Speech by SEC Staff:
Remarks Before the Minority Corporate Counsel 2008 CLE Expo
Linda Chatman Thomsen1
Director, Division of Enforcement
U.S. Securities and Exchange Commission
March 27, 2008
It is a pleasure to be here today, for a whole host of reasons — including some very important ones — but one is quite whimsical and egocentric — I love Chicago. I was in my thirties before I first visited Chicago; I found it beautiful and bustling and manageable. (It was a few trips later before I experienced one of its infamous winters; and by that time, I was already hooked.) The city has a spectacular skyline and is justifiably proud of its architecture, but for non-Chicagoans the city's focus on architecture can be a little like inside baseball. Directions are often given by reference to buildings — for example, it's between the Hancock Building and Water Tower, without any reference to an address or even a street name. One of Chicago's most famous buildings is the Tribune Tower. It was completed in 1925 and is a gothic design modeled after the Button Tower of the Rouen Cathedral.2 It was only this fall that I finally noticed one of its most interesting features: imbedded in its exterior wall is an eclectic rock collection. The collection is not primarily about the rocks, but the places the rocks came from (which are clearly labeled): the Alamo, the Coliseum, the Great Wall of China, Bunker Hill Battlefield, Edinburgh Castle, Hamlet's Castle, Anzio Beach, Columbus' Landing Place, John Brown's Cabin, The Great Pyramid of Cheops, and the original tomb of Abraham Lincoln. Not too long ago, a steel fragment from the World Trade Center was added.3 You can walk through history and circumnavigate the globe by simply walking around the building.
As you might imagine, with such a famous skyline, Chicago has been called home by a number of architectural giants. Frank Lloyd Wright, Louis Henry Sullivan and German-born Ludwig Mies Van Der Rohe, more commonly known as Mies.
Mies designed, and subsequently became the most famous instructor of, the Illinois Institute of Technology.4 His design of the Institute's Main Campus and of other important buildings — such as the apartment towers at 860 and 880 North Lake Shore Drive in Chicago and the Seagram Building in New York — helped set a new aesthetic standard for modern architecture.5 In 1976, the American Institute of Architects designated the campus as one of the most important works of architecture in the country and in 2005 it was added to the National Register of Historic Places.6
Mies is popularly credited with the phrase "the Devil is in the details" and its variant, "God is in the details." And we all know both are true — getting them right is devilishly hard, but when we do is really divine. Now let's dive into some of the details — and of course I'm in enforcement so I'll be focusing on the less divine, some of which is down right depressing. But first, let me remind you that my views are my own and do not necessarily reflect the views of the Commission or any other member of the staff.
And before I get to some of those depressing details, I'd also like to pause to congratulate you all for this year's ambitious agenda. It is inspiring to see both the breadth and the depth of this program and your attention to these issues is just one form of professional insurance.
I understand you want to hear about lawyers' liability and the FCPA. I'll talk about both as well as the role of enforcement generally.
Let's start with lawyers. Most of the corporate and defense lawyers I come across are smart, honest and diligent and add value both to the process and to achieving a right and fair result. But unfortunately, it's the others — and they are no doubt the distinct minority — which we hear the most about.
Over the past five years the Commission has sued more than 125 lawyers, nearly half of whom were General Counsels. To put things in perspective, over the same five-year period, the Commission has brought nearly 3500 cases and sued more than 7,000 entities and individuals.
