Ex-SEC Official Looks At Current Securities Law Issues

Monday, January 3, 2011 - 01:00

Editor: What was the range of your duties while you were chief counsel for the Division of Enforcement at the SEC? When did you join Jones Day's Washington, DC office?

McKown: I was the chief legal officer for the Division and in that position I played a key role in developing Enforcement policy, strategy and priorities and then implementing those across the Division. It was an incredibly exciting job as I was able to participate in every major Enforcement issue before the Commission. Some examples of what I worked on include reviewing all Enforcement recommendations before they were submitted to the Commission, developing the Enforcement legislative priorities and having primary responsibility for special projects such as the Enforcement Manual. The manual is a guide to all investigative staff and is a resource for defense counsel since it is available on the SEC's website. I recently started at Jones Day after a brief break between my government service and joining the firm.

Editor: Please update our readers as to recent developments in SEC regulations and their administration.

McKown: Much is happening at the SEC these days after the Dodd-Frank legislation. Through regulation the SEC is fleshing out the broad parameters of the act. My former Division is developing the whistleblower regulations and setting up the whistleblower office. I'm sure there will be considerable comment on the whistleblower provision because of its potentially significant impact on issuer's internal compliance systems. Additionally, there is rulemaking involving hedge funds, security-based swaps, corporate governance and "say on pay." Every major division at the SEC is working on very significant regulation.

Editor: Is there a clear delineation between the duties of the SEC and the CFTC?

McKown: The SEC appears to be coordinating with the CFTC. Of course, prior to the Dodd-Frank legislation mandating this cooperation the two agencies issued a "Harmonization Report" in October 2009. After Dodd-Frank they have issued coordinated rulemaking defining certain key terms relating to swaps but even on the other rulemaking they appear to be coordinating. Whether there is a clearer delineation of their jurisdiction than there has been in the past we will have to wait and see how the rulemaking is implemented and how it is applied in practical terms.

Editor: Is there a period for comments on the whistleblower provisions? Do you see any conflict between the whistleblower provision, allowing an employee to directly report to the SEC with news of the alleged infraction and the provision in Sarbanes-Oxley that requires anyone aware of corporate wrongdoing to contact the general counsel, who will take the alleged wrongdoing up the ladder to the board of directors?

McKown: The SEC is asking for comments by December 17, 2010. I think there is potential conflict between the whistleblower provision and the internal control and compliance system developed after Sarbanes-Oxley. The SEC has said in their proposal that they recognize this tension and hopefully they will address this issue during the rulemaking process. It is not in anyone's interest if the SEC is flooded with low-quality complaints that are better suited to being cleaned up at the corporate level. It would certainly be an unfortunate and unintended consequence of Dodd-Frank if corporate compliance programs became weaker, but that is possible if whistleblowers side-step companies' systems.

Editor: What are some of the ethical challenges the SEC faces in conducting enforcement actions against attorneys? What kind of activities does the SEC consider violations of an attorney's "gatekeeper" role and worthy of sanctions?

McKown: Attorneys cannot be sued for their role as "gatekeeper," but as a gatekeeper there is more attention paid to what they did when they became aware of misconduct. The SEC has to prove that an attorney has violated the securities laws before they can bring an action, but obviously the SEC takes misconduct by attorneys very seriously.

Editor: I assume the term "gatekeeper" came into greater prominence with the circumstances leading to Sarbanes-Oxley.

McKown: It is a term that gained more prominence around the time of WorldCom, Enron, and all of the major financial frauds that ultimately led to Sarbanes-Oxley. After these large frauds there was an effort to think about how to not just clean up the mess, but how to prevent future misconduct. Holding gatekeepers (people in a position to stop fraud early on) more responsible was thought to be one way of doing that. Editor: What proportion of the SEC's actions against attorneys involve financial or accounting misrepresentation as compared with inadequate legal representation, e.g., improper legal counsel or failure to file?

