Prior to the last couple of years, except for a few notable exceptions a number of years ago, the Securities and Exchange Commission had not brought enforcement actions against attorneys rendering legal advice. That has changed.
On Sept. 20, 2004, in his widely reported speech before the UCLA School of Law, Stephen Cutler, the SEC’s then-director of the Division of Enforcement, aimed a warning shot across the bow of the organized bar. In his speech, which was reflecting on the Sarbanes-Oxley Act of 2002, Cutler remarked that gatekeepers, including “lawyers who advise companies on disclosure standards and other securities law requirements,” were “paramount in ensuring that our markets are clean.”
This shot signaled the SEC’s willingness to take on attorneys for giving legal advice as to whom the SEC found violated or caused violations of the federal securities laws. The SEC then started aiming lower by bringing a number of SEC enforcement actions against attorneys involving the rendering legal advice.
Since Cutler’s speech, the SEC has brought a number of enforcement actions against in-house counsel of public companies. For example, in an SEC enforcement action against Computer Associates (CA) and certain of its officers, the SEC alleged that Steven Woghin, former general counsel for CA, aided and abetted CA’s violations of a number of provisions of the federal securities laws, including the anti-fraud provision.
Woghin allegedly engaged in a number of improper practices that fraudulently increased CA’s reported income, including signing and filing forms with the SEC that he knew contained materially false and misleading statements, and counseling employees to keep information from CA’s outside counsel and SEC investigators.
Woghin consented to an injunction from future violations of the federal securities laws, and pursuant to a related administrative proceeding, Woghin was suspended from practicing or appearing before the SEC as an attorney.
In the SEC’s action against Warnaco Group Inc., the SEC alleged that Stanley Silverstein, Warnaco’s general counsel, aided and abetted and caused Warnaco’s violations of the reporting provisions of the federal securities laws. Silverstein allegedly approved an annual report that he knew or should have known contained a materially inaccurate and misleading description of the reasons why Warnaco made a $145 million restatement of its financial results and approved and signed a quarterly report that he knew or should have known did not accurately represent Warnaco’s debt and cash flow. The SEC issued an administrative cease-and-desist order against Silverstein, ordered him to pay $165,000 in disgorgement and prejudgment interest, and censured him for conduct.
The SEC’s action against Gemstar TV Guide International was based on Gemstar’s alleged widespread scheme to inflate its revenues and mislead investors. In the course of its investigation into Gemstar’s misdeeds, the SEC filed securities fraud charges against three former senior executives of Gemstar, including its general counsel, Jonathan Orlick, alleging, among other things, that Orlick’s conduct – including his knowing, but failing to disclose that Gemstar was improperly reporting revenues and signing false management representation letters to Gemstar’s auditors – resulted in Gemstar’s filing materially false and misleading financial statements.
Orlick agreed to a permanent injunction and to pay over $300,000 in disgorgement, a penalty and prejudgment interest. In a separate administrative proceeding, the SEC suspended him from practicing before the SEC as an attorney.
The SEC also brought an enforcement action against the general counsel of Symbol Technologies, Leonard Goldner, for alleged manipulation of stock option exercise dates that enabled senior executives, including Goldner, to profit at the company’s expense. Goldner ended up facing criminal charges and pleaded guilty to conspiracy charges. Under the terms of his plea agreement, Goldner faces up to five years’ imprisonment and a maximum fine totaling twice the loss he caused, or $250,000, whichever is greater. Goldner also agreed to forfeit $2 million to the government.
Most recently, the SEC brought an enforcement action against Robert Graham, the assistant general counsel of General Re Corp., along with other senior Gen Re executives, for allegedly aiding and abetting a securities fraud committed by American International Group Inc. (AIG). According to the SEC’s complaint, Graham knowingly drafted sham contracts to structure a fraudulent transaction. In addition to the SEC’s action, the U.S. Department of Justice filed federal criminal charges against Graham and other senior Gen Re executives.
In addition to the foregoing examples of SEC actions brought against attorneys whose actions aided and abetted securities violations, the SEC also has brought enforcement actions against attorneys based on their failure to act to prevent securities violations.
The SEC’s action against John E. Isselmann Jr., the general counsel of Electro-Scientific Industries (ESI), was based on Isselmann’s failure to properly report evidence of a fraudulent transaction. The SEC issued an administrative cease and desist order against Isselmann due to his failures to stop the filing of a false Form 10-Q. At issue was the CFO’s announcement of his plan to eliminate certain benefits for ESI’s Asian employees in order to increase reported profits. At the time of the CFO’s announcement, neither Isselmann nor outside counsel had reviewed the decision to eliminate benefits and Isselmann learned that ESI’s auditors falsely had been informed that the decision had legal support.