Perhaps one of the most concentrated group of cases where lawyers have not distinguished themselves favorably is in the backdating stock option cases. As we all now know, over the past decade far too many companies seem to have succumbed to the temptation to make in the money grants that appeared — for all corporate intents and purposes — to be at the money grants. How did they achieve this sleight of hand? Backdating — in all of its myriad forms. Putting false dates on corporate grant documents — as alleged in Brocade — was by far the simplest fraudulent scheme, but the variations seem to be limited only by the perpetrators' imaginations. In Comverse, for example, the company's top officers — the former CEO, CFO and General Counsel — are alleged to have routinely backdated stock option grants, giving themselves and other employees the benefit of 20-20 hindsight. According to the SEC's complaint, they went so far as to create a secret slush fund by making backdated options grants to fictitious employees, and later used those options to recruit and retain key personnel. To hide the backdating scheme, they also allegedly altered corporate records and lied to the company's auditors. Unfortunately, in the course of our investigations, we are finding that schemes like the one alleged in Comverse were not so unusual. Given the extremes that many company's top-level executives — and in several instances lawyers — were willing to go to, backdating must have appeared to offer the best of both worlds — employees enjoyed the dazzling paper profits and stock ownership opportunities of in the money grants, while the corporation enjoyed all the advantages of at the money grants.
To date, the Commission has charged seven General Counsels of eight publicly held companies and twenty-nine corporate executives for their involvement in options backdating scandals.7 These scandals have involved some shockingly bad conduct — allegations of secret slush funds; forgery; grants to fictitious employees, former employees and unknown future employees; falsified corporate documents; self-dealing; self-enrichment; attempted cover-ups; and lying to the auditors. In each of these cases we alleged attorneys had actually altered or completely fabricated documents to conceal or advance the scheme.8
Another area where we see misconduct by lawyers relates to the filing process. Earlier this month, the Commission permanently suspended a corporate counsel from representing clients or filing any documents before the Commission.9 In the underlying district court action, the court found that the lawyer had filed Form 10-KSB's with unsigned, falsified audit reports with the Commission. The court further found that he knew the audit reports were required to be signed, but failed to make any detailed inquiries regarding the auditor's qualifications, findings, or lack of signature. Additionally, he had prepared and signed an opinion letter regarding the validity of stock issuances, which contained falsities and/or misstatements and was included in Commission filings.10
Last Month we charged a California attorney for his alleged role facilitating a multi-million dollar fraud by issuing a series of bogus legal opinion letters used by fraudsters in spam-fueled pump-and-dumps.11 Similarly, we sued two attorneys, one of whom I'm sorry to say is a former Commission staff member, for allegedly assisting a micro-cap company in a scheme to dump millions of shares into the marketplace by arranging a series of sham transactions to help the company avoid registering stock sales with the Commission.12 Just last week, the state bar of Texas suspended the former SEC lawyer's license to practice law for three years.13
Relatedly, this past year, the Commission has increased enforcement efforts in this arena with the formation of a new group dedicated to microcap fraud. This group will focus on investigating and where appropriate suing, shell company manipulators, pump-and-dump artists, and Internet spam fraudsters. We will look for those, including lawyers, who facilitate these frauds.
One of the most inexplicable areas in which we have sued lawyers, among other professionals, is insider trading. In the past year we've sued nine lawyers for insider trading. In January we charged an attorney and former associate General Counsel of a company for directing the sale of his entire company stock holdings upon learning that his company's fourth quarter EPS would be about 50% lower than analysts' expectations. By selling his shares before public announcement of the news, he avoided losses of 27%. He was also charged with tipping his father and a friend, both of whom also were charged with insider trading.14
Last summer, we charged the former managing partner of a national law firm's Washington, D.C. office, with illegally trading on nonpublic information he learned while interviewing a lawyer who applied for a job. During the interview, the former managing partner learned that the applicant, the former Chief Counsel of a public company that was also one of the law firm's clients, was seeking to leave his company because it was about to be acquired. The Commission complaint alleged that based upon this information, the former managing partner purchased 10,000 shares of the company ahead of the public announcement of the impending deal. The day the deal was publicly announced, the company's share price closed 50% higher than it had on the previous day.15
Two of our recent insider trading cases involved lawyers who had substantial compliance responsibilities. In the first case, we charged an attorney who was employed by Morgan Stanley as a compliance officer, along with 13 others, for her role in one of the largest insider trading cases against Wall Street professionals. In the complaint, we allege that the compliance officer and her husband, also an attorney, tipped a broker-dealer concerning upcoming corporate acquisitions involving Morgan Stanley's investment banking clients. The broker-dealer then traded on the information and shared his illicit profits with the couple.16
In the second case, the Commission charged the former General Counsel and chief insider trading compliance officer of a public company for illegally trading in the company's securities prior to five public announcements relating to financial results and company business transactions. The lawyer executed more than fifty illegal trades in the company's stock and options based on information he had learned as a result of his position as general counsel. He executed nearly all of these illegal trades while he and other company employees were subject to company blackout periods that prohibited them from trading in the stock. In addition to the Commission action, he was criminally indicted on related charges.17
As I said earlier, the kind of behavior I just described is not the norm. And I would hope no one in this audience needs to be warned of these behaviors and their consequences.
