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Defense attorneys say they have thought for some time that the Securities and Exchange Commission has been overzealous in pursuing high-ranking executives suspected of white-collar crime. But they had little evidence to support this hunch until mid-June, when a former technology executive was found innocent of securities fraud. A federal jury in San Jose took just five hours to acquit former Legato Systems Inc. executive vice president David Malmstedt of six fraud charges. His lawyers say it was the first time the SEC had pursued a case against an executive not facing related criminal charges. Some attorneys also say the case shows the pitfalls of the government’s tough-at-any-cost attitude. “The significant piece of this case is what many defense lawyers have been saying…that the SEC is overreaching,” says David Bayless, a securities expert and partner at Morrison & Foerster in San Francisco. “Because of that, more individuals are making a calculated decision to take the case to trial.” According to Bayless and other defense lawyers, unreasonable settlement demands set by the SEC are increasingly pushing defendants to go to court. Bayless, who used to run the San Francisco SEC office that charged Malmstedt, adds, “They are charging people who should not be charged.” Malmstedt’s prosecutors deny they overreached. Susan LaMarca of the San Francisco SEC office says prosecutors had “a very good case” against Malmstedt and that the office closely examines every case before deciding to go to trial. “We fully respect the jury’s finding, but I don’t think it’s a reflection on our decision to prosecute,” she says. “No one could possibly accuse us of going overboard because of Martha Stewart and Enron. This predates that by a few years.” The case began when Legato, a software and information management company based in Mountain View, California, was forced to restate its earnings because of improperly recorded sales transactions. The government accused Malmstedt of booking false sales. When the restatement was announced, Legato’s stock plummeted from $44 to $19 per share. Malmstedt was charged with securities fraud, aiding and abetting securities fraud, and improper bookkeeping. Malmstedt’s lawyer, Phillip Eskenazi of Los Angeles’s Akin Gump Strauss Hauer & Feld, argues that his client simply took over a company with poor internal financial controls and was railroaded for the mistakes of others. “Our defense was that ‘revenue recognition’ problems existed prior to his [Malmstedt's] arrival,” says Eskenazi. “The SEC basically bought the story that Legato peddled [to them] because they needed a [corporate] officer to pin this on to send a message,” says Eskenazi. “And there’s no message to send if they don’t pin it on someone at a high enough level.” LaMarca says the SEC pursues white-collar cases that do not involve high-ranking executives, adding that their cases “run the range, depending on conduct.” The SEC has, in the past, been more willing to settle, says MoFo’s Bayless. “Even if you didn’t like it, the feeling was that you could live with the terms and didn’t want to fight the government,” he says. “But under these circumstances, why not litigate?” Other attorneys say it is natural to expect more vigorous prosecution, given the extent of recent corporate problems. “There is a tolerance point that we’ve reached in society, and we’re no longer going to accept people in positions of power abusing their power,” says defense attorney Lance Burrow, of San Jose’s Anderson & Burrow. “There does appear to be a lot of abuse, so you will see the government be more active in policing corporate behavior.”
A version of this story originally appeared in The Recorder, a sibling publication of Corporate Counsel.

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