Corporate Compliance Prof Blog

Sentencing Commission to Study Privilege Waiver Issue

A recent Federal Register publication from the United States Sentencing Commission sets forth gives Notice of Final Priorities for the Commission through the amendment cycle that ends in May 2006.  One of the priorities listed is on a subject blogged on here and at the White Collar Crime Prof Blog:

(6) review, and possible amendment, of commentary in Chapter Eight (Organizations) regarding waiver of the attorney-client privilege and work product protections . . . .

To understand the significance of this item, you need to have some background on the sentencing guidelines as they apply to organizations.  As for individual defendants, the guidelines establish a formula for calculating the applicable punishment – for organizations, that is primarily a monetary fine.  The formula has several steps.  Bear with me for a brief review of the steps – it will pay off in understanding what the Commission proposes.

The first step is to identify the "offense level" for the charged crime.  A chapter of the guidelines assigns each crime an offense level based on its seriousness: offense levels range from one to forty-three, with crimes ranked from least to most severe.  For example, tampering with an odometer is a relatively low offense level six, while treason and first degree murder top off the list at offense level forty-three.

The second step is to identify the base fine associated with an offense level by consulting a chart that assigns each offense level a corresponding base fine.  Not surprisingly, the base fine increases along with the offense level.  Again, consider odometer tampering and treason.  Odometer tampering, an offense level six, carries a base fine of $5,000, while treason, an offense level forty-three, carries a base fine of $72.5 million.

The third step is to calculate the organization's "culpability score."  Each organization starts with a score of five that is adjusted downward for mitigating factors and upward for aggravating factors.  For example, the guidelines subtract two points if the organization fully cooperated with the government, but add two points if the organization committed a similar violation in the last five years.  For our purposes, the most relevant adjustment is a three-point reduction "[i]f the offense occurred despite an effective program to prevent and detect violations of law."  The amended guidelines now refer to this mitigating factor as an "effective compliance and ethics program."

The fourth step is to identify the fine multipliers that correspond to the defendant's culpability score.  For example, consider once again a defendant convicted of tampering with an odometer, and assume that we make no adjustments for aggravating or mitigating factors, leaving a culpability score of five.  The guidelines assign two multipliers to a culpability score of five: one and two.  Recall that the base fine for odometer tampering, a level six offense, is $5,000.  Now, multiply the base fine by the lower multiplier (here, 1 x $5,000), and this gives you the minimum fine of $5,000.  Next, multiply the base fine by the higher multiplier (here, 2 x $5,000), and this gives you the maximum fine of $10,000.  So, our odometer tamperer faces a fine range of $5,000 to $10,000.

The final step is for the judge to set the ultimate fine within the fine range.  In doing so, the court will consider factors such as "the need for the sentence to reflect the seriousness of the offense," "the organization's role in the offense," and "any nonpecuniary loss caused or threatened by the offense."  Further, the court must increase the fine to include "any gain to the organization from the offense that has not and will not be paid as restitution or by way of other remedial measures."  The court may also depart from the fine range for listed reasons.  For example, a judge may reduce the fine below the guideline minimum if the defendant provided "substantial assistance in the investigation or prosecution of another organization that has committed an offense."  Or, a judge may impose a fine greater than the fine-range maximum if the defendant's crime "involved a foreseeable risk of death or bodily injury" or "constituted a threat to national security."

Now, go back to the culpability score.  The sentencing guidelines give a substantial reduction in that score for organizations that cooperate with the government:

(g)    Self-Reporting, Cooperation, and Acceptance of Responsibility

If more than one applies, use the greatest:

    (1)    If the organization (A) prior to an imminent threat of disclosure or government investigation; and (B) within a reasonably prompt time after becoming aware of the offense, reported the offense to appropriate governmental authorities, fully cooperated in the investigation, and clearly demonstrated recognition and affirmative acceptance of responsibility for its criminal conduct, subtract 5 points; or

    (2)    If the organization fully cooperated in the investigation and clearly demonstrated recognition and affirmative acceptance of responsibility for its criminal conduct, subtract 2 points; or

    (3)    If the organization clearly demonstrated recognition and affirmative acceptance of responsibility for its criminal conduct, subtract 1 point.

A pretty good upside here: A cooperating organization gets 5 points off its culpability score.  As explained above, this reduction will (in turn) reduce the multipliers applied to the base fine.  For example, a culpability score of 5 has multipliers of 1 and 2, whereas a score of 0 has multipliers of .05 and .2.  So, if conduct carried a base fine of $10 million, an organization would face the following fine ranges based on these two different culpability scores:

Score = 5

Max = $20 million
Min = $10 million

Score = 0

Max = $2 million
Min = $500,000

How about that!  Cooperation certainly pays.

