Review of SEC Enforcement in 2009
18, 2009 at 11:08 AM EDT
This post is by my colleagues Mark
Schonfeld, John Sturc, Barry
Goldsmith, Eric Creizman, Jennifer Colgan
Halter, Akita St. Clair, Ladan
Stewart and Matthew Estabrook.
Without question, the first six months of 2009 have been a period of sharply
increased enforcement activity at the Securities and Exchange Commission. The
financial crisis, the new administration, new SEC leadership, increased funding
and the focus of Congress and the media have all combined to encourage
heightened government scrutiny. And even though it has only been a few months
since a new Chairman took office, already there are tangible signs that the SEC
has taken a more aggressive enforcement posture. In this alert, we review the
changes the new SEC leadership has instituted and is considering, the
observable impact of the new administration on enforcement activity and
significant cases in key areas that reflect the agencyâ€™s evolving
I. Overview of Changes
A. The Backdrop
The events of 2008 led directly to the current enforcement agenda. The
collapse of the subprime mortgage market, the ensuing credit crisis, the demise
of several major investment banks and, perhaps most of all, the Madoff case led
to a loss of confidence in the agencyâ€™s ability to protect investors.
This loss of confidence was manifested in Congressional hearings and an
intensified media spotlight. At the same time, the SECâ€™s Inspector
General has issued a number of reports critical of the agency, and Congress
intensified pressure on the SEC and Department of Justice to bring cases in the
wake of the financial crisis. At a March hearing of the Senate Judiciary
Committee on the law enforcement response to the financial crisis, Senator
Patrick J. Leahy declared, â€œI want to see prosecutionsâ€¦. I want to
see people go to jail.â€
B. The New SEC
Against this backdrop, the Obama Administration took office with a new
regulatory and enforcement agenda. Mary Schapiro was sworn in on January 27,
2009 as the twenty-ninth Chairman of the SEC. She wasted no time in
implementing changes to â€œreinvigorateâ€ enforcement. In February, in
her first speech as Chairman, Ms. Schapiro announced two changes to the
enforcement process at the SEC intended to â€œempowerâ€ the staff of
the Enforcement Division. 
First, Chairman Schapiro ended a two-year â€œpilotâ€ program,
implemented by the prior Chairman, which required the Enforcement staff to seek
prior approval of the Commission before negotiating a civil money penalty
against a public company for alleged securities fraud. Chairman Schapiro stated
that the pilot program had introduced significant delays into the process of
bringing a corporate penalty case, discouraged staff from arguing for a penalty
and sometimes resulted in reductions in the size of penalties imposed. Chairman
Schapiro further stated that the end of the program was designed â€œto
expedite the Commissionâ€™s enforcement efforts and ensure that justice is
Second, Chairman Schapiro provided for more rapid approval of formal orders
of investigation authorizing the staff to issue subpoenas by permitting
approval within a couple of days pursuant to the SECâ€™s
â€œseriatimâ€ or â€œduty officerâ€ procedures. As Chairman
Schapiro explained the change, â€œin investigations that require subpoena
power, time is always of the essence.â€
In March, Chairman Schapiro announced an initiative to revamp the
SECâ€™s process for reviewing complaints and tips. The SEC retained the
Center for Enterprise Modernization, operated by the MITRE Corporation, to
assist with the creation of a more centralized process to identify leads for
potential investigations and inspections.
Chairman Schapiro has also initiated efforts to bring greater industry
expertise to the staff. In April, Chairman Schapiro announced a new Industry
and Markets Fellows Program to give industry professionals an opportunity to
work for two years in the Office of Risk Assessment and help identify and
assess risks in the financial markets. In addition, Chairman Schapiro created
new senior level positions within the examination program for individuals with
expertise in areas such as derivatives, valuation, securities trading, risk
management and forensic accounting.
C. New Director of Enforcement Division and More Changes
In February, Chairman Schapiro announced the appointment of Robert Khuzami, a
former federal prosecutor and investment bank general counsel, as the new
Director of the Division of Enforcement. In his May testimony to the Senate
Banking Committee,  Mr. Khuzami discussed proposals to
reallocate resources within the Enforcement Division to improve efficiency,
â€¢ increasing the number of trial unit attorneys to present a
â€œcredible threatâ€ to defendants, improve the ability to win at
trial and increase settlement outcomes;
â€¢ increasing administrative, paralegal, and para-professional support,
to free up enforcement lawyers and accountants to focus on high-value
investigative tasks; and
â€¢ increasing information technology support for screening tips,
improving case and document management, analyzing market data and assessing
risks to investors.