Thereafter, Isselmann received a written legal opinion from ESI’s Japanese counsel advising that the elimination of benefits was illegal under relevant law. On that same date, Isselmann attended a meeting with ESI’s CFO and external auditors to discuss the filing of ESI’s Form 10-Q. When Isselmann attempted to raise the benefit-elimination issue, the CFO cut him off. After the meeting, Isselmann provided the written opinion from Japanese counsel to the CFO.
Before ESI filed the fraudulent Form 10-Q, an audit committee member asked Isselmann whether there was legal support for the elimination of benefits and Isselmann failed to convey the legal advice received from Japanese counsel.
In sorting out ESI’s illegal overstatement of revenue, the SEC found that Isselmann’s failure to convey the legal advice received from Japanese counsel caused ESI to file a materially false and fraudulent Form 10-Q: “Isselmann’s failure to fulfill his gatekeeper role was a cause of the company reporting materially false financial results.”
Setting its sights on general counsel who render business advice tinged with improper legal advice, in January 2005, the SEC sanctioned Google’s general counsel, David Drummond, for his alleged role in causing the company’s violation of the registration requirements of the federal securities laws. Based on Drummond’s miscalculation of Google’s entitlement to an exemption to the registration requirements, Drummond found himself the subject of an SEC enforcement action.
SEC Rule 701 requires that a company issuing more than $5 million in stock options over a 12-month period provide detailed financial statements and other disclosures to the option recipients. Prior to its successful initial public offering, Google had been granting stock options to its employees as a form of compensation. Drummond became aware that Google’s continued issuance of stock-option grants might reach levels requiring disclosure under Rule 701, and, based on Drummond’s advice, Google stopped issuing grants for several months.
But a few months later, Google reconsidered its stance on granting stock options and issued stock-option grants far in excess of $5 million. Relying on his interpretation of certain potentially applicable exemptions, Drummond advised the board to approve the new stock-option grants and did not warn the board that issuing the grants might trigger Rule 701. When the board met yet again to consider further option grants, Drummond again advised the board to issue the new grants and failed to warn the board either that Google’s option grants could trigger Rule 701 or that other exemptions may not apply.
In its findings, the SEC acknowledged “Drummond, in consultation with outside counsel and personnel in Google’s legal department, determined that . . . exemptions . . . permitted Google to issue the option grants without [complying with] Section 701.” However, the SEC found Google issued stock options far in excess of $5 million, none of which were accompanied by required Rule 701 disclosures. The SEC thus found that Google had violated sections 5(a) and 5(c) of the Securities Act of 1933, which prohibits the sale of securities without a properly filed a registration statement. Drummond was ordered to cease and desist from committing or causing any violations of Section 5, but was not fined or suspended.
While not an enforcement action against an attorney, a recent case involving the withdrawal of TV Azteca’s outside counsel, Akin Gump Strauss Hauer & Feld, is worth noting. TV Azteca refused to disclose certain information pertaining to a transaction which its outside counsel, Akin Gump, strongly believed was required under the federal securities laws. As a result of its client’s refusal to make the disclosure, Akin Gump resigned.
The SEC later brought an enforcement action against TV Azteca. The SEC’s complaint against TV Azteca included allegations that TV Azteca filed false and misleading reports with the SEC – despite the fact that TV Azteca had received advice from its U.S. counsel, Akin Gump, that these transactions constituted material reportable transactions under the federal securities laws. The SEC noted what it expects from counsel: “TV Azteca’s resistance led to the eventual resignation of U.S. counsel, who told the company’s board of directors and management that it was resigning consistent with its obligations under Section 307 of the Sarbanes-Oxley Act.”
Just as CEOs, CFOs and board members can no longer sign forms required to be filed with the SEC which contain false and fraudulent statements without risking liability, nor can an attorney who advises an issuer avoid liability for the misstatements or omissions of his or her client if he or she is aware, or should be aware, that his or her client’s SEC filings contain misrepresentations. Moreover, counsel who fails to steer his or her company correctly through the SEC’s filing and disclosure requirements may find himself or herself the target of an SEC enforcement action.
Finally, one should not take comfort from the fact that the SEC enforcement actions discussed above did not name outside counsel. It is only a matter of time before the SEC will bring enforcement actions against outside counsel for conduct that is similar to that for which inside counsel have been sanctioned. For example, outside counsel routinely are asked to make representations concerning litigation to the outside auditors for public companies.
Accounting firms make decisions about the appropriateness of litigation reserves based on such representations. To the extent that such representations are materially false and misleading, there is a possibility for enforcement action against the attorney providing such representations.
JAY A. DUBOWis a partner in the litigation and corporate departments of Wolf Block Schorr & Solis-Cohen, and he also is a former member of the firm’s executive committee. His practice concentrates on complex litigation with a special emphasis on defending securities class actions litigation. He can be contacted by calling 215-977-2058.
JILL L. MANDELis an associate in the firm’s business litigation practice group and is resident in the form’s New York office. She concentrates her practice in complex civil litigation.