Parts IV and V: How Corporate Officials Can Get A Good Night's Sleep Despite Current SEC Enforcement Trends

Parts IV and V: How Corporate Officials Can Get A Good Night's Sleep Despite Current SEC Enforcement Trends

This is the fourth in a series discussing new trends in SEC enforcement which impact corporate directors and officers and steps that can be taken to avoid future liability.

Employees, the company and insider trading

The enforcement of insider trading laws is a key SEC enforcement priority. Acting in conjunction with the U.S. Attorney's Office in New York City, the Commission has brought a series of high profile insider trading actions. Many of those cases have focused on hedge funds and professional traders. As enforcement officials seek to protect the integrity of the markets however, increasingly employees of public companies are coming in their sights. This can result in liability for the employee and entangle the company in a law enforcement investigation, something which can be costly and time consuming.

The SEC has been very aggressive in utilizing its new tools. While criminal prosecutors tend to garner the headlines from outsized investigations and cases such as the Galleon and Expert Network series of cases, it is the Commission which is pushing the edge - some might say redefining - of what constitutes insider trading.

Bolstered by new enforcement techniques, the SEC's approach to insider trading is increasingly aggressive. A series of insider trading cases have centered on events that employees viewed at work prior to trading. One group involves those which seem to focus on the mosaic theory. Traditionally, analysis and other market participants have investigated with an eye to gathering bits and pieces of information they fit together and utilize as the predicate for their predictions, hunches and outright guesses as to the direction of the market, a company or a particular security. This activity adds to the efficiency of the markets and improves price discovery. While the line between what constitutes permissible investigation and projection and acquiring actual inside information has always been difficult to draw with precision, the Commission seems to be redrawing it in a way which at least suggests that employees who gather virtually any information at work and then trade are at risk.

Typical of the cases in this group is SEC v. Steffes, Case No. 1:10-cv-06266 (N.D. Ill. Filed Sept. 30, 2010). There the defendants are all family members or friends. The case centers on acquisition of Florida East Coast Railway, LLC by Fortress Investment Group, announced on May 8, 2007. The transaction traces to December 4, 2006 when Morgan Stanley & Co. was engaged to sell the company. After inquiry by possible acquirers the company was in fact sold. Shortly prior to the sale each defendant traded in the securities of the company reaping total trading profits of $1.6 million.

The critical question in the case is whether the defendants actually possessed material non-public information at the time of the trades. The complaint specifies the bits of information from which the Commission concluded that a particular defendant possessed inside information at the time of the trades. For defendant Gary Griffiths, a vice president of the railroad who was not a member of the deal group, the complaint claims he had inside information because:

  • In early March the CFO asked him to prepare a comprehensive list of equipment owned by the company;
  • He became aware that there were an unusual number of yard tours by outside executives, that is, individuals were viewing properties owned by the railroad;
  • "He believed" these tours were provided to investment bankers;
  • Employees asked him if the company was being sold and they would lose their jobs; and
  • He also arranged and monitored a rail trip for Fortress executives in a special rail car reserved for visitors.

Defendant Cliff Steffes, a trainman at the company, had inside information according to the SEC because:

  • He observed that there was an unusual number of yard tours for people in business attire;
  • Many employees became aware of them;
  • Shortly before the tours began a number of employees expressed concern about the company being sold and the possible loss of jobs of their job; and
  • Fortress executives toured where he worked.

It is clear that those outside the company would not be privy to the fact that yard tours were being taken by executives in suits. Equally clear is the fact that speculation by employees about the meaning of the tours or the impact of a take-over on their job is just that - speculation and conjecture. Whether or not this type of information actually constitutes inside information is the subject of the on-going litigation. To date only defendant Robert J. Steffes has settled with the Commission, consenting an injunction and paying disgorgement and a penalty equal to the trading profits of $104,981. The other defendants are litigating the case. See also, SEC v. Carroll, Case No. 3:11-cv-00165 (W.D.Ky. Filed March 10, 2011)(employees learn bits of information that results in trading); see also SEC v. Ni, Case No. CV 11 0708 (N.D. Ca. Filed Fed. 16, 2011)(action against brother who overheard bits of a conversation by corporate executive sister).

While cases such as Steffes focused on what individuals observed at work, others suggest that even complying with company procedures may not be adequate to avoid liability. Many public companies have some type of insider trading policies and procedures. Typically the company institutes black out periods around earning releases and other significant events which preclude certain executives from trading. When the black out periods are not in effect those executives are generally permitted to trade although the policies may require pre-clearance with a designated individual.

In a recent action however, an executive informed the general counsel's office of her intent to trade prior to the institution of a black out period but, nonetheless, was named as a defendant in a Commission enforcement action. SEC v. Knight, Civ. 2:11-cv-00973 (D. Ariz. Filed May 18, 2011).

