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					Sarbanes-Oxley (SOX) and Private Actions
More Opportunities for Plaintiffs Or an Oxymoron

SOX-Private Actions MIA


Sarbanes-Oxley Does Not Amend PSLRA
– Does extend fraud statute of limitations – Provides for 16(b) type of action for insider trading during individual pension plan blackout Otherwise provides no express private action
Some provisions expressly exclude a private action Commission‘s disgorgement powers enhanced Permits SEC to include civil penalties with disgorgement Seen by some as an antidote to private actions—let the SEC make defrauded investors whole – Yet Professor Grundfest said of SOX: ―It is more opportunities for
the plaintiffs‘ lawyers. There‘s no doubt about that.‖



– – – –

SOX Titles
         

TITLE I--PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD TITLE II--AUDITOR INDEPENDENCE TITLE III--CORPORATE RESPONSIBILITY TITLE IV--ENHANCED FINANCIAL DISCLOSURES TITLE V--ANALYST CONFLICTS OF INTEREST TITLE VI--COMMISSION RESOURCES AND AUTHORITY TITLE VII--STUDIES AND REPORTS TITLE VIII--CORPORATE AND CRIMINAL FRAUD ACCOUNTABILITY TITLE X--CORPORATE TAX RETURNS TITLE XI--CORPORATE FRAUD AND ACCOUNTABILITY

Section 304 Reimbursement
 If

issuer required to restate financials

– Due to material noncompliance with financial requirements under securities laws – As a result of misconduct


CEO and CFO shall reimburse the issuer
– Any bonus, incentive or equity based compensation – Any profit realized from sale of issuer‘s securities – During 12 months following public issuance/filing of financials that had to be restated (HSB interpretation)



Does not provide who can bring the action, court in which it can be brought, period of limitations

Can the SEC bring a 304 Action
304 not specifically unlawful  ―Shall reimburse‖ implicitly unlawful  Section 3(b) of SOX—any violation constitutes as violation of ‘34 Act
– Commission presumably could use its arsenal of enforcement weapons – But why would it, since it has more extensive disgorgement remedies – Query whether 304 requires scienter
 Sec.

Can the company bring a 304 action
 Implied

claims & the Securities Laws

– Courts at one time liberal in allowing party statute benefited to assert a claim – That is the basis of Rule 10b-5 claims – Since 1975 Supreme Ct relatively strict – Four criteria of Cort v. Ash
be clearer intended company to be reimbursed and not voluntary  Statute essentially a non-starter if company cannot enforce
 Couldn‘t

Can Shareholders Bring Derivative Action?
 Derivative

actions have been allowed in some limited areas under 10b-5
– Involved fraud on corporation in securities transaction with the corporation



Would such an action be subject to PSLRA
– PSLRA applicable to actions under ‘33/‘34 Act – 304 unlike some other secs. not part of ‘34Act – Sec. 3(b) SOX-violation of SOX for ―all purposes‖ treated as violation of ‘34 Act – Query – is this limited to actions by SEC?

Elements of 304
Material noncompliance  Result of Misconduct


– Supreme Ct. reference in Hochfelder to intentional misconduct – Misconduct less than intentional?—reckless; gross negligence; negligence?


Misconduct by whom?
– CEO and CFO are only ones liable – Misconduct by others that enrich them?



Period Covered—12 months following what

It’s the Money Stupid
Incentive to bring 304 action?  New Management? Combine with breach of fiduciary duties claim  Section 16(b) type plaintiffs—a restatement watch rather than 16(a)  Do you have to be shareholder at time of misconduct?  Combining with class action?


– Conflict of interest?Impact on leadplaint.status

Other Opportunities—Aids to Pleading Class Action Securities Fraud


Section 302 certification—can it help
– Applicable to periodic reports-10Q/10K – CEO and CFO must certify under oath
 Reviewed

the report (10K/10Q)  Based on ―my knowledge‖ does not contain false or misleading material information  BMK financial statements fairly present etc.  We are responsible for establishing and maintaining disclosure controls&procedures  Designed disclosure controls&procedures to assure availability of info for report  Evaluated disclosure controls&procedures  Presented our conclusions as to effectiveness  Have identified to auditors material weaknesses

Disclosure Controls & Procedures
 DCP

designed to ensure info required to be disclosed in the filed report
– Is recorded,processed,summarized etc. – Is accumulated and communicated to issuer‘s managementincluding CEO/CFO – Prepare in connection with each report an evaluation of its effectiveness

 How

does it impact PSLRA pleading?

