National Association of Bond Lawyers Presents
Fifth Annual Tax & Securities Law Institute
Ira Weiss:
SEC Enforcement Actions
Against Securities Counsel
March 1-2, 2007
The Hilton Hotel
Austin, Texas
Mitchell Herr, Esq.
Holland & Knight LLP
701 Brickell Ave. Suite 3000
Miami, FL 33131
(305) 789-7736
mitchell.herr@hklaw.com
Introduction
The SEC also has been transforming how securities counsel discharge their professional obligations through its enforcement process.
The SEC’s enforcement cases are redefining to whom securities counsel owe their professional duties, how they should function as securities attorneys, and the substantive standard by which their professional conduct will be judged.
Securities Counsel as "Gatekeepers"
Traditionally, securities counsel served as confidential counselor to, and partisan advocate for the issuer. Perhaps too often, they allowed the issuer’s interests to be defined by management.
The SEC appears to have concluded that this traditional model has not adequately served issuers, investors or the investing public at large.
In response, the SEC has been transforming securities counsel into so-called “gatekeepers” of the financial marketplace.
In a seminal speech in September 2004, the SEC’s former Enforcement Director, Steve Cutler, noted that:
“Consistent with SOX’s focus on the important role of lawyers as gatekeepers, we have stepped up our scrutiny of the role of lawyer in the corporate frauds we investigate.”
Since Steve Cutler’s 2004 speech, the SEC has brought an unprecedented number of enforcement cases against attorneys.
Most such cases brought to date have been against General Counsels of public companies for aiding and abetting their employer’s securities violations, typically by preparing a misleading public statement (ie, an SEC filing or press release). Applying an aiding and abetting standard to securities counsel is not problematic because it requires, among other things, that the attorney (1) actually be aware of improper conduct and (2) voluntarily associate herself with the conduct as something that she wishes to bring about.
There are, however, a few notable cases that the SEC charged under the theory that the General Counsel “caused” her company’s violation. These cases are more problematic because mere negligence can sustain a “causing” charge.
Two notable causing cases focus on how the attorney rendered private advice to her issuer client.
In re Isselmann
In re Isselmann (Sept. 23, 2004), a settled cease and desist proceeding, involved the company’s reporting a savings from the termination of certain employee benefits on its Form 10-Q quarterly filing. The company's General Counsel was not involved in the relevant accounting decisions.
However, the General Counsel later learned that these benefits could not lawfully be terminated. The SEC stated that the General Counsel failed to fulfill his “gatekeeper role” and “caused” his issuer’s fraud when he failed to timely tell the Audit Committee, Disclosure Committee or external auditors that the benefits could not lawfully be terminated.
Isselmann clearly indicates that one duty incumbent upon securities counsel in her “gatekeeper” role is to “report up” indications of illegality.
Although not brought under the new Part 205 "reporting up" regulations promulgated pursuant to Section 307 of the Sarbanes-Oxley Act, Isselmann clearly indicates that the SEC will not hesitate to enforce the new reporting up obligations.
In re Google and Drummond
In re Drummond (Jan. 13, 2005) is also a notable “causing” case. In this settled cease and desist proceeding, the SEC charged Google’s General Counsel with “causing” it to violate the registration laws.
Google’s General Counsel had recommended to its Board that it issue over $80 million of stock options from 2002 to 2004 when the law provided a clear exemption for the issuance of only $5 million during a 12-month period.
The order and makes clear that Drummond “caused” Google’s violation by stepping out of his role as legal advisor and only offering the Board his bottom-line conclusion that the options should be issued. In essence, the SEC believed that Drummond crossed the line from legal advisor to corporate actor, thereby “causing” Google’s violations.
Google makes clear that a General Counsel should function as legal adviser to the Board and identify any significant legal risks associated with a contemplated course of action.
In re Ira Weiss
Although Isselmann and Google were charged under a “causing” standard, they left open the question as to whether the SEC would impose a mere negligence standard on securities counsel.
This was a substantial question because for the last 25 years or more, it has been well-accepted that a securities attorney would not be sanctioned by the SEC for mere professional negligence.
In the seminal Carter and Johnson decision (1981 WL 384414) in 1981, the Commission stated that:
“If a securities lawyer is to bring his best independent judgment to bear on a disclosure problem, he must have the freedom to make innocent or even … careless mistakes without fear of legal liability or loss of the ability to practice before the Commission.”
This principle has been repeated over the years by Commissioners and senior staff. In fact, as recently as April 2005, the SEC’s General Counsel stated:
“The Commission ordinarily will not sanction lawyers under the securities laws merely for giving bad advice, even if that advice is negligent and perhaps worse.”
(Giovanni P. Prezioso, Remarks before the Spring Meeting of the Ass'n of General Counsel (Apr. 28, 2005))
This time-honored principle appears to have been repudiated by the Commission’s decision later in 2005 in Ira Weiss. It noteworthy that Chairman Cox voted with the majority.
Ira Weiss was a seasoned bond attorney who issued an unqualified legal opinion that the interest on certain municipal bonds would be tax exempt. The IRS later determined that the interest was, in fact, taxable.
In 2004, the SEC commenced administrative proceedings against Weiss for allegedly violating both Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934. The SEC charged that Weiss knowingly or recklessly issued his
unqualified legal opinion in the face of information casting substantial doubt on the tax-exempt status of the bonds.
This charge was legally unremarkable, as it was grounded in a traditional intent or recklessness standard. However, after the Enforcement Division lost at trial and appealed to the Commission, the case took a dramatic and surprising turn. The Commission reversed on appeal and held Weiss liable for violating only Sections 17(a)(2) & (3) of the Securities Act, which do not require intentional or reckless conduct. Under those provisions, mere negligence suffices. Indeed, on multiple occasions in its opinion, the Commission remarked that Weiss’ conduct was “at least negligent” and that Weiss’ conduct “departed from the standard of reasonable
prudence.”
