The SEC's no-guilt deals can be a boon to in-house lawyers, writes Sue Reisinger

Consider the curious case of Jay Lapine. Between 2003 and 2009, the one-time general counsel of McKesson HBOC successfully fought off two criminal indictments for financial reporting fraud. Then he settled civil charges with the Securities and Exchange Commission (SEC), agreeing to pay a $60,000 (£38,000) penalty and to not practise before the commission or act as an officer or director of a public company for five years. Sounds like a bitter pill to swallow.

But there was one sweet side benefit for Lapine. By not admitting any misconduct, he was able to escape disbarment proceedings brought against him in Ohio. A little-known Ohio Supreme Court ruling in December 2010 dismissed the disbarment case, citing the neither-admit-nor-deny settlement as failing to prove wrongdoing.

Lapine, who wants to put the litigation behind him, declined to comment for this story. But as his own counsel of record in the Ohio Supreme Court case, he successfully argued in his pleadings that "imposition of discipline here would be improper, unwarranted, and unnecessary" because he was never the subject of a disciplinary proceeding by the SEC.

Lapine's case is believed to be the only time a state Bar attempted to publicly discipline a GC following an SEC settlement. Ohio disciplinary counsel Jonathan Coughlan (main image) noted in a motion to the court that in 2010 the SEC suspended eight other lawyers from practising before the commission, but Coughlan did not find a discipline case in any other state court relating to the SEC's charges against those eight lawyers.

For its part, the SEC offers no-admit settlements in about 99%of its cases. The agreements usually include a federal injunction, as did Lapine's deal, against violating securities laws in the future. Corporations prefer these controversial deals because the companies can avoid trials over the charges, and they don't have to admit to wrongdoing in statements that could be used against them in shareholder suits.

But companies aren't the only defendants to benefit from these pacts. So do individuals – especially in-house counsel – 
by avoiding the nasty collateral consequences.

Besides Lapine, a number of notable GCs have agreed to SEC settlements in recent years. They include Apple's Nancy Heinen, who was accused of backdating stock options and paid $2.2m (£1.4m), and was banned in 2008 from practising before the agency for three years; Enron's Jordan Mintz and associate GC Rex Rogers, who accepted two-year bans over disclosure issues in 2009; and Google's David Drummond, who in 2005 and again in 2007 simply agreed to "cease and desist" from violating securities laws involving disclosures and revenue recognition.

These lawyers' home states, Texas and California, did not take public disbarment actions against them, as the Ohio Bar did against Lapine. These general counsel continue their legal careers, though only Drummond remains at the same company. Heinen is a partner and adviser at Silicon Valley Social Venture Fund (SV2). She's also on the advisory board of the University of California Berkeley Center for Law, Business and the Economy, and privately consults on legal and business issues. Mintz serves as vice president and chief tax officer of the Kinder Morgan companies in Houston. Rogers, who retired, is treasurer of the corporate counsel section of the state Bar of Texas.

Lapine also has another in-house job, at least in part thanks to the SEC settlement. Today he is general counsel at Intralot in the Atlanta suburb of Duluth, Georgia. The non-public company is a global supplier of lottery and sports betting services, with international headquarters in Greece.

But now a federal judge's continued criticism of the SEC's do-not-admit-nor-deny settlements has reignited a lively debate over the deals. In late November federal district court judge Jed Rakoff in Manhattan rejected an SEC settlement with Citigroup Global Markets. The company neither admitted nor denied misconduct. Outside the realm of securities lawyers, his stand has been widely praised, but the SEC has appealed the rejection. If a judge's decision "does not rest on facts – cold, hard, solid facts established either by admissions or by trials – it serves no lawful or moral purpose", Rakoff wrote.

If that's true, should it be any less so when the defendant is an in-house counsel?

Lapine's legal problems began in 1999. As general counsel of the Georgia software firm HBO & Company, he took part in its merger with McKesson in January of that year. He then became GC of the information technology unit of the merged company, McKesson HBOC. (It is now simply McKesson.)

About four months after the merger, McKesson execs discovered HBOC had cooked its books to hide a $9bn (£5.7bn) financial fraud. By June, Lapine was fired amid civil and criminal investigations. An SEC complaint filed in the fall of 2001 accused Lapine and five other HBOC employees of booking revenue on incomplete deals, backdating contracts, falsifying the company's financial records, and/or lying to the outside auditors to conceal the fraud.