Section 404 Internal Controls
 Pertains

to internal controls relating to financial reporting—annual report
– Commission proposal combining with certification – Must include managements‘ assessment of effectiveness of internal controls

 Must

be attested to in accordance with standards established by PCAOB

Section 906


Certification of CEO/CFO of periodic reports containing financial statements
– Fully complies with reporting requirements – Fairly presents financial conditions and results operation

 

Sole enforcement—criminal penalties Redundancy—How Present
– Mar. 21, 2003 Commission proposed rules, if adopted
  



Section 302 certification will be included as an exhibit Section 906 certification to be included as an exhibit Section 906 certification furnished rather than filed No Section 18(a) liability for 906 certification

Section 409 (15 U.S.C.A. 78m(l))
a new subsection (l) to Sec. 13  Instructs Commissions to adopt rules
– Requiring disclosure in plain English – On a rapid and current basis re – Material changes in financial conditions – Material changes in operations – May include trends/qualitative/graphic – No time limit/No proposed regs yet – Commisssion has not acted on its pre SOX proposal to expand Form 8-K
 Adds

Implications of 409 when Implemented
 Assuming

Commission amends 8-K

– To include expanded or skinnier version of the proposed items – Pursuant to its authority under Sec. 13(a) or – Section 409 or both – Issuer doesn‘t make 8-K disclosure – What opportunities does it provide purchaser during vacuum period? – Can Easterbrook continue to say there is no ―absolute duty to disclose‖? – SEC can bring an enforcement action for violation §13(l) – Does it constitute a violation of 10b-5? – Does §13(l) create implied private action?


At minimum--increases opportunities to mislead

§403 & §16(a) Reporting
 Relevant

to gathering data re insiders‘ trading to allege scienter
– §16(a) required officers, directors, 10%shareholds report on Form 4 all transactions w/10 days after month – §403 requires to be filed w/2 days after the transaction – No later than 7/30/03 will have to be filed electronically on EDGAR – Commission has established a website
https://www.onlineforms.edgarfiling.sec.gov on which Form 4s, 3 and 5 will have to be prepared/transmitted to EDGAR – Will be available on EDGAR database – Several services provide the data—See Vickers e.g.

Why 307? Senate listens to the Professors-

SOX included §602 codified Rule 102(e)
– Authority of SEC to deny privilege of appearing/practicing before SEC – Grounds Include ―improper professional conduct‖ – Applies to accountants, attorneys, and other professionals – SEC in Carter Johnson (1981) (CJ) spelled out improper professional conduct of attorneys acting as disclosure counsel



40 securities law professors wrote SEC while bill was being considered in Congress -- urging up the ladder+CJ
– General Counsel responded was up to Congress not SEC – Disclosed well-kept secret--SEC had not applied CJ for years



Senator Edwards learned this; got mad--proposed 307
– Seemed to be unaware of (didn‘t mention) § 602 – Co-sponsored-Enzi(R.Wyo) only CPA in Senate – Last amendment to be considered--passed 97-0

What §307 Required
 SEC

to adopt rules by 1/26/03

– Setting forth minimum standards of professional conduct for attorneys – Appearing and practicing before SEC – In the representation of issuers


Including a rule requiring an attorney to REPORT – Evidence of material violation SL or breach FD – By the company or any agent thereof – To the chief legal officer or CEO – If no appropriate response to go up the ladder – To the final authority (audit committee, etc.)

SEC Adopts CFR Part 205
On 11/01/2002 SEC proposed 307 rules  On 1/23/03|1/29/03 adopted 307 rules  Consist of 17 C.F.R. §205.1-205.7  Proposed Rules Criticized by SEC Bar etc.


– – – – – – –

Directed at noisy withdrawal provisions But considerable other criticism as well Final rules moderated to some extent Noisy withdrawal not adopted/rejected Noisy withdrawal alternative proposed Commission has both under consideration Commission also has new Chairman/Donaldson

Section 307 Filmwriter’s Million $$ Outline
– Robert Adams (‗05 DU law) Associate of Trecker & Trecker, New World Trade Center – Adam‘s fiancée is Jane Jones daughter of John
Jones, CEO of Jones Global Enterprise (NYSE/JGE)

