Risk & Compliance

How to Beat the SEC

With the commission's recent penchant for heavy penalties, defendants might do better going to court than negotiating settlements, a lawyer contends.
Craig SchneiderJanuary 31, 2005

For many defendants in cases brought by the Securities and Exchange Commission, settling the claim normally seems like the more alluring alternative to going to court against SEC lawyers.

Other defendants, however, might be starting to see the courtroom as a safer haven. With lifetime bans on serving as a corporate director or officer and tens of millions of dollars in civil penalties facing some defendants these days, it may well make sense for an accused executive to fight the Securities and Exchange Commission in court, former SEC officials say.

Indeed, a sizable chunk of cases do go to court. In the SEC’s fiscal year 2004, 43.7 percent of the cases that it brought were litigated upon filing. That means at least one defendant in the case did not settle when the SEC brought actions in federal district court or administrative proceedings. In FY03, that number was 38.1 percent; in FY02, 43.3 percent; and FY01, 34.2 percent.

David Kornblau, chief litigation counsel at the SEC, attributes the bump in litigated cases last year to the SEC’s “big push” to file cases barring people who have been criminally convicted from serving in the securities industry permanently or for a limited time. In 2003, the SEC asked for 170 bars, which prohibit people from serving as an officer or director of a publicly traded company, CFO reported last year. That’s an increase from 126 bars in 2002 and only 51 in 2001.

Pressure seems to be mounting on the SEC to bring more lawsuits against corporations and to seek stiffer penalties in its cases, especially with New York Attorney General Eliot Spitzer leading so many legal battles. “If they don’t want to appear meek to the investors, the SEC will need to keep in stride with state enforcers,” says Elizabeth Nowicki, assistant professor of law at the University of Richmond.

The SEC’s apparent current penchant for lifetime bans on employment and high financial penalties in settlements with individuals may be forcing some of the accused to think twice about settling. The SEC “raised the stakes so much with these heavy-hitting penalties, maybe we should make them prove it,” says David Bayless, an attorney who worked for five years as district administrator of the SEC’s San Francisco office. “You’re not going to do any worse [from a financial or employment perspective] if you lose.”

Legal fees, on the other hand, are likely to mount for defendants after they decide to litigate, rather than settle.

Nevertheless, Bayless, a partner at Morrison and Foerster, did win a case brought by a client of his against the commission recently. He represented David Gane, former president and chief executive of Dicom Imaging Systems, against the SEC. On January 13, the federal courts cleared Gane of all claims of securities fraud brought by the SEC.

The SEC had sought undisclosed maximum monetary penalties in its case against Gane and a lifetime ban against serving as a corporate officer or director. Gane also risked losing his current job heading a digital imaging division of Eastman Kodak if he settled with the SEC, according to Bayless.

Bayless suggests that high SEC penalties and what he calls “government overreaching” in its case selection are practices that are starting to backfire with executives. Because companies often don’t want to fight the SEC, the commission “can get away with demanding huge settlements,” Bayless explains. If defendants, he adds, “have the financial wherewithal, they’re starting to say, ‘I’m not going to accept this settlement.’”

The SEC, of course, has a different perspective on its tactics. Without commenting on the Dicom decision, Paul Berger, associate director of enforcement at the SEC, said that the SEC makes a thorough evaluation of the evidence to see if and how well it can make a case. All cases are brought before the commissioners for final approval, he noted.

Nowicki agrees that the commission takes a careful approach to litigating. Weak cases get “weeded out” early through a very selective process. “They want to maintain the belief that if the SEC comes after you, it’s a big problem,” she says. To that end, the five commissioners are “very cautious” on what cases they approve.

Indeed, the commission’s political prominence is a “safety valve [against] the SEC being too heavy-handed, too greedy,” Nowicki adds. On the other hand, she says, “When litigators see dollar signs, they move forward.”

Bayless says that judges may be another moderating factor, tending to go softer on executives than what the SEC might propose for a settlement. He suggests that federal judges may shy away from lifetime bans for corporate executives “even if the judge thinks you did something wrong.”

In Gane’s case, the U.S. District Court for the Southern District of Florida found that the SEC had no case against the former Dicom CEO. In the court’s January 4 opinion, which followed a six-day trial in December 2004, Judge Jose Gonzalez found that Gane did not act with fraudulent intent concerning any of the alleged misrepresentations or omissions.

The SEC alleged that he failed to disclose that at least $4.2 million, or 17 percent, of the $24.7 million in projected revenues were revenues from products still in development. Gane also never defrauded any investor because he “never sold, or attempted to sell, any Dicom stock that he owned,” according to the decision.