Lapine was specifically accused in a scheme involving secret side deals to contracts. He allegedly "negotiated side letters to customer contracts so that software revenue could be booked prematurely," the SEC complaint said. "He also backdated documents on the fraudulent $20m (£13m) software deal… to make it appear that it had been concluded in the previous quarter," according to the complaint.

Then the other shoe dropped. In 2003 the US Department of Justice indicted Lapine for securities fraud. While other employees pled guilty and cut deals with the Government, Lapine and his boss, CEO Charles McCall, fought the criminal charges. The jury deadlocked on the first trial in 2006, but prosecutors decided to try the case again.

In November 2009, after two jury trials and 10 years of investigation and litigation, Lapine was found not guilty on all counts. His attorneys, partners Marcus Topel and Lyn Agre of Kasowitz Benson Torres & Friedman in San Francisco, successfully argued that Lapine didn't know what McCall and the others were doing. The jury found McCall guilty, and he was sentenced to 10 years in prison.

Despite Lapine's not guilty verdict, the SEC came after him. It claimed that he participated in financial reporting fraud. In March 2010 the commission and Lapine, without admitting misconduct, reached a consent agreement under which he was stripped of his right to practise before the SEC for five years. The deal also included an injunction, signed by a federal district court judge in San Francisco, barring Lapine from violating securities laws in the future. He paid a $60,000 (£38,000) penalty.

Lapine is licensed to practise law in Texas and Ohio. (Georgia allows in-house counsel to practice without being licensed there, so long as they are licensed elsewhere and don't appear in court.) Texas and Georgia, which could have still tried to discipline Lapine, took no public action over the securities allegations; but Ohio did. The Ohio disciplinary office filed a motion to disbar Lapine, citing the SEC order and the federal judge's injunction. The motion relied on a theory of "reciprocal discipline" – where the Bar acts on the findings of another state Bar, court or agency.

But Lapine argued that he had never been found guilty of misconduct. His pleading said he was "never the subject of a disciplinary proceeding commenced by the SEC, let alone found to have committed any wrongdoing based upon any express findings of fact in a disciplinary proceeding. Absent that, the SEC settlement cannot form the basis for imposition 
of 'reciprocal discipline' under [Ohio rules]."

Even Coughlan, Ohio's disciplinary counsel, eventually acknowledged the point and filed a motion to dismiss the disbarment action. Discipline is appropriate, Coughlan's motion said, when the SEC makes an affirmative finding of misconduct. But because that was lacking here, Coughlan conceded: "The agreement between [Lapine] and the SEC was not the result of a disciplinary proceeding."

The court also agreed and dismissed the disbarment action. "The purpose of reciprocal discipline is to prevent re-litigation of misconduct that has already been established in another jurisdiction and to protect the public from lawyers who commit such misconduct," the court's opinion said. "That purpose is not served, however, if the other jurisdiction has not actually established the underlying misconduct."

Today, Coughlan defends the decision. He explains that he and the judges didn't think that the federal injunction or the SEC's suspension of Lapine was actually "discipline" that could be reciprocated in Ohio. What the state means by discipline, he says, "is that you've been found guilty or you've admitted it. It's not what a lay person might think discipline means".

Such cases are rare. There is one other known case of a lawyer facing disbarment proceedings after consenting to an SEC settlement for securities fraud, according to the Ohio Supreme Court. That one occurred in Florida in 1990; and again, the lawyer, Jerome Tepps, won. The Florida Bar "presumed" that Tepps, an outside counsel to a company, was enjoined and suspended from appearing before the SEC because of the misconduct alleged in the agency's complaint. A Bar referee agreed with the presumption and recommended that Tepps be disbarred.

But the Florida Supreme Court rejected the referee's findings. Tepps successfully argued that since he never admitted to nor was convicted of the misconduct, the Bar was wrong to presume his guilt. The court agreed, saying: "Because the SEC is not an authorised disciplinary agency [under Florida rules], we reject the findings and recommendations of the referee and remand for a full evidentiary hearing." There is no record of any further action, however.

Other state Bar officials can't discuss individual cases that have not resulted in public discipline. But they can discuss their disciplinary process in general. Disciplinary counsel in Texas and California, for example, say that they take each case on its own facts. And an SEC action with no finding of misconduct won't necessarily trigger a state Bar action, they say.

