5 Tips for Surviving a Fight with the SEC

corpcounsel.com | February 19, 2014
5 Tips for Surviving a Fight
with the SEC
From the Experts
John A. Valentine and Nicole R. Rabner
If 2013 was a tough year in the
courtroom for the U.S. Securities and
Exchange Commission, 2014 is not
shaping up to be much better.
In October the SEC lost a high-profile
insider trading case against billionaire
Mark Cuban. In December a Kansas
City jury completely exonerated our
client, NIC Inc. CFO Stephen Kovzan,
on claims that he failed to disclose
expenses incurred by the CEO as
“perquisite” compensation. Later
that month, the SEC lost a revenue
recognition accounting fraud case in
Los Angeles. January brought three
additional insider trading losses in
Atlanta and Chicago.
Even the SEC’s few recent trial
victories were underwhelming. In
an accounting fraud case tried in
Austin, Texas, earlier this month,
the jury rejected the majority of the
SEC’s fraud theory and nine out of
its 11 legal claims. A Minneapolis
jury reached a verdict that appears
irreconcilable, finding under one
law that the defendant intentionally
facilitated a Ponzi scheme, but under
another law that he didn’t. The
agency won a complete victory in a
mortgage-backed securities fraud
case in Florida, but that was against
a defendant who was representing
himself—hardly a fair fight.
When a government agency’s track
record in court looks like this, you
might expect its leaders to ask, “Do we
need to pick our cases more carefully?”
But SEC enforcement director Andrew
Ceresney recently told The Washington
Post, “If you’re not losing cases, you’re
not being aggressive enough.”
Mr. Ceresney’s comment came as
no surprise to us. Over our combined
23 years representing clients in
SEC matters, willingness to push
the envelope in close cases—to
“regulate by enforcement”—has
been a hallmark of the agency’s
enforcement division.
So what can you do to stay out of
the SEC’s crosshairs? And how do you
weather the storm if the SEC comes
after you? Here are five simple things
to keep in mind.
1. Culture Matters
The easiest way to avoid trouble with
the SEC is to steer clear of practices
that concern the SEC. Emphasizing
throughout your organization the
importance of doing things right and
dealing fairly with counterparties
and investors reduces the likelihood
of legal missteps, and can provide
compelling evidence that any
February 19, 2014
mistakes that do occur were isolated
or unintentional and not inspired or
condoned by management.
When employees believe that the
company wants them to do the right
thing, they are more likely to report
problems internally rather than send
whistleblower complaints to the
SEC. That trust can also pay off if the
SEC decides to take investigative
testimony or file an enforcement
action. Employees who believe in the
integrity of their firm are likely to be
valuable witnesses for the company.
2. Train People to Use Common
Sense in Emails
Emails are the first thing the SEC
subpoenas in most investigations, and
they’re often portrayed as “smoking
guns” in SEC enforcement actions.
From the SEC’s perspective, off-thecuff email remarks—which may never
have been intended to be taken
literally—provide a window into the
author’s “true” beliefs. When the SEC’s
suspicion is aroused, poor word choice
and ambiguity will be interpreted in
the worst possible light. Inflammatory
speculation and sarcasm will be
treated as fact.
Bad emails are the white-collar
equivalent of self-inflicted wounds.
Do yourself a favor and avoid loose
language in email correspondence. Be
precise. And for complicated matters,
pick up the phone or have an in-person
meeting instead.
3. Get Good Insurance
The importance of good insurance
coverage can’t be overstated. Are your
policy limits high enough? Does your
insurance carrier have a reputation
for standing behind its insureds? If
possible, upgrade to a policy that
covers government investigations. A
policy that gives individual officers and
directors the right to coverage if the firm
can’t advance defense costs (“Side-A”
coverage) is highly desirable as well.
Remember, SEC investigations and
enforcement actions can drag on for
years. Mark Cuban’s trial focused on
a single stock sale, yet his defense
cost $12 million. Complex cases run
up even larger bills. You want a policy
that can go the distance if that’s what
it takes.
4. Don’t Just Roll Over
In the past, firms threatened with
SEC enforcement action usually opted
to settle rather than jeopardize their
existence by litigating. But in today’s
regulatory “tough cop” environment,
SEC settlement terms have become
harder to swallow.
The SEC may demand an admission
of wrongdoing. That admission could
put you at the mercy of the plaintiffs’
bar in follow-on civil actions.
Disgorgement of alleged “ill-gotten
gains,” steep civil money penalties,
a permanent injunction and a bar
from working in the industry are
other common settlement demands.
Individuals who settle on those terms
can face serious financial, professional
and reputational hardship.
Given the high stakes, the charging
stage of an SEC investigation is no time
to just roll over.
You should instead make the SEC
staff explain why they believe the
evidence proves a securities law
violation. Are the SEC’s proposed
charges supported by convincing
and admissible evidence, as opposed
to weak circumstantial evidence and
speculation? Is the SEC stretching the
boundaries of the law?
Engage with the SEC’s trial staff—
the lawyers who will have to prove the
case in court. They have not invested
months or years in the investigative
phase. Often, they have a more
independent perspective.
Realistically assessing both your
litigation risks and the SEC’s at the
charging stage can pay big dividends.
When the SEC overreaches, the odds of
negotiating an acceptable settlement
or convincing a court to dismiss the
SEC’s charges improve dramatically.
5. Litigation Levels the Playing Field
At the investigation stage, the best
strategy usually is to cooperate and
attempt to convince the SEC staff that
enforcement action is not warranted.
After it files charges in court, however,
the SEC becomes just another civil
plaintiff. The Federal Rules of Civil
Procedure apply, and the playing field
levels.
Where the SEC takes liberties with
the law or the facts, challenge its
assertions. If the court won’t dismiss
the complaint, be aggressive in
discovery. The SEC has to show you its
cards. You get to review its investigative
file, subpoena additional records and
depose witnesses. In some cases, you
can demand to see agency documents
outside the investigative file and
depose relevant SEC employees. We’ve
done this (over the SEC staff’s vigorous
objections) when the agency’s
conflicting positions on legal and
accounting standards supported our
client’s defenses.
While the SEC is a formidable
adversary, its recent losing streak
shows that courts and juries will hold
the agency to its burden of proof.
Now more than ever, if you believe the
SEC’s position is unjustified, the best
response may be, “See you in court.”
John A. Valentine and Nicole R. Rabner
are partners in the Securities Litigation
and Enforcement Group at WilmerHale in
Washington, D.C. They were co-counsel to
the defendant in SEC v. Kovzan, in which a
Kansas jury rejected all of the SEC’s claims
against their client in December 2013.
Reprinted with permission from the February 19, 2014 edition of
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