Mr. Khuzami also outlined organizational changes under consideration with a
focus on making the Enforcement Division more â€œstrategic, swift, smart
and successful,â€ including:
â€¢ creating specialized groups of attorneys along product, market or
transactional lines and increasing collaboration among staff across regions;
â€¢ flattening the management structure of the Division and reducing the
levels of review and approvals required for investigative steps to be taken;
â€¢ revising performance metrics to deemphasize quantitative factors,
such as the number of cases filed, and instead focus on qualitative factors,
such as timeliness, programmatic significance and deterrent effect; and
â€¢ increasing the rewards to individuals for cooperating in
investigations, including a potential request to Congress for an expanded
whistleblower program (beyond the existing statutory authorization for insider
trading cases) and greater use of agreements similar to deferred prosecution
The appointment of Mr. Khuzami was followed by appointments of two other
former federal prosecutors to senior positions: George Canellos, as Director of
the New York Regional Office, and Lorin Reisner, as Deputy Director of the
Enforcement Division. Both Messrs. Canellos and Reisner served in the U.S.
Attorneyâ€™s Office for the Southern District of New York earlier in their
careers. Most recently, news reports indicate that Mr. Khuzami has also taken
steps toward eliminating one entire tier of supervisors within the Enforcement
Division in an effort to reduce the levels of review.
D. Increased Enforcement Activity
Both Chairman Schapiro and Mr. Khuzami have cited a number of statistics to
demonstrate a significant up-tick in enforcement activity.  According to these statistics, between February and May
of this year, the number of emergency cases seeking temporary restraining
orders has nearly tripled (most likely due to the wave of Ponzi scheme cases
filed this year in the wake of the Madoff case) and the number of formal orders
of investigation issued has more than doubled from the same period last year.
Aside from the increase in TRO cases, the increase in the number of new
investigations opened and formal orders issued indicates a greater level of
investigative activity. But has there been an increase in the number of
enforcement cases being filed? The answer is a clear yes. We compared
injunctive actions filed in the first six months of 2009 and 2008. We found
that the number of injunctive actions filed and number of defendants charged is
up significantly year over year.
|Injunctive Actions Filed
|Number of defendants
Our analysis also reflected a noteworthy trend in the cases being filed.
While the number of cases filed and defendants charged is up, the percentage of
defendants whose charges were settled at the time of filing is down
significantly year over year.
|Percentage of defendants settled at time of filing
This reflects not only increased enforcement activity, but particularly a
willingness by the SEC to file cases against defendants in the absence of
settlements. This may again be partly a result of the recent number of Ponzi
scheme cases that are typically filed on an emergency basis. But, as discussed
in more detail in the next section, it also likely reflects a priority on
bringing cases against individuals more quickly, without settlements and
without awaiting the result of possible parallel criminal investigations.
E. Significant Cases and Trends
More telling than the statistics, in the last few months, the SEC has filed a
number of high profile cases that demonstrate a more aggressive enforcement
approach and that are consistent with the themes that Mr. Khuzami has
articulated. Not surprisingly, the SEC has focused its attention on cases
related to the financial crisis. In addition, in an effort to bring cases more
quickly, the SEC has also more frequently filed these cases in the absence of
settlements and in the absence of parallel criminal cases. Moreover, presumably
towards its goal of sending an â€œoutsized message of deterrence,â€
the SEC has charged senior level individual executives. As a consequence, the
SEC likely will face vigorous defenses and full litigation. The following cases
illustrate these points: 
â€¢ SEC v. Mozilo, the SEC alleges that former executives of
Countrywide Financial misrepresented credit risks the company was undertaking
to maintain its market share; the SEC also alleges the former chief executive
officer engaged in insider trading despite having followed a 10b5-1 plan in
selling company stock.
â€¢ SEC v. Reserve Mgmt. Co., the SEC alleges that managers of
the Reserve Primary Fund money market fund failed to disclose material facts
about the fundâ€™s vulnerability as Lehman Brothers sought bankruptcy
â€¢ SEC v. Strauss, the SEC alleges that former officers of
American Home Mortgage failed to disclose the companyâ€™s deteriorating
financial condition in 2007.
â€¢ SEC v. Rand, the SEC alleges that the former chief
accounting officer of Beazer Homes artificially reduced the companyâ€™s
income during the housing boom by improperly increasing reserves and
liabilities and then reversed those entries when the housing market declined to
continue meeting analystsâ€™ expectations.
â€¢ SEC v. Rorech, the first case to allege insider trading in
credit default swaps, the SEC alleges that a hedge fund manager traded in
credit default swaps on bonds based on nonpublic information from a bond
salesman at an investment bank that an upcoming restructuring of a bond
offering would impact the price of the swaps.
Note the following similarities in these cases:
â€¢ The cases touch on aspects of the financial crisis, demonstrating
the SECâ€™s emphasis on making this area a priority.