At least one federal agency handles lawyer misconduct differently. The Ohio Supreme Court noted that the Patent and Trademark Office, for example, often makes specific findings of fact and conclusions of law regarding a lawyer's actions before it. And on the basis of such findings, Ohio has imposed reciprocal discipline on lawyers on at least three occasions.

In effect, the SEC's policy means that misbehaving in-house counsel can continue to practise law – as long as it's not in front of the commission. Sometimes, that means the company has to hire a new GC, as Apple did when Heinen (pictured) was banned. Lapine made a point in his pleading that the SEC charges had nothing to do with his current employment. "Any discipline would needlessly impair [his] ability to provide necessary services to Intralot in Ohio and elsewhere," the pleadings state.

In fairness to the agency, the SEC's no-admit settlement process is rooted in history and has resulted in many recoveries. Although no-one at the agency would comment for this story, they did co-operate in research for it. The research shows that suspension orders on at least seven lawyers through the years do not contain the bothersome neither-admit-nor-deny language. Why?

In some cases, such as Marc Dreier's in April 2010, the lawyer had already been criminally convicted for his misconduct. (In January, the SEC formalised a policy of not using the language in settlements where the defendant has already been convicted of a crime for the same behaviour.) In other cases, it isn't clear why these lawyers didn't receive the same treatment as Lapine and Tepps.

Nevertheless, Robert Khuzami, the SEC's enforcement director, defends the settlement process. In a statement reacting to Judge Rakoff's ruling, Khuzami said: "Obtaining disgorgement, monetary penalties, and mandatory business reforms may significantly outweigh the absence of an admission when that relief is obtained promptly and without the risks, delay and resources required at trial."

But what is prompt and resource-saving for the SEC can mean the opposite for others. Jordan Thomas, a former assistant director and assistant chief litigation counsel for the SEC, admits as much. He says: "It is true, when defendants fail to accept responsibility for their misconduct, there can be negative collateral consequences, including the inefficiency and delay associated with requiring the misconduct to be continually re-litigated at other levels," including private suits and state Bar proceedings.

Yet Thomas insists that it is the states' responsibility, not the SEC's, to discipline their lawyers. The SEC can, and does, refer lawyers believed to have engaged in wrongdoing to their state Bars, he says. But he adds, the agency "rarely includes non-public information acquired during its investigation". Still, Thomas says that if some lawyers who commit securities fraud are not disciplined, "this reflects more on the state Bars' oversight than any failing by the SEC".

Arthur Greenbaum, a legal ethics professor at the Ohio State University Moritz College of Law, tends to agree. Nothing bars state disciplinary authorities from independently investigating fraud alleged in SEC actions, Greenbaum says. And "if we believe an SEC allegation in a complaint is a good indicator of possible fraudulent attorney conduct, we might encourage, or even require, the SEC to forward its complaints [to state Bars] and perhaps even share the fruits of its initial investigation in the matter," Greenbaum adds.

Thomas, now a partner with Labaton Sucharow in New York, also defends the SEC's no-admit policy as in the public's best interest, calling it "practical yet imperfect". If the process were changed, the SEC would need a significant budget increase for new investigators and trial lawyers, he adds. "In a world where there is no shortage of potential misconduct and inadequate agency resources, this policy allows the SEC to investigate and prosecute more cases."

Khuzami (pictured) said something similar in a 1 December speech in Washington DC. He first acknowledged that "there has been much commentary on our neither-admit-nor-deny policy". Khuzami added: "While it is easy to criticise from the sidelines, the practical reality is that many companies would refuse to settle cases if they are required to admit unlawful conduct…. Given the chance to reach a favourable settlement with at least some of the parties, and the opportunity to focus the SEC staff on the next fraud where victims need our help, I would not necessarily assume the risk of a lengthy trial simply to get an admission." For Khuzami, the trade-offs are worth it.

But some legal authorities, such as Rakoff, question whether the trade-offs are truly worthwhile. In the Citigroup case, the bank was accused of a substantial securities fraud that "allowed it to dump some dubious assets on misinformed investors", according to Rakoff. It acknowledged no wrongdoing in its consent settlement, and that irked the judge. "In the end, the court concludes that it cannot approve [the settlement] because the court has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment," he wrote.