To ask the obvious, how do you avoid these kinds of problems? Don't lie, don't cheat, and don't steal. But as professionals, I hope you are inspired to do more. In that regard I commend to you the Report of the Task Force on the Lawyer's Role in Corporate Governance, issued by the New York City Bar Association in November of 2006. The report talks about the importance of professional courage. It acknowledges that, given the economic and financial pressures to maintain relationships with major corporate clients and powerful officers and directors, and the fact that the answers to legal questions are rarely beyond dispute, "[i]t may take genuine professional courage to provide unwelcome advice and stick to it."18 Having professional courage is something we can all aspire to.
I've talked a lot about how the details can get you into trouble. But you all know the big picture can be just as difficult to navigate. And because so many of your clients do business globally I want to talk about the Foreign Corrupt Practices Act.
The history of the FCPA began with Watergate, during which it was revealed that a significant number of U.S. issuers were paying bribes to foreign officials to obtain business. The payments were hidden on the companies' books to disguise them from audit and public scrutiny. Further inquiries by the Commission, later summarized in a 1976 report to Congress, showed hundreds of U.S. issuers had created, among other things, "slush funds" to pay bribes to foreign officials and political parties.19 In response to the formidable number of companies engaged in the conduct, then-Director of the Division of Enforcement, Stanley Sporkin proposed what became the voluntary disclosure program. Under the program, any corporation which came forward and self-reported an illicit payment problem and fully cooperated with the Commission was informally assured that Commission enforcement action was unlikely to be taken against it. Full cooperation included conducting an independent internal investigation to determine the full extent of the company's worldwide bribery; sharing the results with the Commission, with the understanding they would be made public; and taking appropriate remedial steps to ensure that the problems were addressed and would not reoccur.20 More than 500 companies, including more than 100 members of the Fortune 500, took part in the program and voluntarily disclosed in excess of $300 million in bribes and other questionable payments.21
In 1977, the FCPA was enacted. (Other post-Watergate legislation included the Sunshine Act in 1976 and the Ethics in Government Act in 1978.).22 The FCPA prohibits the payment of bribes to foreign officials to obtain or retain business. It also establishes the requirement for companies to maintain accurate books and records.23 The genius of the FCPA, if you will indulge the hyperbole, is that it is, like all of the federal securities laws, disclosure-based. It works from the premise that simply requiring companies to clearly and candidly describe what they are doing will cause them to decide to avoid certain problematic behavior.
When it was enacted, the FCPA was decreed by some as the end of U.S. competitiveness in foreign markets.24 But then a funny thing happened — other countries followed suit. It became a regulatory race to the top.25
In the past two years we've seen a marked increase in Commission FCPA enforcement. Since January 2006, the Commission has filed more than 30 FCPA actions, which is more than were filed during the prior 28 years combined. We have also seen a significant increase in the sanctions levied in FCPA cases. Since January 2006, the Commission has ordered the payment of more than $200 million in penalties, disgorgement and prejudgment interest for FCPA violations. The Department of Justice is also very active in this area.
Last week, AB Volvo became the eighth issuer sued by the Commission for allegedly making illegal kickbacks to Iraq when selling humanitarian goods or purchasing crude oil under the U.N. Oil for Food Program. In an attempt to distance itself from the alleged bribery payments, Volvo allegedly restructured its business relationship with its Jordanian agent — making him a distributor — to ensure that Volvo's name did not appear on contract documentation which included inflated prices to cover the illicit payments.26 The Oil for Food cases are especially troubling because they involve schemes which have systematically diverted millions of dollars from a humanitarian program intended to alleviate the suffering of the Iraqi people.