â€¢ With the exception of one defendant, the cases were filed without
settlements. This indicates an emphasis on bringing cases against individuals,
on bringing cases more quickly, and a greater willingness to litigate cases.
Going forward, it will be interesting to observe whether the SEC has sufficient
resources to sustain the continued filing of cases that are likely to be
litigated to final judgment.
â€¢ The cases were also filed without any parallel criminal actions
against the individual defendants. This indicates a trend away from holding off
on filing civil cases while waiting for criminal prosecutors to determine
whether to pursue criminal charges.
F. Increased Funding
Congress and the Administration have also provided additional money for
securities enforcement. In May, the President signed the Fraud Enforcement and
Recovery Act of 2009, which adds $265 million per year to the 2010 and 2011
budgets of the SEC, DOJ and other law enforcement agencies for the
investigation and prosecution of fraud involving financial institutions. In
addition, the Omnibus Appropriations Act of 2009 added $37 million to the
SECâ€™s 2009 budget which the agency is using to enhance enforcement. The
Presidentâ€™s 2010 budget proposal would increase the SECâ€™s budget
13%, with the additional resources to be used to â€œincrease staff and use
new technology to pursue risk-based approachesâ€ to better detect fraud.
G. The Future of SEC Enforcement
This era of heightened enforcement will continue for the foreseeable future.
In this environment, it is more important than ever that financial services
firms and public companies reinforce efforts to assure that their legal and
compliance infrastructure is identifying and resolving potential issues of
concern to regulators and positioning the company to respond effectively to
possible future regulatory inquiries.
II. Financial Reporting Cases
In the first half of 2009, the SEC has emphasized financial reporting cases
related to the collapsed subprime mortgage market. Other cases reflect the
SECâ€™s continuing prosecution of allegedly manipulative accounting
entries. The SEC also resolved outstanding stock option backdating claims that
arose beginning in the spring 2005.
A. Subprime and Financial Crisis Related Cases
In April, in SEC v. Strauss, the SEC charged three former executives
of American Home Mortgage Corporation, including the CEO, CFO and controller.
 The SEC alleges the defendants failed to disclose the
extent to which the company issued loans without income verification and the
impact that accelerating defaults were having on the companyâ€™s liquidity
in 2007. Pursuant to a settlement, the companyâ€™s former CEO consented to
$2.2 million in disgorgement, a $250,000 penalty and a five year officer and
director bar. Litigation continues against the other defendants.
In June, in SEC v. Mozilo, the SEC charged three former executives of
Countrywide Financial Corporation, including the CEO, the COO and the CFO.  The SEC alleges that the defendants presented the company
as a lender of prime quality mortgage loans, different from competitors who
engaged primarily in riskier subprime lending, and did not disclose that the
company had actually developed a â€œsupermarketâ€ strategy that
widened underwriting guidelines to match products offered by its competitors.
The complaint cites to internal email messages that allegedly reflect knowledge
of the increasing risks the company was undertaking. The CEO, Mozilo, was also
charged with insider trading.
On July 1, in SEC v. Rand, the SEC charged the former chief accounting
officer of Beazer Homes USA, Inc.  The SEC alleges that
the defendant artificially decreased the companyâ€™s income during the
housing boom by improperly increasing reserves and recording additional
liabilities and then reversed those entries when the housing market declined in
2006 and 2007 in order to continue meeting analystsâ€™ expectations. On
same day, Beazer reached agreements to resolve criminal and civil charges with
the Department of Justice and the Department of Housing and Urban Development
alleging false mortgage originations and accounting practices. Pursuant to a
deferred prosecution agreement, Beazer will pay up to $50 million in fines and
restitution to home buyers. 
B. Vendor Payment and Inventory Management Claims
The SEC also resolved a number of financial reporting cases outside the realm
of the subprime mortgage market. The SEC announced a settlement with CSK Auto
Corporation alleging that the company overstated operating income from 2002 to
2004 by failing to write off uncollectible vendor allowances receivables and
recognizing vendor allowance receivables in the wrong time period.  The settlement with CSK followed similar charges in March
against several four former CSK employees. The litigation against the
individuals is continuing. 
The SEC also settled claims against several former employees of Cardinal
Health, Inc., alleging that they inflated the companyâ€™s earnings by
misclassifying bulk sales as operating revenue, selectively accelerating
recognition of cash discount income, and improperly adjusting reserves.
Pursuant to settlements, the defendants paid civil penalties ranging from
$50,000 to $100,000, and consented to officer and director bars and suspensions
from appearing or practicing before the SEC as an accountant for three to five
C. Backdating Cases
The SEC continued to settle several outstanding stock option backdating
investigations that began in 2005. The SEC reached a settlement with Monster
Worldwide, Inc., with a $2.5 million penalty, 
Take-Two Interactive Software, Inc., with a $3 million penalty,  and Quest Software, Inc., with no penalty.  Former executives of Take-Two and Quest also reached
settlements. In addition, in May 2009, following a trial, Monsterâ€™s
former chief operating officer, James Treacy, was found guilty of criminal
charges for his role in options backdating at Monster.