McKown: The SEC has to establish a violation of the securities laws, and malpractice isn't necessarily a violation of the securities laws. Whenever lawyers are sued, there is a debate whether they are being sued for their conduct or for their advice. Sometimes it is hard to tell what is mere legal advice and when the advice becomes something more and slides into personal misconduct. Usually that is determined by the amount of scienter, the clarity of the attorney's knowledge as to what misconduct is occurring. Obviously, during the options backdating era there were a number of cases against attorneys who became aware that documents that they or others were creating contained misstatements. When an attorney is aware that a false document is being created she needs to realize that she may be crossing over from giving advice to being personally complicit in the potential wrongdoing. In the last year a lot of the significant cases against attorneys involved alleged insider trading which is clearly individual misconduct.

Editor: In enforcement actions against legal counsel, does the SEC treat differently violations of disclosure or misrepresentation by inside counsel as compared with outside counsel?

McKown: No. If the attorney understood that what was being filed was a false document, he would be liable regardless of whether he was inside or outside counsel. The attorneys who tend to be sued for disclosure-related issues are in large part in-house counsel because they have better knowledge of what is accurate and what is not. I think that virtually all of the attorneys who were sued in the options backdating cases were in-house counsel. Now with the insider trading cases, there have been a number of cases involving outside counsel.

Editor: How can attorneys fulfill their concurrent obligations to represent a client zealously while serving as a gatekeeper for the public interest?

McKown: Being a gatekeeper is not the same as being a regulator. As a gatekeeper a lawyer's role is to honestly advise a client as to what is legal and what is not, which sometimes might not be what a client wants to hear. It should not be incompatible with zealously representing a client.

Editor: As one of the most recent enforcement matters that applies Reg FD to implicit statements, how significant is the Office Depot case?

McKown: I think the Office Depot case is very significant and that the SEC intended to send a signal with it. As you say, it deals with implicit guidance so clearly the SEC intends to send a signal that this is not appropriate under Reg FD. Second, they sued the most senior officials responsible for the misconduct, and this is consistent with the theme we have been hearing from the SEC regarding individual liability. I also note that the SEC highlighted that the firm didn't have adequate policies or training so issuers should take note of that and make sure their compliance systems are adequate. Since this is the third Reg FD case in 14 months (the other cases were SEC v. Presstek and SEC v. Black ), they are clearly active in this area. One of the five new specialized units, the Market Abuse Unit, is focused on this issue along with insider trading.

Editor: What advice do you have for attorneys who find themselves at odds with corporate management in terms of making false disclosure or failure to comply with other matters under the securities laws?

McKown: They should make sure that their advice is as clear as possible as to what is and is not legal. One of the things the SEC focuses on in its investigations is how individuals react when they are confronted with potential misconduct. The large number of lawyers sued in the options backdating cases is an example of what can happen if the lawyer strays into being a participant in misconduct.

Editor: The Dodd-Frank Act allows claw-backs of remuneration paid to executives in cases of accounting restatements. Please discuss the differences between Sarbanes-Oxley's claw-back provisions and those of the recent legislation.

McKown: The claw-back provision in Dodd-Frank is subject to rulemaking by the SEC, but based on the legislation there appears to be a number of differences. SOX 304 can only be enforced by the SEC, whereas the Dodd-Frank provision is potentially subject to derivative actions. SOX 304 applies only to CEOs and CFOs whereas Dodd-Frank applies to current and former executive officers. Sarbanes-Oxley has a one-year lookback and Dodd-Frank is a three-year lookback.

Editor: Do you know when that rulemaking will take place?

McKown: This is not mandated by the legislation but it is likely to be the second quarter of 2011. The SEC will write rules for the stock exchanges who will require the issuers listed on their exchanges to have policies in place regarding how this compensation will be repaid.

Editor: What advice would you give to in-house attorneys in terms of keeping their companies in compliance with all the provisions of Dodd-Frank as well as assuring that they can withstand any SEC scrutiny of their own actions?

McKown: Dodd-Frank emphasizes good corporate governance. Lawyers should help their clients ensure that they have the best possible compliance programs and policies for effectively dealing with issues as soon as they arise. Obviously from Sarbanes-Oxley forward lawyers have been viewed as playing an important role as gatekeepers to try and stop misconduct before it happens, and they should take their responsibilities seriously.

Please email the interviewee at jemckown@jonesday.com with questions about this article.