The Times ? They are a-Changin'


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The Times ? They are a-Changin'

SEC Actions Aimed at Altering Corporate Culture Say White & Case Lawyers

Larry Byrne

White & Case

Corporate defense lawyers from White & Case say that SEC enforcement actions indicate the Commission's agenda goes beyond simply investigating and punishing corporate financial fraud. The lawyers also say that the SEC appears determined to use both "carrots and sticks" to effect fundamental changes in corporate conduct and culture.

"Recent developments at the SEC indicate that the Commission is not conducting investigations of corporate fraud simply to punish wrong-doers but as a way of completely re-engineering how public companies and their boards function," said Joe Armao, a corporate defense lawyer with White & Case in New York.

Since the latest wave of corporate accounting scandals broke three years ago, the SEC has been extremely aggressive in enforcing rules and meting out penalties, most recently imposing a fine of $150 million in one high-profile action.

Last week, however, in a precedent-setting settlement with White & Case client Royal Ahold, NV, the SEC chose not to impose a monetary fine after Ahold's board and management voluntarily disclosed accounting irregularities at the company, including that its subsidiary U.S. Foodservice unit had overstated revenue by more than $800 million. The company also conducted a top-to-bottom review of all potential problems, analyzed accounting practices at its 17 operating units and dismissed workers who took part in the alleged fraud without prompting from the regulatory agency.

In announcing its settlement with Ahold, the SEC cited the "extensive" cooperation of the company as the reason why it chose not to fine the company.

"Having demonstrated a willingness to make robust use of their enforcement stick, the Ahold settlement sends an unambiguous signal that the SEC is also ready to offer the carrot to companies that act responsibly and proactively to redress any wrongdoing," said White & Case partner Larry Byrne, who represented Ahold in the SEC investigation along with Armao. "Clearly the SEC hopes this case will serve as a model for how the Commission expects boards and management to behave."

Armao added that while the new "up-the-ladder" reporting protocols established in the Sarbanes-Oxley Act require that board members alert authorities if they suspect wrongdoing, the SEC appears prepared to go even further by charging independent directors for not being better stewards of the company in general.

Armao points to the SEC's 2003 administrative cease-and-desist proceeding against a former outside director of Chancellor Corporation, in which the Commission found that the director recklessly ignored signs indicating improper accounting treatment, which resulted in Chancellor's management orchestrating a fraudulent financial reporting scheme.

"Can independent board members be investigated along with management? In a word, yes," said Armao. "Outside directors now bear significant exposure, even if the up-the-ladder processes do not notify independent members of the board of suspected wrongdoing. Even if the outside directors didn't know about the suspected irregularity, the SEC may well respond that 'they should have known!'"

And it's not only the SEC that is trying to evince change. When New York State Attorney General Eliot Spitzer recently announced his latest enforcement campaign, this aimed at insurance brokers, Spitzer specifically challenged directors to think very hard about whether to keep current management in place.

"To me, the message from the regulatory bodies is that directors, officers and managers must not lose sight of whom they serve. It's the company, which is to say, the shareholders. Therefore a successfully, and ethically, managed company is one that does all it can to maximize and protect shareholders interests," said Byrne.

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