Author: Doug Cornelius

You can find out more about Doug on the About Doug page

How NOT to Run a Safety Drill

gun

Running drills is important. Experience with adverse circumstances is important so that you and your co-workers know what to do if there is a problem. Drills are especially important for dangerous circumstances.

There is a reason that building managers, schools and other institutions run fire drills. If there is an actual fire, you will know where to go and what to do. Of course, when you run a fire drill, you don’t light an actual fire and don’t fill the hallways with smoke.

I’m not sure what Hampton Behavioral Health Center was thinking when they decided to have an unannounced safety drill. They sent in a masked gunman to demand Oxycontin from a pharmacist’s assistant. The “gunman” told her he was holding Hampton’s human resources director hostage and the phone lines were dead.

It also sounds like the drill was for situation that the employee was not trained on how to handle. In her lawsuit, she is seeking damages for assault, false imprisonment and intentional infliction of emotional distress.

September is National Preparedness Month: Ready.gov. It’s good to plan for an emergency situation, train your employees and run drills. But be sensible about it and don’t scare the crap out of them.

References:

Image is by Domingouceda: 1. http://www.flickr.com/photos/domingouceda/ / CC BY 2.0

Madoff Hearing at the Senate Banking Committee

I will be covering today’s Senate Hearing (”Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance“) along with several guest panelists via the interactive discussion below. Please visit this page today at 2:30 pm to join me, Bruce Carton of Securities Docket, Compliance Week editor Matt Kelly, and others as we follow the hearing – and bring your questions!

The SEC’s Madoff Report

madoff

The SEC decided to take a look at how it failed to uncover the Madoff fraud. The SEC’s Inspector General has been running an investigation and compiling information. The SEC Inspector General, H. David Kotz, released a public version of their report on August 31: Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme – Public Versionpdf-icon

The big question being whether it was case of internal corruption or just incompetence. Of course, hindsight is 20/20 and the fraud looks so obvious, you have to wonder how they missed it. I think it is more important to learn from the mistakes so they can avoid this happening again. But people are still looking for heads to put in the guillotine.

Senate hearing

Of course, politicians are looking to blame someone. Today at 2:30, the Senate Banking Committee will hold a  hearing concerning Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance. The witnesses currently slated are:

  • H. David Kotz, Esq., Inspector General of the U.S. Securities and Exchange Commission;
  • Mr. Harry Markopolos, Chartered Financial Analyst and Certified Fraud Examiner;
  • John Walsh, Esq. Acting Director, Office of Compliance Inspections and Examinations, SEC
  • Robert Khuzami, Esq., Director of the Division of Enforcement, SEC

Was there corruption?

The investigation did not find evidence that any SEC personnel who worked on an SEC examination or investigation of Madoff had any financial or other inappropriate connection that influenced the conduct of their examination or investigatory work. The report also concludes that former SEC Assistant Director Eric Swanson’s romantic relationship with Bernard Madoff’s niece, Shana Madoff, did not influence the conduct of the SEC examinations of Madoff. The report concludes that no senior officials at the SEC directly attempted to influence examinations or investigations of Madoff and that there was no evidence of interference with the staff’s ability to perform its work.

How much did the SEC know?

The Inspector General found that the SEC received more than ample information over the years to warrant a comprehensive investigation of Madoff. Despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. Between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff’s operations. There was enough for SEC to question whether Madoff was actually engaged in trading.

What about private investors?

I found it unusual that the Inspector General includes information from private parties about their due diligence findings of Madoff’s operations. Many sophisticated investors gave significant money to Madoff. But there were traders, funds, investment banks, and other investors who thought something was not right with Madoff. They were concerned about the suspiciously consistent returns, the lack of transparency, the use of a small captive auditing firm, and the lack of an independent custodian.

The decisions to not invest were made based upon the same red flags that the SEC considered in its investigations, but ultimately dismissed. The Inspector General concludes:

The SEC examination program should analyze the approaches utilized by private entities who conducted due diligence of Madoff’s operations and apply these methods to strengthen their program. They should also seek to learn from these private entities through training mechanisms and in fact, several private entities informed the OIG that they would be willing to conduct training of SEC examiners in their due diligence approaches. Learning from private sector efforts would improve the SEC’s ability to conduct meaningful and comprehensive examinations and detect potential fraud.