The defendants in Knight are Mary Beth Knight, a senior vice president of Choice Hotels and her friend, Rebecca Norton. Ms. Knight learned at a senior management meeting that the company expected to miss expectations as to its quarterly earnings. At lunch following the meeting Ms. Knight told executives she planned to sell shares of the company. The next day she e-mailed the associate general counsel about her plan to sell company stock and asked about black out days. She received a response stating that the black out ran from June 30 to July 26. A copy of the insider trading policy was attached to the e-mail from the associate general counsel.

The next weekend Ms. Knight told her friend Rebecca the information she learned at the management meeting. She knew that her friend was a shareholder of the company.

Subsequently, on June 27 Ms. Knight sent a follow-up e-mail to the associate general counsel stating: "exercising 12,000 shares today. I also mentioned to [my boss] last week I would be doing so." The complaint does not indicate that she received a response.

Prior to the black out period both Ms. Knight and her friend sold company shares. The day after the earnings announcement the share price dropped nearly 25%.

Both defendants settled, consenting to the entry of permanent injunctions. Ms. Knight agreed to pay disgorgement. That obligation was deemed satisfied by the fact that Ms. Knight had previously given the amount of the disgorgement to the company. No explanation is provided for that action. Ms. Knight also agreed to pay the disgorgement for her friend and pay a penalty. Ms. Norton agreed to pay a civil penalty.

Collectively there can be little doubt that Steffes, Carroll and Knight are aggressive enforcement. The SEC views these cases as straight forward insider trading actions. Others view them as pushing the edge of what constitutes insider trading. Which ever view is correct, the common thread is that employees observed or learned something while on the job, engaged in transactions in company stock, followed company procedures and were named in an enforcement action charging insider trading. While it might be argued that the cases tend to push toward the discredited "parity of information" theory of insider trading, perhaps the more important question is how to avoid becoming entangled in the cases in the first place. In view of these trends companies would do well to reconsider their policies and procedures and alert employees in programs about those procedures to avoid becoming entangled in a investigation.

This is the fifth in a series discussing new trends in SEC enforcement which impact corporate directors and officers and steps that can be taken to avoid future liability.

FCPA enforcement

Aggressive enforcement of anti-corruption laws by the DOJ and the SEC is another area in which individuals and their business organizations are at risk. Enforcement officials have declared that this is a "new era" of FCPA enforcement. Few would doubt that they are correct. More FCPA enforcement cases have been brought in the last few years than in the history of the statute. More is being paid in settlement by corporations than at any time in the history of the FCPA. More individuals are being prosecuted and sent to prison and there are more FCPA trials than at any time since the enactment of the law in 1977. While enforcement of anti-corruption laws around the globe is on the increase as indicated in a a recent report by the OECD Working Group on Bribery, there is no doubt that the U.S. is far and away the leader in bringing corruption actions.

The key trends and characteristics of the New Era are:

  • Ever increasing amounts paid by business organizations to settle;
  • Ever increasing amounts paid by companies to cooperate with enforcement officials in an effort to mitigate their potential liability;
  • Expansive interpretations of the statutes by enforcement officials;
  • An increasing use of industry sweeps; and
  • An emphasis on individuals coupled with demands for prison terms.

One of the hallmarks of corporate FCPA settlements is the spiraling cost of settlement. That cost begins with what is paid to the enforcers. The current top ten largest settlements as compiled by the FCPA blog are:

  • Siemens in 2009 paid $800 million in 2008
  • KBR in 2009 paid $579 million
  • BAE in 2010 paid $400 million
  • Snamprogetti Netherlands B.V. in 2010 paid $365 million
  • Technip S.A. in 2010 paid $338 million
  • JGC Construction in 2011 paid $218.8 million
  • Daimler AG in 2010 paid $185 million
  • Alcatel-Lucent in 2010 paid $137 million
  • Magyar Telekom/Deutsche Telekom: $95 million in 2011 and
  • Panalpina in 2010 paid $81.8 million

It is noteworthy that eight of the largest amounts paid were from settlements in 2010 and after with 6 cases added in 2010 and 2 in 2011. These cases are frequently, but not always, based on pervasive patterns of misconduct. Siemens and Daimler for example, involved that type of conduct based on multiple violations over a period of time - essentially corporate cultures which utilized bribes as a business tool, according to prosecutors. The cases involving KBR, Tehnicup,Snamprogetti and JGC centered on the years long and highly profitable TSKJ consortium, formed to secure contracts and ultimately the payer of millions of dollars in bribes.

In contrast, the latest addition to this rogues gallery of FCPA cases is Magyar Telekom/Deutsche Telekom. There the action is not based on a pervasive, years long pattern of misconduct or an international conspiracy running for years. Rather, the action is based on just two transactions. Indeed, an analysis of the underlying conduct raises significant question concerning just how the case moved up to the number nine slot on the list and ahead of Panalpina which engaged in multiple violations around the globe for years. Despite the fact that settlements are based on the sentencing guidelines on the criminal side and the SEC's disgorgement policies on the civil side, it appears that the cost of settlement is increasing.

