The SEC seems to be stepping up its enforcement efforts and has, in recent weeks, announced several initiatives designed to create incentives to comply with the federal securities laws. A summary of these initiatives, courtsey of Nick Morgan and Patrick Hunnius in DLA Piper’s Los Angeles (Century City) office, follows.

In recent weeks, the SEC has announced several initiatives designed to create incentives to comply with the federal securities laws.

Cooperation credit for individuals

The SEC has long given “cooperation” credit to companies under investigation if the companies meet certain criteria. Companies that cooperate during SEC investigations generally receive more favorable treatment when the SEC decides whether or not to pursue enforcement actions against those companies. Recently, the SEC made clear that cooperation by individuals would receive similar credit.

In 2001, the SEC set forth criteria that it would take into consideration in deciding whether or not to bring charges against a company.¹ Those initial criteria were set forth in what became known as the Seaboard report (named after the company subject to investigation), and the SEC made clear that Seaboard’s cooperation during the investigation contributed to the SEC’s decision not to charge the company. The SEC followed Seaboard with other, similar announcements describing, for example, which factors would influence the assessment of monetary penalties against corporations.²

In January 2010, the SEC announced for the first time a formal program with respect to rewarding cooperation by individuals involved in SEC investigations.³ Finally, on March 19, 2012, the SEC made its first announced application of the cooperation incentive program for individuals in a litigation release entitled “SEC Credits Former Axa Rosenberg Executive for Substantial Cooperation during Investigation.”⁴

In the AXA Rosenberg announcement, the SEC declined to charge a former senior executive of a California-based money management firm that had previously settled SEC charges. The action against the management firm arose out of a failure to disclose a coding error in the firm’s quantitative investment process that, according to the SEC, impacted more than 600 client portfolios and caused approximately US$217 million in losses.

The executive, who was the first to cooperate, provided information that the SEC called “timely,” “forthcoming,” “truthful,” “complete, and reliable.” His position in the company as well as his knowledge of the issues and other individuals involved made his assistance particularly helpful to the SEC staff. The SEC also cited as important factors in its consideration (1) the fact that the executive did not request any specific outcome in exchange for his truthful testimony and (2) the importance of the underlying issues to the securities markets. Finally, the SEC noted that the executive had no disciplinary history and had retired from the investment advisory industry.

One week later, the SEC announced that it had again awarded “cooperation credit” to an individual defendant, this time naming the individual. On March 27, 2012, the SEC announced that it had filed and settled charges against John Cinderey, a former executive vice president at a California bank, who allegedly misled the bank’s outside auditors and circumvented the company’s internal controls.⁵ Unlike the unnamed executive in the AXA Rosenberg announcement, Mr. Cinderey was charged with securities law violations, but due, in part, to his cooperation with the SEC, Mr. Cinderey was not required to pay a civil penalty. The SEC credited Mr. Cinderey for his “substantial assistance in the investigation and the fact that he has entered into an cooperation agreement to assist in an ongoing related enforcement action.”

The SEC clearly intends for the AXA Rosenberg and Cinderey announcements to send a strong signal to individuals that their cooperation in investigations will be considered in the decisions about whether charges will be brought against them as well as what, if any, sanctions the SEC will attempt to assess against them.

Punishment of innocent CEOs and CFOs pursuant to SOX Section 304

While the SEC is rewarding individuals who cooperate during investigations, it is also continuing to punish innocent CEOs and CFOs of public companies that issue accounting restatements due to material noncompliance as a result of company misconduct. On April 2, 2012, the SEC brought its most recent so-called clawback action under Section 304 of the Sarbanes-Oxley Act against the former CEO and CFO of an Austin, Texas-based surgical products manufacturer, seeking reimbursement of bonuses and stock profits they received after the company filed allegedly fraudulent financial statements in 2006, 2007 and 2008.⁶

In its litigation release, the SEC noted that neither the CEO nor the CFO was “charged with personal misconduct.”⁷ However, the director of the SEC’s Enforcement Division observed that “[c]lawback of incentive compensation and stock sale profits as authorized under the Sarbanes-Oxley Act is yet another reason for CEOs and CFOs to be vigilant in preventing misconduct and requiring that companies comply with financial reporting obligations.”

This clawback action is the latest in a handful of such actions brought by the SEC under Section 304 starting in 2007. While most such actions allege wrongdoing by the individuals, the SEC’s pursuit of clawbacks from innocent officers of public companies signals an aggressive position designed to incentivize even individuals to monitor others and to prevent them from committing violations of the federal securities laws.
_____________________________________