– JGE is a major client of Trecker& Trecker (T&T) – Conference Adams, C.A.Trecker & John Jones (JJ), on Mon. discussing letter received from Atlas Corp., major customer (40% rev) of JGE – Atlas is terminating contract shoddy JGE work – C.A. Trecker & JJ discuss when, if, and how to make/soften any disclosure

Million $$$ Plot Con’t
– Adams interjects--SEC regs. Under 409 require disclosure in Form 8-K by Wed. in plain English of

of contract  Loss of 40% of revenue  Litigation cost if contest  Issues in litigation--since clear noncompliance with contract specifications – JJ turns to Trecker: Do all of your associates listen to left-wing professors.I know with some adjustments I can persuade Atlas to withdraw notice. We will disclose when,what,if I decide – Screenwriters to finish with §307 consultant

 Termination

Back to Reality


Notwithstanding efforts of ABA and Securities Practitioners to Moderate Rules as proposed – §307 Rules will dramatically impact – SEC practitioners & in house corp. counsel – In preparation of documents filed with SEC – In decisions as to whether to file documents – In representing issuer investigated by SEC – In defending issuer in SEC & private litigation – Law firms procedures and policies – Testing integrity of securities practitioners

Some Key Definitions -Exercise in Multiple Negatives
– Issuer-Reporting companies; IPO,IC – Attorney-licensed gives advice to Issuer; attorney client relationship – Appearing and practicing before the SEC – Evidence of a material violation – Reasonably likely – Qualified Legal Compliance Committee (QLCC) – Appropriate Response

Chief Legal Officer (CLO) Route
– – – – – – Subordinate Attorney to Supervising Attorney Supervising Attorney reports EMV to CLO CLO responds back to Reporting Attorney Reporting Attorney determines if Adequate Not adequate goes to Final Authority Reporting Attorney may go directly to Final Author if regards it futile to go to CLO

If Issuer has QLCC Route
 Innovative


idea of SEC; not 307

Must be in existence when EMV reported  Reporting Atty may go directly to QLCC  In that event s/he no further responsibity  Or if reported to CLO, CLO may refer it to the QLCC
– In either event becomes responsibility of QLLC – If determines is past, ongoing, about to occur violation--must take steps to rectify;remedy – If unable, may have to report same to SEC

Impact on Private Actions/Herein of a Noisy Withdrawal (NW)



Plaintiff‘s Opportunities Depend on NW
Initial Proposed Noisy Withdrawal
– Reporting attorney reasonably believes no appropriate response from top of ladder – If material violation ongoing/about to occur – Likely to cause substantial injury to financial interest or property of the issuer or investors – Retained attorney to withdraw and notify issuer is doing so for professional considerations – Notify Commission s/he withdrew for PR – Disclaim related filed documents – In house counsel to disclaim filed documents

Noisy Withdrawal Remnants in Final Rules


Attorney appearing/practicing SEC may
– To prevent the issuer from committing a material violation likely to cause substantial injury to the financial interest or property of the issuer or investors, or – To rectify the consequences of a material violation that caused substantial injury to the financial interest or property of the issuer or investors in the furtherance of which the attorneys services were used, – To prevent the issuer from committing or suborning perjury or commit an act likely to perpetrate a fraud on the Commission in a Commission investigation or administrative proceeding



Reveal to the SEC confidential information related to the representation without the consent of the issuer

Alternative Noisy Withdrawal Under Consideration
– Reporting attorney reasonably believes no appropriate response from top of ladder – If material violation ongoing/about to occur – Likely to cause substantial injury to financial interest or property of the issuer or investors – Retained attorney to withdraw and notify issuer is doing so for professional considerations – In house attorney to stop working on and notify issuer – Issuer to report notice/circumstances on 8-K,20-F,40-F – Issuer fails, reporting attorney MAY inform SEC of notice

Investigating/Defense Attorney
 CLO


may retain/direct attorney to investigate/defend Evidence MV
Dual function of investigate/defend attorney – attorney may have responsibility to go up the ladder – attorney may become part of response – Includes attorney retained/directed to investigate/defend SEC or private action – Appropriate response may be- Investigating

attorney concludes no basis/or recommends remedial action that is taken  Defense attorney consistent with his/her professional obligations directed to present colorable defense on behalf of issuer, officers,directors, employees,agents

Part 205/§307 Sanctions
subject to civil penalties and remedies available under ‘34 Act  Includes disqualification in administrative action plus
– Civil penalties – Officer/director Bar  Expressly—does not create private action  SEC exclusive authority to enforce
 Violators


				
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