III. Cases Against Broker-Dealers
The SECâ€™s enforcement actions against broker-dealers have addressed
the financial crisis, but have also encompassed sales practices, information
barriers, international business and market operations.
A. Financial Crisis
In May, the SEC charged ten brokers in Florida in connection with the sale of
collateralized mortgage obligations (CMOs) to retirees and other conservative
investors.  The SEC alleged that the brokers
misrepresented the CMOs as guaranteed by the U.S. government and suitable for
investors with conservative objectives. The SEC also alleged that the
defendants misrepresented the extent to which margin would be used and the
risks it would create.
B. Cross-Border Business
This year the SEC played a role in challenging a foreign financial institution
allegedly used by U.S. citizens to avoid taxes. The defendant was a Swiss
financial institution that was not registered as either a broker-dealer or
investment adviser in the U.S. In a settled enforcement action, the SEC alleged
that the defendant opened accounts in Switzerland for U.S. citizens, but used
U.S. jurisdictional means to provide brokerage and advisory services to those
customers in the U.S.  Thus, the SEC alleged that
the defendant acted as a broker-dealer and investment adviser without
registering as such. Pursuant to the settlement, the defendant agreed to pay
$200 million in disgorgement. The defendant also entered into a deferred
prosecution agreement with the Department of Justice pursuant to which it will
pay an additional $180 million, as well as $400 million in tax-related
C. Information Barriers
In 2005 and 2006, the SEC filed enforcement actions against brokers at
several firms and day traders outside those firms, alleging that the brokers
permitted the day traders to hear confidential information regarding the
firmsâ€™ institutional customersâ€™ unexecuted orders as they were
transmitted over the firmsâ€™ squawk box. The day traders allegedly traded
ahead of the institutional customer orders and profited from price movements
caused by execution of the institutional customer orders. The brokers allegedly
received kickbacks from the day traders in exchange for providing access to the
This year, the SEC instituted a settled action against one of the broker-dealer
firms alleging that the firm had not established, maintained and enforced
written policies and procedures reasonably designed to prevent the misuse of
material, non-public information relating to customer orders.  According to the SECâ€™s administrative order,
the firm lacked policies and procedures to limit and track employee access to
the squawk box and to supervise its use. Pursuant to the settlement, the firm
agreed to pay a $7 million penalty and to implement certain policies and
procedures to prevent misuse of the squawk boxes.
In 2004, the SEC brought settled administrative proceedings against the seven
specialist firms on the New York Stock Exchange alleging trading ahead and
inter-positioning. In March of this year, the SEC brought similar enforcement
actions against fourteen specialist firms that operated on several regional and
options exchanges.  As in the earlier actions, the
SEC alleged that the specialist firms did not fulfill their obligation to match
executable public customer orders and instead traded ahead of such orders or
inter-positioned proprietary trades between them. Pursuant to the settlement,
the fourteen firms agreed to pay collectively nearly $70 million in
disgorgement and penalties.
IV. Cases Against Investment Advisers
Cases against investment advisers also focused on the financial crisis. In
general, the cases involving advisers reflect a continued emphasis on
fulfilling fiduciary duties of accurate and timely disclosure to clients of
material information and potential conflicts of interest.
A. Cases Related to the Financial Crisis
The SEC filed an action against managers of the Reserve Primary Fund money
market fund, which â€œbroke the buckâ€ when its net asset value fell
below $1.00 per share the day after Lehmanâ€™s bankruptcy filing.  The SEC alleges that, following the bankruptcy filing,
the defendants made inaccurate disclosures concerning the fundâ€™s
to Lehman and the management companyâ€™s willingness and ability to
In another enforcement action, the SEC challenged an investment
valuations of a mutual fundâ€™s holdings of mortgage-backed securities.  In this settled action, the SECâ€™s
administrative order alleged that the respondents overstated the value of
mortgage-backed securities in the fundâ€™s portfolio in 2007 and 2008 by
failing to take into account certain adverse information, such as the decline
in a benchmark asset-backed derivative index and the cessation of payments on a
CDO tranche held by the fund, and recommended overriding the declining
valuations provided by third-party pricing vendors. In June 2008, the
fundâ€™s valuation committee re-priced several of the securities in the
fund, which caused a decline in its NAV. According to the SECâ€™s order,
the respondents prepared talking points for wholesalers to provide to certain
sales channels and to respond to investor inquiries. The SECâ€™s order
alleged that the respondentsâ€™ selective disclosure of information about
the repricing to certain fund shareholders, and failure to disclose such
information more broadly, constituted a separate violation of the Advisers Act,
which allowed certain investors to redeem their shares ahead of others at a
higher net asset value. Shortly after the re-pricing, investor redemptions led
the fund to close and go into liquidation. Pursuant to the settlement, the
respondents agreed to pay a total of $40 million in compensation to fund
shareholders, disgorgement and penalties, and to retain an independent
compliance consultant to review certain policies and procedures.
