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Not too long ago, the biggest worry among securities defense lawyers was the flurry of class actions that seemed to accompany every negative piece of corporate news. Not anymore. These days, defense lawyers have bigger things to worry about, like keeping the company and its officers from being indicted. Why has the corporate defense bar gone from sweating about the size of class action settlements to worrying about whether the company itself will face criminal charges and be run out of business? The answer is not, as some have argued, because the U.S. Department of Justice (DOJ) has recently decided to “criminalize” the federal securities laws. Of course, there can be no dispute that criminal securities prosecutions are being brought today in record numbers. Looking back, all the handwringing by defense lawyers in the 1990s over a few class actions now seems positively quaint. Today, bad news about a company’s accounting is likely to bring not only a federal class action, but also claims by large institutional and individual investors in state court, a derivative action in state court, an inquiry from the Securities and Exchange Commission and grand jury subpoenas from DOJ and maybe a state attorney general or two. So what happened? As discussed below, the actual penal provisions of the federal securities laws have remained virtually unchanged for more than 70 years and DOJ’s interpretation of those laws is basically no different now than it ever has been. What has changed are the priorities, resources and sophistication of DOJ, all of which has greatly enhanced its ability to investigate and charge securities fraud cases. The statutory provisions that permit criminal prosecution under the federal securities laws are by no means new. The Securities Act of 1933 and the Securities Exchange Act of 1934, as enacted, both provide for criminal liability in the event of a “willful” violation of their substantive provisions or related rules. Similar provisions are found in the Public Utility Holding Company Act of 1935, the Trust Indenture Act of 1939, the Investment Company Act of 1940 and the Investment Advisors Act of 1940. The vast majority of criminal securities prosecutions, however, have come under the penal provisions of the Securities Act and the Exchange Act. Section 24 of the Securities Act provides criminal liability for any person “who willfully violates any of the provisions of this Act, or the rules and regulations” promulgated thereunder. Section 24 also provides for criminal liability for persons who “willfully” make false or misleading statements or omissions in registration statements filed with the SEC. Section 32 of the Exchange Act provides criminal liability for a person who “willfully violates” any provision of the statute or its related rules and regulations or who “willfully and knowingly” makes or causes false or misleading statements in documents required to be filed with the SEC pursuant to the statute or a rule or regulation thereunder, unless the person can prove lack of knowledge of the rule or regulation. These two criminal provisions have been available to federal prosecutors for more than 70 years. They have not been amended in any relevant way since their enactment for purposes of criminal liability. Indeed, criminal prosecutions under the penal provisions of the federal securities laws date back to at least 1941, when a corporate president and a broker were indicted and convicted in the Eastern District of Pennsylvania for their roles in an alleged offering fraud. U.S. v. Sussman, 37 F. Supp. 294 (E.D. Pa. 1941). Moreover, federal prosecutors have long used other criminal statutes, such as wire fraud and mail fraud, in lieu of the penal provisions of securities laws, to prosecute crimes relating to the securities industry. See, e.g., U.S. v. Buckner, 108 F.2d 921 (2d. Cir. 1940) (charging violations of mail fraud and conspiracy in alleged fraudulent scheme involving redemption of bonds). UPTICK IN THE 1950S AND 1960S Although reported decisions involving the criminal prosecution of the federal securities laws in the 1940s and 1950s are rare, these prosecutions began to pick up in the late 1950s and early 1960s, thanks largely to the work of the U.S. Attorney’s Office for the Southern District of New York. See, e.g., U.S. v. Shindler, 173 F. Supp. 393 (S.D.N.Y. 1959) (charging criminal violations of � 17(a) of the Securities Act and conspiracy); U.S. v. Guterma, 189 F. Supp. 265 (S.D.N.Y. 1960) (charging willful violations of the Exchange Act and conspiracy). Since at least the 1960s, federal prosecutors have aggressively, although not always frequently, charged criminal violations of the securities laws. Again, many of these cases were brought by the U.S. Attorney’s Office for the Southern District of New York, and many, even by today’s standards, were tough, “envelope-pushing” prosecutions, including most of the well-known insider trading cases