Lawsuits Against Lawyers

          Two SEC enforcement cases filed in late 2005 illustrate the perils faced by securities attorneys who sell their corporate clients’ stock under questionable circumstances.  These cases can be best understood in the context of guidance provided by the SEC about when it will sue a company’s lawyers.

          In 2005, then-SEC General Counsel Giovanni P. Prezioso explained the Commission’s view of attorney liability. Mr. Prezioso stated that “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.”  However, Mr. Prezioso indicated that “the Commission will sanction a lawyer for conduct that - if carried out by any other person - would have given rise to an enforcement proceeding.”[1]  Mr. Prezioso noted that in cases involving a mixture of conduct and advice, a critical factor was “the extent to which the decision-making process depended on the lawyer,” In this regard, he observed that:

if a lawyer makes a legal judgment about an issue that cannot fairly be viewed as immaterial and fails to inform anyone else at the company of the potential legal risks - in other words, if the lawyer doesn't advise anybody about anything - it will be much more difficult to argue that the lawyer played a purely advisory role. Rather, the lawyer's continuing participation in the activity without providing advice to others may, in some cases, constitute part of a course of conduct that effectively makes the ultimate business decision for the company.   

Moreover, Mr. Prezioso noted that the Commission would look at “the nature of the legal judgments made by the lawyer,” and would prosecute lawyers only in cases where “every securities lawyer ought to know the answer,” as opposed to “matters involving close or difficult judgment calls.”  Finally, Mr. Prezioso stated that there was a “strong” policy against sanctioning lawyers representing a corporate client before the Commission or its staff, in the absence of “misrepresentations to the Commission or other unethical conduct.”

It is worth exploring whether the two recently filed cases are consistent with Mr. Prezioso’s guidance.  In SEC v. Packetport.com, Inc., Civ. No. 3:05-CV-1747 (D. Conn.) (Nov. 16, 2005) [2] the Commission charged attorney Robert H. Jaffe with direct or indirect violations of the antifraud, reporting, and securities registration provisions. The Commission alleged that Jaffe, who was the company’s securities counsel as well as a board member, misrepresented facts to the transfer agent in support of requests to remove restricted legends from share certificates.  The complaint further alleged that Jaffe engaged in insider trading by selling restricted stock that he had received as compensation for his participation in a manipulative pump-and-dump scheme carried out by the issuer’s undisclosed control person.  Moreover, the complaint alleged that Jaffe aided and abetted the issuer’s reporting and books and records violations concerning financial misrepresentations, and that he lied to the SEC’s staff during a voluntary phone interview before asserting his Fifth Amendment privilege in response to subpoenas issued by the staff.

The Commission’s complaint against Jaffe seems consistent with Mr. Prezioso’s statements, in that he was a director and corporate decisionmaker who engaged in a variety of alleged illegal conduct. Indeed, according to the complaint, Jaffe realized about $335,000 by selling Packetport.com stock as part of the alleged scheme.    His role as an attorney seems almost incidental, and there is no reference to legal advice being rendered.  Jaffe’s status as an attorney was no defense, in that his conduct, “if carried out by any other person,” would be illegal.  Jaffe’s alleged misrepresentations to the staff – which are not a basis of the proposed charges against him -- and invocation of his Fifth Amendment privilege appear to be aggravating factors that contributed to the Commission’s decision to charge him.

          In SEC v. Integrated Services Group, Inc., Civ., No. 4:05-CV-04071 (S.D. Tex.) (Nov. 29, 2005),[3] the Commission charged attorney David M. Loev with violations of the registration provisions.  Integrated Services Group appears to indicate that the Commission is willing to charge lawyers with securities law violations for giving extremely bad advice, at least in the presence of other factors.  The Commission’s complaint alleged that Loev, the issuer’s outside securities attorney, issued opinion letters to the transfer agent opining that  large quantities of shares issued to Loev and certain other major investors, all of whom were legally “affiliates” of the company, nonetheless “could be issued without a restrictive legend.”  Although the complaint is silent as to this issue, the Commission obviously regarded Loev’s advice as clearly erroneous, given the status of the shareholders. [4]  The complaint alleged that Loev was a “necessary and substantial participant” in the illegal distribution by virtue of giving this bad advice, and that his personal sales of 18% of the issuer’s outstanding stock for $25,000 in proceeds, at a time when he was an affiliate of the issuer, also directly violated the securities registration provisions.

Loev’s role in the alleged misconduct did not involve fraud and was far less substantive that Jaffe’s.  Instead, this case appears to embody of an example of suing an attorney for giving key advice that “every securities lawyer ought to know” was wrong. Loev’s personal stock sales may be considered an “aggravating factor” supporting the charges against him, even in the absence of allegations that he lied to the Commission staff or otherwise engaged in fraud. 

The personal sale by these attorneys of their corporate clients’ stock is the common thread in the cases against Jaffe and Loev.  To avoid finding themselves in caption of an SEC lawsuit, securities lawyers should avoid accepting stock as payment for legal services, or, if this cannot be avoided, ensure that their stock sales comply with Rule 144 or are effected under cover of a written legal opinion.

         

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[1] Giovanni P. Prezioso, Remarks Before Association of General Counsel (Apr. 28, 2005), available at http://www.sec.gov/news/speech/spch042805gpp.htm.

[2]  Litigation release available at http://www.sec.gov/litigation/litreleases/lr19465.htm; Complaint available at http://www.sec.gov/litigation/complaints/comp19465.pdf

[3] Litigation release available at http://www.sec.gov/litigation/litreleases/lr19476.htm; Complaint available at http://www.sec.gov/litigation/complaints/comp19476.pdf.

[4]  Stock issued pursuant to Regulation D is generally restricted in nature However, investors may receive freely tradeable securities only through transactions that are: (1) registered under state law requiring public filing and delivery of a disclosure document to investors before sale, or (2) exempted under state law permitting general solicitation and advertising so long as sales are made only to accredited investors.  See Revision of Rule 504 of Regulation D, the "Seed Capital" Exemption, Rel. No. 33-7644 (Feb. 25, 1999), available at http://www.sec.gov/rules/final/33-7644.txt.  Although the complaint does not allege that the illegal distributions complied with these conditions, distribution of the shares presumably was unaccompanied by a disclosure document or not limited to accredited investors.