B. Due Diligence of Other Advisers
In a settled enforcement action, the SEC challenged the sufficiency of due
diligence performed by an investment adviser before placing client funds with
another adviser.  The SEC alleged that the
respondents, a hedge fund consultant and its principal, breached fiduciary
duties owed to clients by not performing the due diligence evaluation it
represented it would do before and after recommending investment in the Bayou
Fund. The SECâ€™s administrative order alleged that the respondents failed
to conduct a portfolio trading analysis and failed to verify Bayouâ€™s
relationship with its outside auditor. In settling the matter, the respondents
agreed to pay approximately $800,000 in disgorgement and penalties.
C. Public Pension Fund Asset Management
In the last six months, the SEC, in conjunction with the New York State
Attorney General, has taken action against individuals who have allegedly
participated in arrangements to require investment advisers to pay
consideration in return for the opportunity to manage money from a New York
State pension fund.  In its original complaint,
filed in March 2009, the SEC alleged that David Loglisci, former Deputy
Comptroller and Chief Investment Officer of the New York State Common
Retirement Fund, working with Hank Morris, a political adviser to the former
New York State Comptroller, required investment managers seeking to manage
Common Fund money, to pay a â€œfinderâ€™s feeâ€ to Morris and
others. The complaint alleges that those who received the payments did not
perform legitimate services for the fees and that the fees were merely
kickbacks of a portion of the investment advisory fees received by the
advisers. Since filing the original complaint, the SEC has added several other
individual defendants who also received payments, as well as one investment
adviser who made such payments.  The SECâ€™s
release announcing charges against the investment adviser noted that, at the
time of making the suspect payments, the adviser was serving as an outside
consultant to the Common Fund, thus making the adviser a fiduciary of the
Common Fund.  The New York State Attorney General
has pursued parallel criminal charges against some of the same defendants.
E. Ponzi Schemes
In a typical year, we would not discuss Ponzi schemes. However, this has not
been a typical year thus far. In the wake of the Madoff case, the SEC has filed
a series of Ponzi scheme cases. This is probably due to both increased investor
redemption demand exposing more schemes and the SECâ€™s heightened focus
these cases. Many of these cases have been against individuals and firms that
were, or purported to be, investment advisers.
One particularly noteworthy development came in the Stanford case. For the
first time, to our knowledge, the SEC has charged a foreign regulator with
violation of the U.S. securities laws. In June, the SEC amended its complaint
in the Stanford case to add as a defendant the administrator and chief
executive officer of Antiguaâ€™s Financial Services Regulatory Commission
for allegedly accepting bribes to ignore the Ponzi scheme, supplying Stanford
with confidential information about the SECâ€™s investigation and
collaborating with Stanford to withhold information requested by the SEC. 
V. Insider Trading
This year the SEC for the first time alleged insider trading in credit
default swaps. In another case the SEC charged insider trading despite the
defendantâ€™s use of a 10b5-1 plan.
A. Insider Trading in Credit Default Swaps
In May 2009, the SEC filed the first case alleging insider trading in credit
default swaps, in this case swaps on the bonds of Dutch company, VNU N.V.  The defendants are a bond salesman at an
investment bank and a portfolio manager at a hedge fund. The SEC alleges that
the bond salesman learned from fellow employees confidential information
concerning changes in a proposed VNU bond offering that the investment bank was
underwriting, changes that would increase the price of credit default swaps on
VNU bonds. The SEC alleges that the bond salesman tipped the hedge fund manager
about the confidential information and that the hedge fund manager purchased
credit default swaps on VNU bonds for his hedge fund and later covered the
position for a profit when news of the bond restructuring became public. As for
the SECâ€™s jurisdiction over trading in the credit default swaps, the
complaint alleges, â€œThe CDSs at issue in this matter qualify as
security-based swap agreements under the Gramm-Leach-Bliley Act of 2002 and are
therefore subject to the antifraud provisions set forth in Section 10(b) of the
Exchange Act and the rules promulgated thereunder.â€ This case will likely
test the SECâ€™s assertion of jurisdiction over trading in credit default
swaps in general and in the circumstances of this case in particular.
