by Neil T. Bloomfield and Valecia M. McDowell, Moore & Van Allen, PLLC
The week of May 9, 2011 revealed the best and the worst of government investigation and oversight. On May 10, 2011, the acquittal of former GlaxoSmithKline in house counsel Lauren Stevens “mark[ed] a huge rebuke to federal prosecutors, who have been aggressively seeking to pin blame on individual executives . . . .”1 One day later, federal prosecutors won a significant victory when Raj Rajaratnam was convicted on 14 counts of securities fraud and conspiracy.2
Many experts have blamed the financial crisis of the late 2000s (“Financial Crisis”) on a lack of regulation and oversight of the financial system and corporate America. Since the Financial Crisis, the effort by regulators to investigate corporations and financial institutions has increased dramatically. With the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), government oversight continues to increase. The question is, has this new emphasis on oversight and enforcement done anything to strengthen the economy, which continues to struggle to create jobs, or rebuild value in the stock market which recently experienced six straight weeks of decline for the first time in almost a decade?
In 2009, Congress authorized the Financial Crisis Inquiry Commission (“FCIC”) to issue a report about the causes of the Financial Crisis. The FCIC summarized the heart of the problem as follows:
Financial institutions made, bought, and sold mortgage securities they never examined, did not care to examine, or knew to be defective; firms depended on tens of billions of dollars of borrowing that had to be renewed each and every night, secured by subprime mortgage securities; and major firms and investors blindly relied on credit rating agencies as their arbiters of risk. What else could one expect on a highway where there were neither speed limits nor neatly painted lines?3
The FBI’s financial crimes unit reported a significant increase in investigations and pending cases in all areas related to corporate entities, including corporate fraud, securities and commodities fraud, and mortgage fraud. Pending cases alleging corporate fraud increased steadily from 423 cases in 2005 to 592 in 2009.9 Pending cases alleging securities and commodities fraud increased by 33 percentfrom 1,210 in 2008 to 1,510 in 2009.10 The FBI-led task force against mortgage fraud, which included the Office of the Inspector General at the Department of Housing and Urban Development, announced that mortgage fraud investigations increased 33 percent from 2008 to 2009 and 275 percent from 2005 to 2009.11
These increased enforcement efforts have certainly led to substantial increases in disgorgements, penalties and fines. In 2009, the SEC ordered individuals and companies to disgorge, or release, $2.09 billion in profits, an increase of 170 percent from 2008, when it recovered $774 million.12 Individuals and companies paid penalties totaling $345 million, an increase of 35 percent compared to $256 million in 2008. 13 From 2007 to 2009, the agency nearly doubled the number of emergency temporary restraining orders and asset freezes it sought in an effort to stop ongoing misconduct and prevent further harm to investors.14
In 2009, the FBI secured $6.1 billion in restitution orders and $5.4 million in fines.15 Cases of securities and commodities fraud resulted in $8.1 billion in restitution orders, $126 million in seizures, $63.4 million in recoveries, and $12.8 million in fines.16 Operation Stolen Dreams, the FBI-led crackdown against mortgage fraud, involved 1,517 criminal defendants nationwide, including 863 informations/indictments filed and 525 arrests of those who allegedly responsible for more than $3.05 billion in losses. 17 As of September 2010, the operation had resulted in 191 civil enforcement actions, and the recovery of more than $196 million.18
New legislation has expanded the power of certain agencies to pursue investigations, but agencies have also developed tools to increase the reach of their investigative authority. For example, in August of 2010, the SEC amended its rules to permanently grant its Enforcement Division the power to issue formal orders of investigation, greatly expanding the Division’s power to compel the production of documents and testimony.19 As of August of 2009, the five SEC commissioners had delegated their power to issue formal orders to the Enforcement Division in a one-year trial program.20 Robert Khuzami, the Enforcement Director, made it clear at the time that the office planned to fully employ the power to compel corporate defendants to comply.21 “[I]f defense counsel resist the voluntary production of documents or witnesses, or fail to be complete and timely in responses or engage in dilatory tactics, there will very likely be a subpoena on your desk the next morning.”22
Further, according to SEC commissioner Troy Paredes,
[O]ne of law enforcement’s many purposes is to change the behavior of individuals by changing the consequences associated with certain conduct. In other words, law enforcement is intended, in part, to make illegal conduct an unattractive option. Law enforcement discourages individuals from engaging in illicit behavior when the expected sanction for a violation is such that compliance is the wiser course.23
However, are the disgorgements and fines resulting from these public enforcement actions the proper measure of success? Perhaps not. For example, what proportion of these payments are made by companies, who do not admit any wrongdoing, in an effort to close the investigation and focus valuable resources on the company’s business? As will be discussed later, the defense costs associated with these investigations can make settling them for significant sums of money appear to be sound business decisions even where no wrongdoing occurred.