References:

KPMG Fraud Survey 2009

kpmg-fraud

KPMG Forensic has released their Fraud Survey 2009pdf-icon.

The survey shows that many managers remain concerned about fraud. There are plenty of investigations of fraud that may have helped fuel the financial markets meltdown. Record levels of government spending may usher in record levels of fraud, waste, and abuse. In these difficult economic times, managers may face pressure to do whatever it takes to “make the numbers.” For those companies operating outside the United States, increased investigation and prosecution of anti-bribery and corruption laws mean foreign operations have increased penalties associated with their risks.

Here are some of the key findings:

Nearly 1/3 of executives expect some form of fraud or misconduct to rise in their organizations.

The majority of executives cite fraud and misconduct as posing significant risks to their industry today.  If such wrongdoing were to be experienced, the greatest concern for over two-thirds of executives is the potential for a loss of public trust when market confidence is at a premium.

Executives expect the threat of fraud to remain steady or rise in the coming year. About three out of four executives believed that fraud and misconduct risks, such as misappropriation of assets and fraudulent financial reporting, will either stay the same or increase over the next 12 months.

Inadequate internal controls or compliance programs heighten the risks of fraud and misconduct. Twothirds of executives reported that inadequate internal controls or compliance programs at their organizations enable fraud and misconduct to go unchecked.

Roughly a quarter of respondents lack effective protocols on how investigations should be conducted and at what point the board of directors should be alerted to potential concerns.

Those areas where respondents cited the most amount of improvement needed include employee communication and training, technology-driven continuous auditing and monitoring techniques, and fraud and misconduct risk assessment.

Rating Agencies and the First Amendment

s-and-P

Rating agencies have long argued that their ratings of securities are constitutionally protected opinions. Many people have pinned some of the responsibility for the financial markets meltdown on the rating agencies. It sure looks like they gave a fair number of these securities a high rating when they were actually toxic.

Abu Dhabi Commercial Bank and King County, Washington decided to bring a class action because of their losses in a structured investment vehicle. They included the arranger, placement agent, the rating agencies, the administrator and others involved in the structuring of the securities issued by the structured investment vehicle. The plaintiffs included a full slate of claims against these parties.

The first decision in the law suit was a ruling on a motion to dismiss that was issued last week. U.S. District Judge Shira Scheindlin ruled in this opinion that the investors in the structured investment vehicle containing mortgage-backed securities sufficiently alleged an actionable misstatement against the credit rating agencies and the investment bank that placed the rated notes.

Under typical circumstances, the First Amendment protects ratings agencies, unless there was actual malice. (See Compuware Corp. v. Moody’s Inv. Servs., Inc.., 499 F.3d 520 (6th Cir. 2007) [pdf.]) But are the ratings of securities that were distributed to a limited number of investors deserving of the same free-speech protection as more general ratings of corporate bonds that were widely disseminated? Judge Scheindlin said no and rejected the rating agencies’ First Amendment argument.

Judge Scheindlin also rejected the argument that the ratings are merely non-actionable opinions. “[A]n opinion may still be actionable if the speaker does not genuinely and reasonable believe it or if it is without basis in fact.”  Judge Scheindlin also found that the disclaimers in the offering materials are insufficient to protect the rating agencies from liability for promulgating misleading ratings.

This decision is only an early step in the litigation and has not imposed liability on the rating agencies. The plaintiffs will still need to prove the facts that they alleged in the initial pleadings.

But the ruling does open a door that was previously thought closed. The stock prices of McGraw-Hill, which owns Standard & Poor’s, fell 10%, and Moody’s Corp., parent of Moody’s Investors Service, fell 7.1% in New York Stock Exchange composite trading on Thursday.

Other plaintiffs are likely to use this decision to persuade other judges to open rating agencies up to potential liability. I’m sure that plaintiffs’ lawyers involved in subprime lawsuits are amending their complaints this morning.

References:

Blink and Compliance

blink

I am a little late to the game when it comes to reading some of Malcolm Gladwell’s books. Last week, while on vacation with the family, I managed to read Blink: The Power of Thinking Without Thinking.