Of more immediate concern, however, are the implications of this case for
ongoing compliance at broker-dealers and investment advisers who trade in
credit default swaps. Whether or not the SEC prevails in this case, the filing
of the case means that broker-dealers and investment advisers need to make sure
their information barriers designed to prevent the misuse of material nonpublic
information encompass potential trading in credit default swaps. Depending on
the nature of the organization, this may mean the implementation of additional
surveillance systems or physical separation of personnel not previously
considered to be at risk for insider trading.
B. Insider Trading and 10b5-1 Plans
In SEC v. Mozilo, in addition to the disclosure allegations discussed
above, the SEC also alleged insider trading. 
The complaint alleges that, at the time Mozilo established four Rule 10b5-1
plans to sell Countrywide stock, he was aware of nonpublic information
concerning Countrywideâ€™s increasing credit risk and the risk that the
poor expected performance of its loans would prevent the company from
continuing its business model of selling its loans into the secondary market.
This case emphasizes the care that must be taken when establishing a 10b5-1
plan to ensure that it will provide an effective defense to potential
allegations of insider trading.
VI. The SEC In The Courts â€” Litigation Developments
As one would expect, in the first half of 2009, the SEC met with some
successes and some setbacks in the courts. We focus here on court decisions
that have implications for future litigation against the SEC.
A. Statute of Limitations
For years, the SEC has struggled with litigating old conduct and, consequently,
often has to surmount a defense based on the statute of limitations, typically
relying on arguments that the statute should be tolled due to the
defendantâ€™s concealment of the fraud. These arguments have met with
varied success in the courts. This year, the SEC prevailed in a case in the
Seventh Circuit.  In SEC v. Koenig, the
SEC filed its complaint more than five years after the alleged accounting fraud
had ended, but less than five years after the company issued a press release
announcing that its prior financial statements were unreliable. The court held
that in applying the statute of limitations in 18 U.S.C. Â§2462 to an SEC
fraud claim, the statute does not begin to run until the SEC discovers, or
reasonably could have discovered, the fraud. The court determined that the
companyâ€™s press release was the earliest event that put the SEC on
of the need for inquiry, and thus, the SECâ€™s complaint was timely. The
Koenig decision sets a lower threshold for the SEC to establish tolling than
the standard previously articulated by a district court in the Southern
District of New York.  Thus, while the Koenig
decision is helpful to the SEC, the divergence in these cases means that the
SEC will continue to face uncertainty over the viability of claims in future
litigation involving old conduct.
B. The Scope of Secondary Liability
The SEC received a setback from the First Circuit on the scope of aiding and
abetting liability.  In SEC v. Papa, the
First Circuit affirmed the dismissal of aiding and abetting claims against
three defendants who signed audit confirmations that failed to disclose a prior
fraud allegedly committed by three other co-defendants.
The SEC complaint named six former executives of a trust company that
provided administration services to pension funds and mutual funds. According
to the allegations of the complaint, the trust company inadvertently delayed
investing a pension fundâ€™s assets, which caused losses to the fund. The
defendants then tried to remedy the loss by executing certain back-dated
cross-trades between the pension fund client and mutual fund clients that
partially shifted the losses from the pension fund to the mutual funds, without
disclosure to the affected clients. The complaint alleged that all six
defendants participated in meetings in which the plan was discussed and agreed
to; three of the defendants effected the trades and associated accounting
entries; and three signed audit confirmations one and two years later that did
not disclose these events.
The district court dismissed all claims against the three defendants who had
signed the audit confirmations, holding that the SEC had not stated a claim of
either primary or secondary liability. On appeal the SEC pressed only the
theory of secondary liability, that the false audit confirmations substantially
assisted the fraud by continuing the trust companyâ€™s breach of fiduciary
duty of disclosure to the clients. The First Circuit affirmed the dismissal,
holding that the execution of audit confirmations did not render substantial
assistance to the fraud because the fraud had ended long before the letters
were signed. In the words of the court, â€œone cannot aid and abet a
fraudulent scheme that is already complete.â€ As the court explained, to
hold otherwise â€œwould extend the supposed wrong indefinitely and until
its disclosure,â€ and â€œwould create new liability under section
10(b), long after the original transactionsâ€ had occurred. 
The Papa decision puts into question the viability of aiding and
abetting fraud claims against a defendant whose only misconduct consists of
signing an inaccurate audit confirmation. On the other hand, in dicta, the
court noted the possibility that the SEC might have sustained an aiding and
abetting claim against the same three defendants based solely on their alleged
acquiescence to the original plan, a theory the SEC had not pursued on appeal.
Thus, the SEC may take from this decision encouragement toward asserting such
claims in the future.
C. The Scope of Primary Liability
In December 2008, a divided panel of the First Circuit held that the SEC had
adequately alleged a primary violation of Section 10(b) and Rule 10b-5(b) for
misstatements concerning market timing â€œimpliedlyâ€ made in mutual
fund prospectuses by defendants, employees of the underwriter and distributor
of mutual fund shares.  In SEC v.
Tambone, the First Circuit reasoned that underwriters hold a â€œunique
positionâ€ that carries with it a â€œduty to review and confirm the
accuracy of the material in the documentationâ€ an underwriter
distributes. Thus, even though the defendants did not author the statements at
issue, the court held that defendantsâ€™ â€œuseâ€ of the
prospectuses to sell securities amounted to â€œimplied statements of their
own regarding the accuracy and completeness of those prospectuses.â€ A
sharply-worded dissent criticized the courtâ€™s holding for enlarging the
scope of primary liability and blurring the line between primary and secondary
liability that the Supreme Court recently drew in Stoneridge Investment
Partners LLC v. Scientific-Atlanta, Inc. 
Subsequently, the court solicited briefs from the parties and amici in
connection with the defendantsâ€™ motion for a rehearing en banc, but then
denied the defendantsâ€™ motion for rehearing. The defendantsâ€™
petition for certiorari is pending in the Supreme Court.
D. Transnational Enforcement Actions
In emergency actions, the SEC frequently obtains preliminary asset freeze
orders, but such orders may not have extraterritorial effect. Recently, the SEC
received affirmation of its ability to freeze assets abroad through a foreign
court.  At the outset of SEC v. Lydia Capital
LLC, in 2007, the SEC obtained from a U.S. district court an asset freeze
order against a defendant who was a citizen of the U.K. In 2008, with the
assistance of the U.K. FSA, the SEC retained U.K. counsel and filed a limited
notice application with the High Court of Justice, Queenâ€™s Bench
Division, seeking an order freezing the defendants assets in the U.K.  The High Court granted the SECâ€™s emergency
request the same day, and then, following an evidentiary hearing, extended the
freeze order pending adjudication of the SECâ€™s enforcement action in the
U.S. The defendant appealed the High Courtâ€™s order, and, in January
a three-judge panel of the Supreme Court of Judicature Court of Appeal
dismissed the defendantâ€™s appeal, upholding the asset freeze order in
E. Discovery in Enforcement Litigation Against the SEC
The SEC drew a sharp rebuke from Judge Shira Scheindlin in the Southern
District of New York, for its posture in responding to discovery requests in
SEC v. Collins & Aikman Corp.  The
court ruled that the SECâ€™s production of a 10.6 million page,
database of documents produced in its investigation was improper because it was
not maintained that way â€œin the usual course of business.â€ Instead,
the court required the SEC to identify and produce particular documents
responsive to the defendantâ€™s specific document demands or produce the
documents in the manner in which the SEC staff had organized them, rejecting
the SECâ€™s assertion of work product protection as to the staffâ€™s
The defendant also requested discovery on the SECâ€™s consideration in
other contexts of accounting pronouncements at issue in the litigation. The SEC
asserted the â€œdeliberative processâ€ privilege. The court declined
to accept at face value the SECâ€™s broad claim of the privilege. The
held that the deliberative process privilege must be construed narrowly, that
the SECâ€™s privilege log was conclusory, and that its search for
was inadequate. Accordingly, the court ordered that the SEC produce the
withheld documents for in camera review and negotiate in good faith regarding a
search protocol for internal SEC emails that had not yet been searched.
This decision may reduce the cost of litigating against the SEC and permit
access to information which could support a defense that good faith regulatory
and accounting judgments were made in an uncertain environment.
 Mary L. Schapiro, Chairman, SEC, Address to Practising Law
Instituteâ€™s â€œSEC Speaks in 2009â€³ Program (Feb. 6, 2009), here.
 Robert Khuzami, Director, Div. of Enforcement, SEC, Testimony Concerning
Strengthening the SECâ€™s Vital Enforcement Responsibilities (May 7,
 Mary L. Schapiro, Chairman, SEC, Testimony Before the Subcommittee on
Financial Services and General Government (June 2, 2009), here.
 The descriptions of SEC actions in this article are based on allegations
made by the SEC in its charging documents and do not assume the truth of the
facts alleged in them. Gibson, Dunn & Crutcher LLP represents various
parties in related matters. Thus, these descriptions do not reflect the
positions of the firm, its lawyers or its clients.
 Press Release No. 2009-37, SEC, Statement from Chairman Schapiro on
Proposed Budget for SEC (Feb. 26, 2009), here.
 SEC v. Strauss, et al., No. 09-CV-4150 (RB) (S.D.N.Y. filed April
28, 2009); see also SEC Litig. Release No. 21014 (April 28, 2009), here.