Thus, it appears that in Weiss the SEC has turned 25 years of practice on its head and lowered the bar for liability for securities counsel to mere negligence. And, unlike the settled Isselmann and Google orders discussed above, as a fully-litigated Commission opinion, Weiss has precedential effect.
As surprising as this change in substantive standard may seem, it is unfortunately
consistent with the SEC’s view of securities attorneys as “gatekeepers,” with duties extending to the investing public at large. In essence, the SEC appears to have federalized the law of
professional malpractice for securities counsel.
The SEC's Weiss decision was affirmed by the Court of Appeals for the District of Columbia Circuit on November 28, 2006. Unfortunately, Weiss did not raise and the Court did not address the appropriateness of the SEC federalizing the law of professional malpractice. In affirming, the Court merely observed that "[p]roof of negligence is sufficient to establish a violation of these [section 17(a) (2) & (3)] provisions."
Conclusions
In light of the SEC’s recent enforcement cases against securities counsel, several conclusions are warranted:
(1) The SEC will give securities counsel more scrutiny and probably will examine how securities counsel discharged her professional obligations;
(2) The SEC will insist that securities counsel act in the interests of the issuer, not management;
(3) The SEC will examine the securities attorney’s private advice to her client – this will be made possible by the attorney-client waivers that are now expected in the sprit of
“cooperation”;
(4) The SEC is now free to employ a mere negligence standard in judging the professional conduct of securities counsel; and
(5) Viewing securities attorneys as “gatekeepers,” the SEC is likely continue to expand the scope of securities counsel's duties beyond the issuer, to the investing public at large.
Mitchell E. Herr exclusively concentrates his practice in securities litigation, primarily the defense of SEC
enforcement matters, securities class actions and internal corporate investigations. Mr. Herr frequently lectures on SEC enforcement matters.
Mr. Herr joined Holland & Knight in December 2000, after serving for over five years as the chief trial counsel for the SEC’s Southeast Regional Office where he was responsible for the SEC’s litigation in eight states and two territories. At the SEC Mr. Herr successfully handled many significant and complex SEC cases, including several of first impression (list attached).
Since joining Holland & Knight, Mr. Herr has handled numerous SEC enforcement matters and internal corporate investigations. Mr. Herr has represented public companies, broker-dealers, registered investment advisers and associated persons, municipal issuers and bond counsel, accountants, and others concerning a variety of subjects, including revenue recognition, disclosure of insurance broker compensation
arrangements, loss reserves, aged and obsolescent inventory, insider trading, tax-exempt status of
municipal bond, secondary liability for contra-party accounting treatment, mutual fund market timing, prime bank investments, and unregistered offerings. Mr. Herr has also handled several securities class actions (including obtaining dismissal of an IPO case that had been included in the multi-district litigation pending in the Southern District of New York) as well as a number of securities arbitrations.
On the SEC’s nomination, Mr. Herr was recently appointed by a federal court to serve as Equity Receiver in
SEC v. KS Advisors, Inc. et. al., Civil Action No. 2:04-CV-105-FtM-29 (M.D. FLA.), an action concerning two
failed hedge funds and an investment advisor that had raised $10 million from over 100 investors located nationwide and overseas.
Mr. Herr is a member of The Florida Bar.
Honors and Awards
Mr. Herr was elected by his peers to The Best Lawyers in America (2006 and 2007 ed.). Additionally, in 2005, 2006 and 2007 he was recognized as a Top Lawyer in the field of Securities Litigation in the South
Florida Legal Guide; in 2006 and 2007 Mr. Herr was recognized as a Florida Super Lawyer; he also was
named by Florida Trend magazine in 2006 and 2005 as a member of Florida's Legal Elite; in 2006 Mr. Herr was selected as a finalist in the South Florida Business Journal's Key Partners competition.
Education
Mr. Herr earned his B.A. degree summa cum laude from Dickinson College, Carlisle, Pennsylvania, in 1978, where he was elected to Phi Beta Kappa in his junior year and was awarded a three-year Army ROTC full-scholarship. Mr. Herr received his J.D. cum laude from the University of Chicago Law School in 1981, where he served as an Associate Editor of the Law Review and was elected to the Order of the Coif.
Publications and Papers
"SEC Investigations of Public Companies: a Primer for Directors and Officers," published in Wolters Kluwer Law & Business issue of Corporation, Vol. LXXVII, No. 14, Section 2 (July 17, 2006).
"Lawyer Liability: Why The SEC Should Clarify Its Recent Ira Weiss Decision," published in Securities
Regulation & Law Report (BNA), Vol. 38, No. 21, pp. 892-896 (May 22, 2006).
"Does the SEC Demand More in Settlement Than It Can Get at Trial?" originally published in Securities
Regulation & Law Report (BNA), Vol. 33, No. 16 (April 23, 2001) and republished in U.S. Law Week (BNA),
"SEC Resolves Long-Standing Questions About Its Cease-and Desist Remedy," Securities Regulation & Law
Report (BNA), Vol. 33, No. 29 (July 23, 2001).
"SEC Enforcement: A Better Wells Process," originally published in Washington Legal Foundation, Critical
Legal Issues, Working Paper Series No. 119 (October 2003), and republished in the Spring 2004 edition of Securities Regulation Law Journal.
"SEC Investigations Of Public Companies: a Primer for Directors and Officers," white paper (2006). "SEC Practice and Procedure: What to Do When the SEC Comes Knocking." presented at the National
Association of Bond Lawyers 4th Annual Tax & Securities Law Institute (2/23/06).
