Scott O'Connell, the leader of the Financial Services and Securities Litigation team at Nixon Peabody LLP, approached the topic of securities enforcement and litigation by using a hypothetical scenario involving "Inkblot Industries", a fictitious Delaware corporation doing business in California as a manufacturer of computer peripherals. Inkblot management had uncovered material revenue recognition issues; the company had reported revenue derived from certain oral side agreements.
Using those facts as the background, Mr. O'Connell discussed a potential situation in which Inkblot receives an informal request for documents and information from the Los Angeles office of the SEC. Post-Sarbanes Oxley, said Mr. O'Connell, "regulatory scrutiny has continued to increase, and informal" requests for information now must be scrutinized very closely for the multi-faceted implications of such a request. Mr. O'Connell advised counsel to "treat every inquiry from regulators with heightened suspicion and educate your leadership team why this is necessary."
Mr. O'Connell compared management of corporate governance issues in today's environment to playing six different but interrelated games of chess while flying a jet at the speed of sound. A major issue, he pointed out, is dealing with the preservation of documents once this type of proceeding has begun. Sarbanes-Oxley includes severe penalties for destruction or material alteration of any information once some type of proceeding has begun. Mr. O'Connell pointed out that "The DOJ is not going to take the position that the request in this hypothetical is informal, once they find out that document information is gone. So, the question becomes: once this request lands on your desk, can you stop the destruction of documents in any of the business units that are implicated? It is the kind of thing that keeps you awake at night, but once this kind of request comes in, the company has this obligation"
Addressing the potential for multiple agency involvement once a reporting issue arises, Mr. O'Connell opined "thanks to the Patriot Act and Sarbanes-Oxley, agencies are increasingly sharing information. Assume that if it is going out the door to one authority, it will wind up in the hands of another." Understanding the interrelationship between and among parallel regulatory investigations, derivative claims, civil securities fraud and ERISA class actions, possible criminal proceedings against the company and its officers and directors, and applicable insurance coverage is crucial. These problems are inextricably intertwined, and early or uninformed decisions made on any one of these fronts may have catastrophic implications elsewhere.
Mr. O'Connell noted that the trend in such cases is that plaintiffs swarm from a number of directions. "You have a class action that is related to the 10b -5 claims, the ERISA pension-related claims, and basically a multi-front war that keeps growing exponentially. You have to get in right up front, to take control of the litigation away from the people who are bringing it." Mr. O'Connell stressed that assembling an interdisciplinary team of securities, governance and litigation professionals is essential to stave off the dire consequences that often result from financial reporting issues. "Assemble your SWAT team of response professionals now -- don't wait until you are in the midst of the corporate 'death spiral'."
To further ensure staving off catastrophe, Mr. O'Connell recommended that counsel take steps to avoid such reporting issues at the inception. "Don't reach for every nickel -- moderate any aggressive positions you are taking on your financial statements."