 SEC v. Mozilo, et al., No. CV 09-03994 (VBF) (C.D. Cal. filed
June 4, 2009); see also SEC Litig. Release No. 21068 (June 4, 2009), here.
 SEC v. Rand, No. 1:09-CV-1780 (N.D. Ga. filed July 1, 2009); see
also SEC Litig. Release No. 21114 (July 1, 2009), here.
 Press Release, Depâ€™t of Justice, Beazer Homes U.S.A., Inc. Reaches
$50,000,000 Settlement of Mortgage and Accounting Fraud with United States
(July 1, 2009), here.
 In the Matter of CSK Auto Corp., File No. 3-13485 (SEC May 26,
 SEC v. Fraser, et al., No. 2:09-cv-00442-LOA (D. Ariz. filed
March 5, 2009); see also SEC Litig. Release No. 20933 (March 6, 2009), here.
 SEC v. Miller, et al., No. 09-CV-4945 (S.D.N.Y. filed May 27,
2009); see also SEC Litig. Release No. 21058 (May 27, 2009), here.
 SEC Release No. 2009-113, SEC Charges Monster Worldwide Inc. for
Backdating Scheme (May 18, 2009), here.
 SEC Release No. 2009-72, SEC Charges Take-Two for Stock Options
Backdating Scheme (Apr. 1, 2009), here.
 SEC Release No. 2009-57, SEC Charges Quest Software and Three
Executives for Stock Option Backdating (Mar. 12, 2009), here.
 SEC v. Betta, et al., No. 09-80803 (S.D. Fla. filed May 28,
2009); see also SEC Litig. Release No. 21061 (May 28, 2009), here.
 SEC v. UBS AG, No. 1:09-cv-00316 (D.D.C. filed Feb. 18, 2009);
see also SEC Litig. Release No. 20905 (Feb. 18, 2009), here.
 In the Matter of Merrill Lynch, Pierce, Fenner & Smith
Inc., File No. 3-13407 (SEC Mar. 11, 2009), here.
 See SEC Release No. 2009-42, with links to five complaints and seven
administrative orders, here.
 SEC v. Reserve Mgmt. Co., Inc. et al., No. 09-CV-4346
(S.D.N.Y. filed May 5, 2009); see also SEC Litig. Release No. 21025 (May 5,
 In the Matter of Evergreen Inv. Mgmt. Co., LLC, File No.
3-13507 (SEC June 8, 2009), here.
 In the Matter of Hennessee Group LLC, File No. 3-13454 (SEC
Apr. 22, 2009), here.
 SEC v. Morris, et al., No. 09-CV-2518 (S.D.N.Y. filed Mar. 19,
2009); see also SEC Litig. Release No. 20963 (Mar. 19, 2009), here.
 SEC v. Morris, No. 09-CV-2518 (S.D.N.Y. amended complt. filed
May 12, 2009); see also SEC Litig. Release No. 21036 (May 12, 2009), here.
 SEC v. Morris, No. 09-CV-2518 (S.D.N.Y. amended complt. filed
Apr. 30, 2009); see also SEC Litig. Release No. 21018 (Apr. 30, 2009), here.
 SEC v. Stanford Intâ€™l Bank, Ltd., et al., No.
3:09-cv-0298 (N.D. Tex. amended complt. filed June 19, 2009); see also SEC
Litig. Release No. 21092 (June 19, 2009), here.
 SEC v. Rorech, et al., No. 09-CV-4329 (JGK) (S.D.N.Y. May 5,
2009); see also SEC Litig. Release No. 21023 (May 5, 2009), here.
 SEC v. Mozilo, No. CV 09-03994 (VBF) (C.D. Cal. filed June 4,
2009); see also SEC Litig. Rel. No. 21068 (June 4, 2009), here.
 SEC v. Koenig, 557 F.3d 736 (7th Cir. 2009).
 SEC v. Jones, 476 F. Supp. 2d 374 (S.D.N.Y. 2007).
 SEC v. Papa, 555 F.3d 31 (1st Cir. 2009).
 Id. at 37 (emphasis in original).
 SEC v. Tambone, 550 F.3d 106 (1st Cir. 2008),
denied (1st Cir. 2009).
 Stoneridge Investment Partners LLC v. Scientific-Atlanta,
Inc., 552 U.S. 148 (2008).
 SEC v. Lydia Capital, LLC, No. 07-10712-RGS, 2008 WL 5273313
(D. Mass. Dec. 19, 2008).
 SEC v. Manterfield, Claim No. HQ08X00798 (High Court of
Justice, Queenâ€™s Bench Division, Royal Courts of Justice).
 SEC v. Collins & Aikman Corp., 256 F.R.D. 403, 2009 WL
94311 (S.D.N.Y. Jan. 13, 2009).