The book is about rapid cognition, the kind of thinking that happens in a blink of an eye. What is going on inside our heads when during rapid cognition? When are these quick judgments good and when are they not? What kinds of things can we do to make our powers of rapid cognition better?

The book left me with a bunch of little tidbits of information. Gladwell illustrates each of his points with interesting narratives. In the process he makes several insightful points about the nature of rapid human decision-making. Sometimes, over-thinking a problem results in bad decisions. Our first instincts are often correct, if we have a clear picture of what is happening and our perception.

But often that clarity is missing. One example is the difference in selecting elite musicians when the audition is conducted behind a screen, rather than in full view. In the past thirty years since screened auditions have become commonplace, the number of females in the top U.S. orchestras has increased five-fold. Even though the judges were not overtly discriminatory, their first impressions from seeing a woman, the color of her instrument and the way she played had an unconscious negative effect on the judges.

There are lessons in this book for compliance professionals.

Snap judgments are often correct when they come from clarity and experience. But they can also easily be corrupted. Be aware of the situation, the person you are dealing with and the environment around you.

Sometimes too much information can cloud your decision-making. Gladwell finds an example in how an emergency room should handle potential heart attack victims. Typically, doctors try to gather as much information as possible and then make an estimate of whether the chest pain is a heart attack. Instead, they found that three factors were key to determining if chest pain is a heart attack. By focusing on these three factors, the correct diagnosis rate rose from 75%-89% correct rate of diagnosis to 95%.

Experience is clearly the most important factor in developing a strong snap judgment and practice is key in developing that expertise.

When Work Papers are not Subject to the Attorney-Client Privilege

textron

The recent Textron decision is causing quite a kerfuffle. The court permitted Internal Revenue Service to gain access to documents created by the defense-contracting firm to determine whether the company’s calculation of its tax liabilities would pass muster during a possible IRS audit. Textron was trying to shield the documents under the Work-Product Doctrine.

Work-Product Doctrine

The Work-Product Doctrine shields an individual or business from having to turn over documents created in anticipation of litigation. The Doctrine traces its roots to a 1947 Supreme Court decision, Hickman v. Taylor, 329 U.S. 495. It protects material prepared in anticipation of litigation from being revealed to opposing lawyers in a court case. Seeing those materials gives an opponent the edge by sharing the other side’s legal strategy.

Tax Work Papers

Tax accrual work papers for public companies may never deserve work product immunity. Corporate taxpayers create work papers to comply with federal securities law. They exist exclusively because of financial accounting and disclosure requirements. Their creation occurs regardless of any prospect for future litigation.

Attorney-Client Privilege

One of the concerns of this case is that this may be an attack by the IRS on the Attorney-Client Privilege.  That privilege is broader and protects communications between clients and their lawyers. That privilege is not solely for communications that deals with anticipated litigation.

However, Textron, like most other public companies, showed the tax accrual papers to outside accountants. Once you send documents to someone other than the lawyers you have effectively removed attorney-client privilege over these documents.

Dangers of Email

One of the points to take away from this case is the danger of sending out blast emails to your lawyers, copying third parties who are not lawyers. If you do so, you have probably waived the attorney-client privilege for the contents of that email. It is all too easy to add others to the email distribution. Independent auditors do not enjoy confidential relationships with their clients for purposes of the attorney-client privilege.

References:

In-House Counsel as Whistleblowers under SOX

whistleblower

Section 806 of the Sarbanes-Oxley Act (18 USC §1514A) expressly authorizes any “person” alleging discrimination based on protected conduct to file a complaint with the Secretary of Labor and, thereafter, to bring suit in an appropriate district court. There is no exception for lawyers or in-house counsel.

Recently, the Ninth Circuit tackled this issue in the case of Van Asdale v. International Game Technology.

Shawn and Lena Van Asdale were in-house counsel for IGT. As part of the merger of IGT with another company, the Van Asdales raised some issues regarding the validity of a valuable patent owned by IGT. They thought the patent issue should be disclosed in connection with the merger. Their bosses thought otherwise and fired them instead.The Van Asdales sued, asserting a whistleblower claim under the SOX because they were terminated for reporting possible shareholder fraud in connection with that merger.

