “extraordinary payment” if it appears that, during an investigation of a company or its officers or directors, the company will make such a payment to an officer or director. The frozen money is then placed in an escrow account pending the outcome of the SEC investigation. The purpose of Section 1103 is to ensure that company insiders do not receive these kinds of payments or dissipate corporate assets while under the cloud of an SEC investigation. The SEC has also successfully used Section 1103 asset freezes in connection with investigations of
The SEC had originally charged Mr. Yuen in 2003 with various violations of the federal securities laws. After a three-week trial held in December 2005, the U.S. District Court for the Central District of California found for the SEC on all of its claims. The return of the Section 1103 funds to the company brought the total financial cost to Mr. Yuen of the SEC’s securities fraud claims to more than $51 million.
SEC Proposes Short Sale Rule
The SEC proposed a new short sale rule designed to address the abusive practice of “naked” short selling. Naked shorts involve selling stock short without actually having the stock available for delivery, and thus, intentionally failing to deliver stock within the standard three-day settlement cycle. These manipulative schemes are deemed to violate the general anti-fraud provisions of federal securities laws, including Rule 10b-5. Proposed Rule 10b-21 would impose liability on short sellers who deceive specified persons about their intention or ability to deliver securities in time for settlement, including those who deceive their broker-dealer about their source or ownership of shares, and who ultimately fail to deliver securities by the settlement date. Broker-dealers could also be liable for aiding and abetting in the customer’s fraud. The proposed rule is intended to aid broker-dealers in complying with the locate requirement of Regulation SHO, and help reduce manipulative schemes involving “naked” short selling.
Proposed Rule 10b-21 makes it unlawful for any person to submit an order to sell a security if such person deceives a broker-dealer, participant of a registered clearing agency, or purchaser regarding its intention or ability to deliver the security on the date delivery is due, and such person fails to deliver the security on or before the date delivery is due. For purposes of proposed Rule 10b-21, broker-dealers, including market makers, acting for their own accounts are considered sellers and if a seller enters a short sale order into a broker-dealer’s direct market access or sponsored access system with any information purporting to identify a locate source, the seller would be making a representation to the broker-dealer. A seller would be liable under the proposed rule for deceiving a broker-dealer, participant of a registered clearing agency, or purchaser about its ownership of shares, including designating an order to sell a security “long” if the seller knows or recklessly disregards that it is not “deemed to own” the security, or the deliverable condition of owned shares, and fails to deliver securities by settlement date. Broker-dealers selling for their own accounts would be liable under the same conditions as any other seller.
If, however, a seller relies or a broker-dealer, including its “Easy to Borrow” list, to comply with Regulation SHO’s locate obligation and to make delivery on a sale, the seller would not be making a representation that it can or intends to deliver the security. Additionally, a market maker engaged in bona fide market making activity would not be making a representation at the time it submits an order to sell short that it can or intends to deliver securities on the date delivery is due, because such market makers are excluded from the locate requirement of Regulation SHO due to their need to facilitate customer orders without the possible delays associated with the locate requirement.
Rules To Regulate Finders in the Works at the SEC
At the recent American Bar Association spring meeting, the head of the SEC’s Office of Small Business Policy, Gerald LaPorte, indicated that the SEC intends to prepare a proposal to require “finders” of capital for companies to register with the SEC. It is intended that the registration of finders would be less stringent than the registration requirements applicable to broker-dealers. The purpose of the rule is to regulate the activities of finders who are not currently registered like broker-dealers but who connect companies who need money with individuals who provide such capital. Currently, finders can make introductions but cannot receive a commission or other compensation in connection with the sale of securities without registering as a broker-dealer.
Notes
-
United States - United States v. Stringer, 408 F. Supp 2d 1083 (D. Or. 2006).