in the late 1970s and early 1980s, such as Chiarella v. U.S., 445 U.S. 222 (1980), as well as the Wall Street trading scandals of the late 1980s. Other jurisdictions around the country have also brought similarly aggressive securities cases over the years. See, e.g., U.S. v. Weiner, 578 F.2d 757 (9th Cir.), cert. denied, 439 U.S. 981 (1978) (addressing mental state required for criminal violation of securities laws). INCREASE IN THE 1990S In the 1990s, the criminal prosecution of the federal securities laws began to increase not only in numbers but in geographic scope. One reason for this increase is the fact that Arthur Levitt, chairman of the SEC from 1993 to 2001, pushed publicly for greater cooperation between the SEC’s enforcement staff and the country’s criminal authorities, allowing prosecutors who were not familiar with the securities laws the benefit of the SEC’s expertise. Federal prosecutors across the country, not just in New York, began to bring more securities fraud cases, especially in the area of complex, financial reporting fraud. For example, prosecutors in New Jersey brought the Cendant case, perhaps the largest accounting fraud ever at that time. Prosecutors in California also brought large accounting fraud cases, for example, the cases involving McKessonHBOC, Media Vision, and California Micro Devices Corp. In keeping with the SEC’s commitment to work closely with the criminal authorities, most of these cases were brought in collaboration with the SEC as parallel civil and criminal proceedings. The momentum of these parallel proceedings increased steadily throughout the 1990s — until the Enron and WorldCom scandals exploded in late 2001 and early 2002 and the phrase “securities fraud” began to be pounded into the public’s consciousness on a daily basis. In the immediate aftermath of the Enron and WorldCom scandals, it became obvious that the steps taken by the DOJ and SEC to work more closely together and to increase at least somewhat the pace of securities fraud prosecutions were not sufficient, at least from a political perspective. In the years following Enron’s collapse, at least four developments have changed the legal landscape for companies and their executives facing securities fraud allegations. These developments have led directly to an increase in the number of criminal prosecutions brought under the securities laws. RECENT DEVELOPMENTS The first development was the enactment of the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley immediately added $776 million to the SEC’s budget, a 77 percent increase. A large portion of this money was used to hire staff attorneys to investigate financial fraud by securities issuers. Continuing the pre-Enron practice of working closely with DOJ, these cadres of new enforcement attorneys have often picked up their phones to call prosecutors with offers to work together on their new and most promising securities fraud cases. After Sarbanes-Oxley, the second development leading to an increase in the number of criminal securities fraud prosecutions was the formation of the Corporate Fraud Task Force. In July 2002, President George W. Bush created the task force by executive order. Led by the deputy attorney general, the task force includes the director of the FBI; seven U.S. Attorneys; and secretaries, chairmen and directors of eight different federal departments, agencies and commissions. The central mandate of the task force is to “provide direction for the investigation and prosecution of cases of securities fraud, accounting fraud, mail and wire fraud, money laundering, tax fraud based on such predicate offenses, and other related financial crimes.” The targets for prosecution are “commercial entities and directors, officers, professional advisors, and employees.” IMPACT OF THE TASK FORCE With the creation of the task force, additional resources were bestowed upon the FBI and U.S. Attorneys. The U.S. Attorneys received $9 million in fiscal year 2004 for new fraud prosecutors — a considerable amount, given that the highest paid federal prosecutors in the country at that time made only about $140,000 per year. The FBI received $16 million in fiscal year 2004 for new agents to be assigned to squads investigating financial fraud. DOJ now conducts frequent training sessions devoted specifically to corporate fraud at its national training center in Columbia, S.C., where prosecutors and agents are instructed on the nuts and bolts of securities and accounting frauds. All of this amounts to the “if you build it, they will come” principle in action. Vast numbers of SEC staff attorneys, prosecutors and FBI agents with a mandate to discover and prosecute fraud cases; training in the basics of these kinds of cases; and a high-level political bureaucracy to satisfy have inevitably resulted in more cases being brought across the country. The metrics the task force uses to measure its success are blunt: raw numbers of charges and convictions. These measures have been