An often unseen cost of these cases is what is spent on cooperation credit. Each of the amounts paid by the companies in the top ten, with the exception of BAE, was reduced by "cooperation credit," that is, credit from enforcement officials for cooperating with their investigative efforts. Enforcement officials urge business organizations to self-report and cooperate, promising meaningful credit, although in the top ten only Magyar Telekom/Deutsche self-reported. Cooperation is typically defined in terms of self-reporting, furnishing enforcement officials the pertinent facts and instituting the necessary remedial steps to prevent a reoccurrence of the wrongful conduct. An examination of the settlement papers in the top ten clearly demonstrates that meaningful credit is given by the DOJ, although the SEC settlements evidence little impact from the often extensive efforts of the company.

Regardless of whether settlement costs are increasing, it is beyond dispute that those costs are only the beginning. The hidden cost in all of this is that of cooperation. In their quest to earn credit many companies are going far beyond the basics. Siemens, Panpelina and others, for example, have developed evidence of wrong doing by others, becoming a kind of corporate whistleblower which is part of a trend that will be discussed later in this series. Others, such as Siemens, created a significant compliance function while Alcatel-Lucent fundamentally altered its business model.

The cost of these undertakings can be significant. Siemens, for example, spend $850 million in its efforts to cooperate over two years and another $150 million on compliance. Diamler reportedly spent $500 million in its efforts to win cooperation credit. Currently, Avon Products Inc. has reportedly spent over $160 million in its efforts to cooperate with enforcement officials conducting an FCPA inquiry and has yet to settle the underlying actions. The increasing cost of settlement, coupled with the expense of cooperation, can make the decision by a corporate board to self-report and cooperate most difficult. It may be for this reason that the President of TRACE International, a non-profit focused on anti-corruption, recently noted that most corporations do not self-report after learning of a potential difficulty.

Another characteristic of the new era of FCPA enforcement is an expansive interpretation of the statutes. On the question of jurisdiction, for example, enforcement officials have frequently adopted a reading of the provisions which some commentators argue unduly expands the reach of the statutes. The case involving JGC Corporation is a good example.

There the defendant is a Japanese company with no operations in the United States. It was a member of the TSKJ discussed above. The jurisdictional contacts, according to the court papers, appear to be two e-mails from the company to Houston and two bank transfers from one foreign bank to another through New York.

Initially, the company raised jurisdictional issues. Later the company cooperated, according to the DOJ. The case was resolved when the JGC entered into a deferred prosecution agreement. Subsequently, the court in U.S. v. Patel, Case No. 1:09-CR-335 (D.D.C.) one of the prosecutions arising out of the now collapsed Africa Sting actions discussed later in this series, rejected a DOJ claim that similar contacts were sufficient to support a claim of jurisdiction.

Enforcement officials have also taken an expansive view of what constitutes a bribe. Under U.S. law small facilitation payments for routine items are not bribes. Yet the vitality of this exception despite specific statutory authorization is anything but clear in view of recent FCPA cases. The point well illustrated by the SEC's settlement in In the Matter of Diago plc., Adm. Proc. File No. 3-14410 (July 27,2011). That action charges FCPA books and records violations based on small payments to government-owned liquor store operators for product placement, label registration, lobbying fees and promotion. Another payment was to a Korean Customs Service official as a reward for assistance in negotiating a tax refund. Rewards are not bribes, but gratuities under domestic U.S. law. Gratuities are not violations of the FCPA. In this case the payments were not charged as bribes but for not being properly recorded, an FCPA books and records violation.

Even if the payments are properly booked, however, there may be liability. In SEC v. Noble Corporation, No. 4:10-cv-4336 (S.D. Tex. filed Nov. 4, 2010); SEC Litg. Rel. No. 21728 (Nov. 4, 2010) the payments were actually recorded in a facilitating payments account. The SEC said they were not facilitation payments so the books and records were false.

Under the expansive views of the New Era, even payments made under compulsion can be viewed as bribes. This point is illustrated by the SEC's settlement in In the Matter of NATCO Group, Inc., Adm. Proc. File No. 3-13742 (Jan 11, 2010); SEC v. NATCO Group. Inc., No. 4:10-cv-00098 (S.D.Tex. Jan. 11, 2010). There the company employed local workers and expatriates in Kazakhstan. Local immigration authorities claimed the expatriates did not have the proper documentation and threatened to impose fines and to either jail or deport the workers if the company did not pay the fines. Management paid the fines based on the belief that the workers would otherwise be jailed. The local subsidiary made payments to facilitate the proper visas using bogus invoices totaling $80,000 to obtain the money from the bank. The company reimbursed the invoices. NATCO settled the case based on FCPA books and records charges.

Next: FCPA enforcement (cont.)

For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.

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