Over the last year, SEC Enforcement Director Rob Khuzami has made no secret of his disdain for defense counsel who engage in “questionable tactics” to gain advantage for their clients involved in SEC investigations. He made a speech last June in which he cited a number of examples of those tactics. They included:
- Multiple representations of witnesses with what appear to be adverse interests;
- Multiple witnesses represented by the same counsel who all adopt the same implausible explanation of events;
- Witnesses who answer “I don’t recall” dozens and dozens of times in testimony, sometimes hundreds of times, including in response to questions about basic and uncontroverted facts documented in their own writings;
- Counsel signaling to clients during testimony; and
- Questionable tactics in document productions and internal investigations.
He also noted one hilarious episode in which a witness in investigative testimony – looking for a toe-tapping signal his lawyer had been warned against during a break – “extended [his foot] so far [under the table] that he was almost doing a split.”
The Wall Street Journal picked up the tune in an article on May 1, highlighting comments by the SEC’s Structured and New Products Unit chief Ken Lench, who said he had seen “some factual situations where [he] seriously question[ed] whether the advice that was given was done in good faith.”
Though the conduct is different from that described in Khuzami’s speech, the SEC quickly made good on its word, and sued three attorneys at the end of April and start of this month. All of the cases were filed in federal courts in Florida, and all three involved issuing shares of microcap companies’ stock. These sorts of cases have been mainstays in the SEC’s Enforcement Division for a long time, but they have typically named only the issuers and their officers as defendants. These three recent cases are different. In all three, the companies purported to convert their debt into “free trading” stock held by the companies’ affiliates. To accomplish this conversion, the companies’ transfer agents required legal opinion letters from attorneys attesting to the propriety of issuing share certificates without restrictive legends. (Many microcap, or penny stock, companies do not record shares electronically and actually still use share certificates.) The SEC alleges that the opinion letters written in these cases had no legal basis, and has charged the attorneys themselves with violating Section 5 of the Securities Act. Briefly, Section 5 prohibits using interstate commerce to sell a security unless a registration statement or exemption covering it is in effect.
It is a fairly bold position to take, though it’s not like the SEC has never considered the possibility before. In 2008, it settled charges with attorney Ken Christison for being a cause of a number of Section 5 violations for writing just the sort of legal opinion letters that are at issue in the current cases. In the new cases, though, the attorneys are being charged with direct violations of Section 5, and in one of the cases with an additional count of aiding and abetting Section 5 violations. It is an interesting way to get at gatekeepers who are ethically obliged to give good-faith advice about the law. Without their legal opinion letters, many of the shares in these tiny companies will never be issued. I wonder, though, if the staff filing the two cases alleging only direct violations will regret not including an aiding-and-abetting count as well. If the attorneys themselves did not own the securities, could they sell them? We might soon learn the answer if the defendants move to dismiss on that basis.