tracked and used by federal law enforcement authorities, U.S. Attorneys and other DOJ components for many years and largely determine funding and staffing allowances. They are, in short, the end-game when it comes to measuring value. By its own account, the task force is quite valuable. According to its 2004 two-year report, “Justice Department prosecutors, working hand-in-hand with regulatory Task Force members” and federal agents have “[o]btained over 500 corporate fraud convictions or guilty pleas” and charged “over 900 defendants and over 60 corporate CEOs and presidents with some type of corporate fraud crimes.” CORPORATE COOPERATION A third significant factor in the increase in corporate fraud prosecutions is the value explicitly placed by DOJ and the SEC on meaningful cooperation by corporations in federal criminal and regulatory investigations, including the voluntary disclosure of fraud. A January 2003 memorandum to federal prosecutors by then-Deputy Attorney General Larry Thompson plainly states that DOJ will place a premium on early, voluntary disclosure and vigorous cooperation by corporations under investigation in determining whether criminal prosecution is appropriate. The SEC offered similar guidance in 2001 in a public report issued pursuant to an investigation of the Seaboard Corp. The reward offered by both agencies is simple and compelling: A corporation that discloses fraud and cooperates in the investigation likely will not itself be charged. This carrot is simply too tasty to avoid, and most corporations faced with an investigation readily give up their executives in exchange for the promise of leniency in charging. The government policy of declining corporate prosecution in exchange for disclosure and cooperation dovetails with another significant provision of Sarbanes-Oxley. Section 906 of Sarbanes-Oxley requires that chief executive officers certify that their companies’ annual financial statements are “fairly presented.” At least in the short run, the due diligence undertaken by companies in anticipation of their CEOs’ signing-off on financial statements revealed problems that might previously have gone undetected. With DOJ and the SEC aggressively promoting the benefits of early disclosure and cooperation, this process has resulted in more investigations and more criminal prosecutions. One last phenomenon that has surely increased criminal securities prosecutions, while subtle, should not be overlooked: the political and career benefits that flow to prosecutors who focus on white-collar fraud and the resulting competition among prosecutors for high-profile securities cases. A corollary to this idea is the development of competition among state and federal prosecutors’ offices around the country to bring the best securities cases. The most striking examples of the political benefits of securities prosecutions obviously come from New York, where Rudolph Giuliani and Elliot Spitzer launched themselves into popular orbit by making white-collar crime a top priority. These career benefits also trickle down to successful line prosecutors, many of whom have gone on to coveted partnerships in big-city law firms. Successful securities prosecutions have given rise to competition, both between federal prosecutors and many of the states’ attorneys general, as well as among U.S. Attorneys across the country, including those in Brooklyn, N.Y.; San Francisco; Los Angeles; Denver; Birmingham, Ala.; and elsewhere. This competition, along with the other developments discussed above, has led prosecutors in jurisdictions that did not traditionally pursue securities fraud cases to investigate and file them in ever-increasing numbers. For nearly 50 years, DOJ has taken a hard-edged approach to securities fraud and advocated aggressive positions in cases ranging from offering fraud to insider trading to accounting fraud. Today, these cases are prosecuted in greater numbers than ever before. However, this increase in the number of securities prosecutions is not due to a fundamental change in the government’s position on what constitutes criminal conduct. The securities laws have not been criminalized. What has changed, the evidence suggests, are DOJ’s priorities and resources, as well as its overall sophistication and interest in working collaboratively with the SEC. As long as the public continues to support vigorous enforcement of the securities laws, there is no reason to believe that the pace of criminal prosecution will slacken in the near future. John H. Hemann and William Kimball are partners in the San Francisco office of Morgan, Lewis & Bockius. They were previously Assistant U.S. Attorneys in San Francisco, and both served on the Justice Department’s Enron Task Force. While he was a government attorney, Hemann also worked on the McKessonHBOC and Media Vision cases mentioned in this article, and Kimball worked on the McKessonHBOC and California Micro Devices cases.

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