What About Legal Ethics Restrictions?

IGT argued that the Van Asdales were prohibited from filing suit because of  their ethical obligations as Illinois-licensed attorneys. There is some Illinois law that “in-house counsel do not have a claim under the tort of retaliatory discharge.” Balla v. Gambro, Inc., 584 N.E. 2d 104 (Ill. 1991). However, this case is based on federal law, not Illinois law. So the court rejected that argument.

What About Attorney-Client Privilege?

The Van Asdale’s case is based on a conversation the two had with their boss regarding a pending litigation matter involving the company. To bring the case, they have to disclose information subject to the attorney-client privilege.

The Court looked at Section 806 of the Sarbanes-Oxley Act (18 USC §1514A) which expressly authorizes any “person” alleging discrimination based on protected conduct to file a complaint. Since there is no exception, in-house counsel should not be prevented from bringing a claim. There are ways to protect information. The trial court should “use the many ‘equitable measures at its disposal’ to minimize the possibility of harmful disclosures, not to dismiss the suit altogether.”

What About the Substance of the SOX Claim?

Beyond the attorney-client privilege in the case, there was also a disagreement of the standards for the claim under the whistleblower protections of SOX.

The plaintiffs only needed to show that they reasonably believed that there might have been fraud and were fired for suggesting further inquiry. Section 1514A prohibits discriminating  against an employee for “provid[ing] information . . . regarding any conduct which the employee reasonably believes constitutes a violation of” a listed law. So an employee “must have (1) a subjective belief that the conduct being reported violated a listed law, and (2) this belief must be objectively reasonable.”

References:

Image is by HughElectronic: Whistleblower. http://www.flickr.com/photos/hughelectronic/ / CC BY 2.0

Social Networking for the Legal Profession

Social-networking-for-the-legal-profession

I just finished reading Social Networking for the Legal Profession by Penny Edwards and Lee Bryant. They were nice enough to send me a copy.

Penny and Lee used a few quotes from me, referred to some of my writings and used some of my social networking activity as examples. That poor judgment aside, the book is otherwise a great report on how legal professionals can take advantage of online networking tools.

The book contains practical examples and strategies. They explore the use of the tools externally as part of your marketing and business development efforts. They also explore the use of them internally for operations, communication, and knowledge management 2.0. They present a good road map with lots of options for an organization to chose among.

They start with the basics and run through a survey of the social networking sites most useful to lawyers: LinkedIn, Avvo, blogs, Facebook, Twitter, Legal OnRamp, Martindale-Hubbell Connected, JD Supra and many others.

It is not all kumbaya. The report takes into account the risks and challenges you must overcome to make implementation a success. They spend significant time talking about the culture challenges. They also explore the security, privacy and compliance issues.

Penny and Lee point out the paradigm shift with these tools. Unlike previous generations of collaboration tools, these 2.0 tools target individual benefits rather than the benefits to the organization as a whole. They focus on what’s in it for the individual. The benefits to the larger organization are a by-product. There is less emphasis on standardization and centralization.

The focus on standardization and the collective benefits was what knowledge management got wrong. The big central databases of knowledge management were useful to the organization as a whole, but provided little benefit to the individual contributor. They did not want awards or financial compensation (not that more money wouldn’t hurt), but wanted a way to help organize their own stuff in a way that was useful to them.

Unlike past generations of software, most of the innovation is coming from the consumer space. Free tools on the web are far ahead of enterprise systems. IT departments are constantly being asked why its so easy to search on Google or publish on the web, but so much harder to do so inside the law firm. If you want to know how these tools can help you inside your organization, you need to try them outside your organization.

There is a great chapter on the benefits of networking tools used inside the organization and how to achieve great benefits.

The book is expensive. The Ark Group gave it a cover price of £245. It is a great book and worth the price. If you are interested, I was given the details of a discount offer, taking $115 off the price, making it $285 plus $10 shipping. The details are on the US publicity flyer for Social Networking for the Legal Profession (.pdf).

You can read more from Penny, Lee and others at Headshift on the Headshift blog.

I thought I would also share links to some of my material that Penny and Lee cite in the book: