When the Security and Exchange Commission’s head of enforcement announced that corporate gatekeepers are fair game for SEC civil actions, he wasn’t kidding.

Stephen Cutler in a September 2004 speech at the University of California, Los Angeles School of Law listed no fewer than 22 enforcement actions on gatekeepers alone. Since then, more allegations have come at a steady clip in an effort to hold gatekeepers accountable for failing to fulfill their obligations under Sarbanes-Oxley.

That means lawyers, independent directors, accountants and bankers are squarely in the cross hairs of SEC enforcement efforts.

“We see more charges in enforcement actions being brought against outside directors. That’s a trend that is not going to go away,” said Beth I.Z. Boland of Bingham McCutchen. “You see a renewed commitment by the SEC for director and officer bars – meaning that if you get convicted or settle with respect to [a violation of securities laws] or fraud, you are barred from ever being a director or officer or a publicly traded company.”

The commission will be tougher on everything and everybody, agreed Steven Honig of Duane Morris.

“Their approach,” Honig said, “is to identify the individuals who in their mind are culpable for misstatements or nondisclousres or improper transactions. And if they identify the individuals – and these individuals are particularly not cooperative and forthcoming – then the commission is much more willing to attempt to obtain enforcement against [them] in more significant and draconian ways.”

This includes civil fines, as well as officer and director bars, Honig said.

In 2004, the SEC “stepped up our scrutiny of the role of lawyers in the corporate frauds we investigate. We have named lawyers as respondents or defendants in more than 30 of our enforcement actions in the past two years,” Cutler said in his speech.

Citing lawyers who “twisted themselves into pretzels” to accommodate management or covered up evidence of wrongdoing, Cutler also noted that half the allegations had been levied against outside counsel.

“One area of particular focus for us is the role of lawyers in internal investigations of their clients or companies. We are concerned that, in some instances, lawyers may have conducted investigations in such a manner as to help hide ongoing fraud, or may have taken actions to actively obstruct such investigations,” he said.

In a December 2004 interview with In-House, Walter Ricciardi, head of the New England District Office of the SEC, echoed Cutler’s statements, saying, “In every one of these matters where we will be looking at misconduct, we will be asking, where were the auditors, where was the board, where were counsel, inside and outside counsel?”

Bankers, too, are targets. The SEC filed cases against Merrill Lynch, Citigroup, JP Morgan Chase and CIBC in connection with their roles in the Enron fiasco, alleging they knew or should have known that transactions they conducted for the company were aimed at obscuring its financials, according to Cutler’s speech.

“Over the next year,” Cutler said, “we intend to continue focusing closely in our investigations on whether outside directors have lived up to their role as guardians of the shareholders they serve.”

(Cutler’s speech is available at: http:// www.sec.gov/news/speech/spch092004smc.htm)

Out For Blood

The SEC’s focus on the gatekeepers comes at a time of increased private shareholder litigation where institutional investors – including pension funds and retirement accounts for public employees – are taking the lead.

“As a result,” explained Boland, “you see a kind of political pressure being brought into this private litigation … coming from the fact that these are public officials” who have lost money in the pension funds or retirement accounts.

And they’re out for blood. The pressure is on for a finding of personal liability against the directors, meaning damages come directly from their pockets, not from insurance policies.

As lead plaintiff in the WorldCom case, the state controller of New York and trustee of the retirement fund for the state of New York made it clear “that as part of his perceived public duty, he needed to get personal liability out of the WorldCom directors,” Boland said.

Similarly with Enron, the lead plaintiff was the Wisconsin pension and retirement fund. In both cases, outside directors got slapped with huge fines – $18 million in the WorldCom case and $13 million against Enron’s directors.

“Those dynamics are not going to go away,” Boland continued, because it’s likely the SEC will begin to feel the same public pressure to secure findings of personal liability.

Derek Meisner, of counsel to Kirkpatrick & Lockhart, said that he sees many more enforcement actions against lawyers, and much more SEC attention being brought to them.

“The SEC is bringing cases at double the pace they have in the past for attorney conduct. The basis for the cases is that the lawyer didn’t say ‘no’ when they should have or committed some affirmative misconduct that allowed an existing fraud to continue,” said Meisner, a former SEC enforcement attorney.

The trickle-down effect is even hitting those people whom companies want to sit on audit committees, Honig noted. Recalling a recent talk about the risk today in being a corporate director given by Roger Raeber, president of the National Association of Corporate Directors, Honig said the association hasn’t yet found that people are shying away from being a director because of the increased risk.

“But they are finding,” Honig said, “that it’s hard to get people to serve on the audit committee and as chair of the audit committee because of the perception of the potential that they will be held to a very high standard and if they [falter], they won’t be able to meet it and will have either liability or a shareholder lawsuit, or might be subject to enforcement proceedings from the SEC.”

Communicate Early And Often

In-house lawyers can develop operational procedures to help officers, directors and committees remain attentive to the important business they’ve agreed to take on.

Honig suggested holding numerous and regular meetings, clearing the lines of communication from the internal audit directly to the audit committee and the audit chair, and holding regular executive sessions for boards to discuss issues without management present.

Truly independent and top-rate directors are another must. “It takes some courage for a company to put on the board people who are mildly disruptive intellectually and aren’t just rubber stamps. But that’s really what board governance could be and will be in the future,” Honig said.

Boland added that in-house counsel has to make sure directors get general guidance on corporate governance, perhaps even getting involved with an outside educational program.

Case law on D&L liability is in flux, Boland said, making it critical to stay up to date.

“That’s all basic, good advice, but now we’ve had it crystallized in a way that is very keen,” she continued.

Meisner reminded both inside and outside counsel that Section 307 of Sarbanes-Oxley requires attorneys to report evidence of a material violation of the securities laws, or a breach of fiduciary duty by a corporate officer or director or employee, to the company’s chief legal officer or the CEO.

“When the attorney becomes aware that the evidence exists of such a violation, it is entirely possible that the SEC would construe an attorney’s failure to [report], under circumstances where it’s objectively reasonable to do so, as helping facilitate corporate wrongdoing,” he said.

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