— Taxpayers Foot the Bill
— Shareholders Foot the Bill
The losses incurred by corporations in connection with investigations extend well beyond defense and investigation costs. A company’s decision to disclose that it is subject to an investigation “may have [consequences] on the market, business relationships, employees, and relationships with government regulators or prosecutors.”31 These costs are reflected in share price. Share prices of companies subject to government investigations fall an average of 40 percentduring the period between the initial disclosure of the investigation and the time when the investigation is resolved.32
Because the costs are reflected in share price, the costs of government investigations are ultimately borne by the shareholders, not the alleged wrongdoers. In today’s economy, shareholders come from all walks of life. There are pension funds for teachers, police officers, firefighters and other state and federal employees, employees investing through their 401-Ks and retirees seeking to protect the nest eggs they worked so hard to create. Are these the people who should bear the costs of corporate investigations?
— Cost Reduction Efforts Have Not Been Successful
— High Costs Come at a Time They Can Least Be Afforded
The U.S. national debt is in excess of $14.3 trillion, which is nearly equal to the gross domestic product.41 The average taxpayer’s portion of the national debt exceeds $129,000.42 The deficit for 2011 alone is estimated to be around $1.4 trillion.43 The federal government posted its largest monthly deficit in history in February, a $223 billion shortfall.44
— Prosecutions of Innocent People
— Questionable Deterrent Effects
— Continued Failure to Prosecute Egregious Violations
— Increased Delay and Uncertainty
Besides inefficiently expending resources by dragging on past a productive point, inactive investigations present due process concerns that should trouble all of us. It is a serious matter for the government to exert its authority against an individual. We must not forget that investigations can wreak havoc on people and their families. If we are not going to bring an enforcement action, we owe it to people to close the investigation and send them a closing letter.56
Some have also argued that permitting whistleblowers to report directly to the SEC creates an incentive for corporations to conduct rushed internal investigations to detect wrongdoing before it can be reported to the government.59 The dangers of a rushed internal investigation are painfully illustrated by the experience of French carmaker Renault. In August 2010, Renault received an anonymous letter accusing three executives of accepting bribes.60 Renault responded by tasking its internal security team with conducting an internal investigation. The internal investigation revealed that the three executives had been hiding bribery proceeds in offshore bank accounts. Renault promptly fired the employees and reported the incident to French law enforcement.61 French authorities quickly determined that the alleged offshore bank accounts did not exist and no wrongdoing occurred. By the time that result had been reached, both the company, and the accused individuals had already suffered significant harm from the earlier investigation. Not only has Renault issued a personal apology to the fired employees, but the company has suffered reputational harm from the incident and is likely to face actions for significant damages from the discharged employees.
The Financial Crisis made clear that there were problems in the financial system and the corporate marketplace. Increased oversight and investigation were the prescription of the day to remedy the problems in the market. While these investigations have resulted in the discovery of numerous violations and substantial fines, they levy substantial costs on companies, and ultimately on the U.S. economy at a time when both are a long way from a complete recovery. Unfortunately, years later, problems with corporate wrongdoing persist and it is unclear whether the substantial expenditures both in the public and private sectors have strengthened the economy or will prevent the next crisis.
Neil Bloomfield is an attorney in Moore & Van Allen’s litigation group focusing on complex commercial litigation and government and internal investigation. In his investigations practice, Mr. Bloomfield has represented clients in response to investigations from U.S. governmental entities, including the Securities and Exchange Commission, the Commodities Futures Trading Commission, the U.S. Attorney’s Office and the North Carolina Attorney General’s Office. He has also represented clients receiving inquiries from international authorities, including the U.K.’s Financial Services Authority and the European Commission.
Valecia McDowell is a seasoned trial lawyer with noted successes in complex, high-stakes litigation. Her experience spans a broad range of civil and criminal defense matters, representing domestic and international clients in arbitration, commercial litigation, employment discrimination, securities, and D&O liability. Additionally, she has extensive experience conducting internal investigations for publicly-traded, privately held and non-profit institutions.Ms. McDowell is an appointed member of the United States District Court for the Western District of North Carolina’s Advisory Committee on Local Rules.
A special note of thanks to Daniel Gude and Jade Craig whose work was essential in putting this article together.
©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.
To view additional stories from Bloomberg Law® request a demo now