Legal error, Khuzami shot back. In a statement announcing the SEC's appeal in mid-December, he said that Rakoff was incorrect in requiring an admission of facts – or a trial – as a condition of approving the consent judgment. And he called the decision "a new and unprecedented standard that inadvertently harms investors by depriving them of substantial, certain and immediate benefits".

But Rakoff's opinion has won wide praise elsewhere. It was "like a voice crying out in the wilderness", Pamela Stuart, a Washington DC – based former federal prosecutor, who is of counsel to New York's Simon & Partners, told The National Law Journal. "Everyone does this [settlement] dance; we're all familiar with it," Stuart said. "This is how the system works, but it's not working in the public interest."

The New York Times, among other publications, also lauded Rakoff's stand. The no-admission settlements should concern all Americans, the Times wrote in a December editorial, "because without any admission, there is no way to know if the remedies – including fines and pledges by Citigroup not to violate antifraud laws in the future – will, indeed, protect investors and ensure the integrity of markets".

It went on to say that besides obtaining timely compensation, the SEC "has a responsibility to develop and prosecute big cases that can expose and change patterns of wrongdoing in ways that settlements do not."

That's a philosophy that should extend further than just federal courts in big securities cases, says William Sorrell, state attorney general of Vermont. And it often does in his state.

Defence lawyers are shocked, he says, when he insists that a company under state investigation should acknowledge its wrongdoing. "I've been somewhat of a lone wolf," Sorrell says. "So I was glad to see Judge Rakoff's ruling. It was music to my ears."

The attorney general says he takes the tough stance because he grew weary of companies seeking public sympathy. Some companies, he explains, claimed that they were forced, even extorted, into government settlements when they didn't do anything wrong, just to avoid bad publicity and a hit on their stock prices. So Sorrell told his legal staff: "I don't want to do these deals anymore. If they want a settlement, they don't have to say they violated a specific section of Vermont law, but I want them to admit the factual allegations."

And if the company refuses, then it's usually off to court. His policy extends to antitrust and consumer cases as well, Sorrell says. For example, in October, Sorrell's office reached a settlement with a car dealership over false ads that offered "employee pricing" to consumers. In the settlement, the company's owner admitted that there was no special employee discount because "the price an employee pays for a new car is negotiated, just as the price a retail customer pays is negotiated."

The message he is trying to get across, Sorrell explains, is "if we don't have the goods, then fine; but if we do, then let's have a neutral party make the decision".

That's a policy that Coughlan can embrace. "Would I prefer to have an evidentiary finding or admission of guilt if I think there was misconduct? Yes," he says. "I don't know why the SEC is doing what it's doing. It's probably what makes both parties happy."

———————————————————————————————————————————————–

Timeline – the trials of Jay Lapine

September 2001 – The Securities and Exchange Commission (SEC) files fraud complaints against six former officers of HBO & Company, which had merged with McKesson, including one against former general counsel Jay Lapine.

June 2003 - Lapine is indicted on seven counts of securities fraud along with his boss, chairman Charles McCall. They plead not guilty. Other executives at the company plead guilty and agree to co-operate.

November 2006 – A San Francisco jury clears Lapine of conspiracy, but jurors are deadlocked on six other charges, voting 11 to one to convict him on three of them.

November 2009 – In a second trial, Lapine is found not guilty on all counts. Co-defendant McCall was found guilty and sentenced to 10 years in prison.

March 2010 - The SEC enters a consent judgment against Lapine for financial reporting fraud. Without admitting or denying the charges, Lapine agrees to pay a civil penalty of $60,000 (£38,000), is enjoined from future violations and is banned from practising law before the SEC for five years.

November 2010 – The disciplinary counsel of the Ohio Bar, where Lapine is licensed, files a motion to disbar him, citing the SEC action.

December 2010 – The Ohio Supreme Court rules that the SEC settlement reflects "no finding or admission of wrongdoing" and is not a disciplinary order in another jurisdiction that supports reciprocal discipline by the Bar. It dismisses the case.

28 November 2011 – US district court judge Jed Rakoff (pictured) in New York criticises and rejects the SEC's no-admission settlement in a case involving Citigroup, and the ruling sets off a new round of debate about SEC deals.

15 December 2011 – The SEC appeals Rakoff's order.

This article first appeared in Corporate Counsel, a US affiliate title of Legal Week.

• Click here for the latest reader comments as they come in