HOW TO ACHIEVE A LENIENT SETTLEMENT WITH THE SEC

A recent settlement in an SEC case against an attorney accused of engaging in an illegal scheme to “pump and dump” the shares of a microcap company demonstrates the value of persistence and good lawyering in litigation against the agency. In an earlier article posted on this blog, I wrote that SEC v. Packetport.com, Inc., Civ. No. 3:05-CV-1747 (D. Conn.) (Nov. 16, 2005), a civil injunctive action filed in the U.S. District Court, was consistent with previously announced factors that the SEC stated it would apply when considering when to bring charges against lawyers. 

.  In Packetport.com, the SEC “threw the book” at Robert Jaffe, who was the company’s securities counsel as well as a board member. The SEC charged him with violations of the antifraud provisions set forth in Section 10(b) of the 1934 Act and Rule 10b-5 and Section 17(a) of the 1933 Act on the basis of allegations that Jaffe misrepresented facts to the company’s transfer agent in support of requests to remove restricted legends from share certificates, engaged in insider trading by selling restricted stock that he had received as compensation for his participation in a manipulative pump-and-dump scheme, and lied to the SEC staff during a telephone interview.  Further, the complaint alleged that Jaffe’s sale of restricted shares into the open market violated the securities registration provisions set forth in Section 5 of the 1933 Act, and that Jaffe aided and abetted Packetport’s reporting violations of Section 13(a), and failing to disclose his share ownership under Section 16(a) of the 1934 Act.

            The SEC’s recent settlement of this case on lenient terms, In the Matter of Packetport.com, File No. 3-12868 (Oct. 18, 2007), stands in sharp contrast to its harsh complaint.  The settlement consisted of an order in which Jaffe and the other named respondents agree to imposition of an order directing them to cease and desist from violating the securities registration and ownership reporting provisions of the federal securities laws. Several aspects of the settlement are noteworthy, and directing them to disgorge profits from their stock sales.  First, the settlement is in the form of a cease-and-desist proceeding.  The media typically pays less attention to these proceedings, which are regarded as more lenient than civil actions filed in federal court.  The SEC’s use of a cease-and-desist order also prohibited it from seeking a civil money penalty of at least $25,000 against each of the respondents.  Second, and most importantly, the settlement, while alleging that Jaffe made inaccurate statements to Packetport’s transfer agent, does not charge Jaffe with fraud.  This omission was an enormous concession by the SEC.  The absence of fraud charges makes it far less likely that the state bar of New Jersey will suspend or revoke Jaffe’s law license as a result of the settlement.  Third, the SEC dropped the inflammatory allegations that Jaffe lied to the staff.

            There are several reasons why the SEC may have been willing to settle with Jaffe and the other respondents on such lenient terms.  Notwithstanding the agency’s powerful image, its “trial unit” that litigates on its behalf is chronically shortstaffed. Its litigators may also be less experienced than their defense counterparts.  This problem is particularly acute in the SEC headquarters in Washington, and in the SEC’s regional offices in New York, Chicago and Los Angeles, where higher-paying private sector jobs lead to high turnover.  The agency’s relative lack of resources not only gives it a strong incentive to seek settlement both before and after a case is filed.  Well-heeled defendants who can afford to pay high legal fees may be able to overwhelm the SEC lawyers by filing numerous motions and taking an aggressive posture during civil discovery.  The docket sheet indicates that Jaffe and the other defendants in the civil case filed numerous motions to dismiss and/or motions to strike and for summary judgment, and attempted to appeal adverse rulings by the Court.  The SEC evidently had difficulty managing this litigation, since the court noted in early 2007 that it was “troubled by the apparent inability of the SEC to meet deadlines.” 

            By gaining a thorough understanding of the facts and legal issues raised in the case, skilled defense lawyers may be able to persuade the SEC attorneys that litigating the case to trial would entail significant risk, due to evidentiary or other weaknesses.  Perhaps aided by such arguments, defense lawyers in this case apparently were able to persuade the SEC to accept relatively lenient offers of settlement.  Such offers presumably were more palatable in light of the defendants’ spirited and resource-consuming legal defense.   The resolution of this case illustrates the difficult realities that the SEC often confronts in litigation.