Well, given the potentially large benefit from cooperation, the commentary explains that an organization must be forthcoming with the government:

To qualify for a reduction under subsection (g)(1) or (g)(2), cooperation must be both timely and thorough. To be timely, the cooperation must begin essentially at the same time as the organization is officially notified of a criminal investigation. To be thorough, the cooperation should include the disclosure of all pertinent information known by the organization. A prime test of whether the organization has disclosed all pertinent information is whether the information is sufficient for law enforcement personnel to identify the nature and extent of the offense and the individual(s) responsible for the criminal conduct. However, the cooperation to be measured is the cooperation of the organization itself, not the cooperation of individuals within the organization. If, because of the lack of cooperation of particular individual(s), neither the organization nor law enforcement personnel are able to identify the culpable individual(s) within the organization despite the organization’s efforts to cooperate fully, the organization may still be given credit for full cooperation. Waiver of attorney-client privilege and of work product protections is not a prerequisite to a reduction in culpability score under subdivisions (1) and (2) of subsection (g) unless such waiver is necessary in order to provide timely and thorough disclosure of all pertinent information known to the organization.

It is in the last sentence of this commentary (in bold) that the Commission stepped (quite gingerly) on the third rail that is white collar privilege waiver.  Frankly, the commentary takes a quite mild position: (1) waiver is NOT required to get credit, unless (2) the government cannot get all pertinent facts without waiver.  Remember – if we are applying the sentencing guidelines, there has already been a conviction or a plea.  So, the organization is either a convicted or admitted law breaker.  The court is simply trying to figure out whether the organization deserves leniency in sentencing.  Using the privilege to block the government from the ONLY means of accessing needed information seems the opposite of cooperation.

For those interested in criticisms of the above guidelines commentary, the National Association of Criminal Defense Lawyers has collected letters from various lawyer and other groups urging the Commission to reconsider.  As the issue of privilege waiver has received increasing attention in compliance circles, this is an issue I will try to keep on top of.

Why Self-Report?

At one of the panels I attended at the ABA Annual Meeting (oh boy – that meeting is a gift that keeps on giving to this blog), government lawyers on the panel stated that self-reporting of legal violations is often part of full cooperation with a government investigation.  An attendee posed the following comment/question in response to that statement (of course, this is a paraphrase):

Let’s say that a company discovers wrongdoing by one of its employees.  The company investigates, determines the extent of the wrongdoing, remedies the wrongdoing (including making any victims whole), disciplines the wrongdoers (up to and including termination, when warranted), and makes any necessary changes to internal policies and procedures.  If the organization does all of this, why also require self-reporting?  If the organization acted admirably in correcting the misconduct, what else does self-reporting add?

The panelists gave two pretty good answers that I will share here.

First, the question incorrectly assumes that (1) the government ALWAYS expects self-reporting, or (2) absent self-reporting, there will be no credit for cooperating with the government.  Neither assumption is correct.  Rather, self-reporting is A FACTOR to be considered along with many others in determining the culpability of and cooperation offered by the organization.  (The Thompson Memo, which was discussed in a prior post, sets forth the main factors.)

Second, without self-reporting, the government cannot take action that will ensure that the individual wrongdoers will not cause further harm.  If the employee who orchestrated the wrongdoing is simply let go, that person can simply find another organization at which to continue similar wrongdoing.  (This is especially so given employer’s hesitance to give any reference – especially a negative one – for a former employee.)  Self-reporting that includes identification of individual wrongdoers allows the government to take steps, including prosecution or barring the individual from the marketplace, that will protect the public from further wrongdoing.  Allowing organization’s to keep the problem within the family keeps the government from taking action needed to protect society.

Increasing Foreign Bribery Investigations

The White Collar Crime Prof Blog has an excellent post on new Foreign Corrupt Practices Act investigations that have been opened.  This law is an ongoing thorn in the side of American companies, as it makes it a crime under US law to bribe a foreign government's officials (to obtain or retain business), even if the foreign government turns a blind eye toward (or encourages) the bribe.