The Commission has also been increasingly active in holding individuals accountable for FCPA violations. In December, the Commission sued former Chairman and CEO of Schnitzer Steel Industries for allegedly authorizing over $200,000 in cash bribes and other gifts to managers of Chinese government-owned steel mills to induce them to purchase millions of dollars in scrap metal from Schnitzer.27 In September, Monty Fu, the former CEO and Chairman of Syncor International settled Commission allegations that he authorized Syncor's Taiwanese subsidiary to bribe doctors employed by public hospitals in Taiwan.28
Significant penalties and disgorgement of ill-gotten gains have become the norm in Commission FCPA actions. Last Spring, FCPA recidivist Baker Hughes, paid a combined record $44 million in penalties and disgorgement to resolve FCPA allegations brought by the Commission and the Department of Justice. The company self-reported $5.2 million in bribes paid to officials of state-owned companies in Kazakhstan to obtain oil services contracts.29
Avoiding FCPA pit-falls requires companies to be both proactive and aggressively reactive. Proactively, companies should implement FCPA internal controls which include written policies and procedures, as well as FCPA compliance and training programs. Reactively, companies are well-counseled to respond promptly and appropriately to "red flags" both by conducting internal investigations to identify potential problems and by taking steps to remedy any violative conduct found. Voluntary disclosure is the norm in these cases.
Now I'd like to take an even more macro view about enforcement and our markets. Let me begin with two basic points. First, in our financial and business markets, all are welcome and all can succeed. Second, no one is above the law. Indeed, the latter — that no one is above the law — is essential to the former. An integral part of the attraction of our financial markets to companies and investors from around the globe is that our markets offer a level playing field.
There is substantial evidence that financial markets succeed not in spite of strong enforcement and regulation, but because of it. One academic study stated that the U.S. securities regulatory system that has evolved since the 1930s "has proven itself the most successful in the world."30 In general, transnational studies have found a strong correlation between the maturity and size of financial markets and the aggressiveness of the enforcement efforts on behalf of investors.31 The merits of the existing U.S. securities regulatory and enforcement model are demonstrated by the ongoing trend toward the adoption of U.S.-type standards in other countries. As we speak, our regulatory and enforcement regimes are being adopted and emulated in other countries all over the world.32 If imitation is the sincerest form of flattery, then our securities regulation and enforcement regime is being honored with the highest possible accolades.33
Let's look at a few aspects of U.S. securities law that have been adopted by other countries. Consider our prohibition of insider trading: While the U.K. and France have long prohibited insider trading, an E.U. Directive in 1989 required that all member states adopt laws against insider trading. By the year 2000, virtually all developed countries had enacted insider trading prohibitions consistent with U.S. law.
More recently, the international community is adopting standards similar to those created by the Sarbanes-Oxley Act.34 Other countries are adopting portions of the Act, or creating similar compliance regimes.35 These foreign countries are adopting the standards set by the Act as the new international ideal — the "gold standard," if you will, for market integrity — in yet another "race to the top.36 Indeed, even countries with developing markets that are just struggling to their financial feet are adopting standards similar to those of Sarbanes-Oxley to enhance their competitive position in the international financial community.37 This convergence provides yet more evidence that instead of harming our competitive position, good governance, rigorous compliance and tough enforcement provide significant competitive benefits to our financial markets, which other countries are seeking to obtain for their own markets by adopting similar standards. Convergence also makes it even more important to know every aspect of your client's business at home and abroad.
Of course knowing your clients' business is all about the details, which brings me back to where we started. To paraphrase Mies, both the devil and the divinity are in the details. And if you haven't visited the Tribune Tower, I encourage you to take a closer look; the address is: 435 North Michigan Avenue (or for those of you who are local, between the Wrigley Building and the NBC Tower).