Also, the bribes can be discovered in the most unlikely ways.  For example, in one case the EPA was investigating an American company for environmental violations when it discovered paperwork that indicated a bribe to foreign government officials.  Bingo -- referral to the DOJ and SEC for an FCPA prosecution.  Other amusing ways to get caught are being reported by your competitors (after all, if your company got the business, some else's company didn't), newly elected foreign officials (who campaigned on the slogan, "Throw the bums out," and the aforementioned bums happen to be the foreign officials your company was bribing), and my particular favorite, the jilted consultant (several consultants competed to be your foreign agent -- to basically deliver the bribe -- and because there is no honor among thieves, the agent who did not get the job turns you in).

The bottom line under the FCPA is that there is no way to pay a safe foreign bribe.  While many such payments surely go undetected, they are ALL illegal (with a few exceptions), and if caught, the government can make serious trouble.  And that trouble goes far beyond any fine to include effectively hijacking your compliance program.

Seaboard Report in Action

Following up on yesterday’s post about the Seaboard Report, here is a case of the SEC’s policy in action.  Securities and Exchange Commission Litigation Release No. 18929 (October 13, 2004) describes accounting problems at Royal Ahold:

On October 13, 2004, the Securities and Exchange Commission filed fraud and other charges in the United States District Court for the District of Columbia against Royal Ahold (Koninklijke Ahold N.V.) (Ahold) and three former top executives: Cees van der Hoeven, former CEO and chairman of the executive board; A. Michiel Meurs, former CFO and executive board member; and Jan Andreae, former executive vice president and executive board member. The Commission also filed a related administrative action charging Roland Fahlin, a former member of Ahold's supervisory board and audit committee, with causing violations of the reporting, books and records, and internal controls provisions of the securities laws. The SEC's complaints allege that, as a result of the fraudulent inflation of promotional allowances at U.S. Foodservice, Ahold's wholly-owned subsidiary, the improper consolidation of joint ventures through fraudulent side letters, and other accounting errors and irregularities, Ahold's original SEC filings overstated: (a) net income by approximately 17.6%, 32.6%, and 88.1% for the fiscal years 2000, 2001 and first three quarters of 2002, respectively; (b) operating income by approximately 28.1%, 29.4%, and 51.3% for the fiscal years 2000, 2001 and first three quarters of 2002, respectively; and (c) net sales by approximately 20.8%, 18.6%, and 13.8% for the fiscal years 2000, 2001 and 2002, respectively. Ahold and three of the individual defendants have agreed to settlements with the Commission.

The Commission did not seek a penalty from Royal Ahold, with the Release offering the following explanation:

The Commission also did not seek a penalty from Ahold, among other reasons, because of the company's extensive cooperation with the Commission's investigation. Ahold self-reported the misconduct and conducted an extensive internal investigation. On its own initiative, Ahold expanded its internal investigation beyond the fraud at U.S. Foodservice and the improper joint venture accounting to analyze accounting practices and internal controls at seventeen operating companies. Ahold promptly provided the staff with the internal investigative reports and the supporting information and waived the attorney-client privilege and work product protection with respect to its internal investigations. Ahold also made its current personnel available for interviews or testimony, significantly assisted the staff in arranging interviews with, or testimony from, former Ahold personnel located in the United States and abroad. Ahold promptly took remedial actions including, but not limited to, revising its internal controls and terminating employees responsible for the wrongdoing.

If you are keeping a scorecard, the SEC credited Royal Ahold’s “extensive cooperation,” which included:

Self-reporting
Internal investigation that went beyond the narrow conduct discovered
Turn investigation report over to Commission
Waiver of attorney-client and work product privileges
Made current personnel available to testify.
Remedied internal controls
Terminated wrongdoers

Note that Royal Ahold conducted an internal investigation that went beyond the division where the misconduct that came to light.  The thinking must have been that a problem in one division is a red flag that similar problems might (barring reason to think otherwise) exist in other divisions.  This would be true particularly if the same processes and controls existed across divisions.  The message is that the Seaboard Report requires an organization to ask whether a detected violation indicates a weakness in the overall internal controls or compliance program, rather than treat assume that it as a discrete event.

Seaboard Report in Action

Following up on yesterday’s post about the Seaboard Report, here is a case of the SEC’s policy in action.  Securities and Exchange Commission Litigation Release No. 18929 (October 13, 2004) describes accounting problems at Royal Ahold:

On October 13, 2004, the Securities and Exchange Commission filed fraud and other charges in the United States District Court for the District of Columbia against Royal Ahold (Koninklijke Ahold N.V.) (Ahold) and three former top executives: Cees van der Hoeven, former CEO and chairman of the executive board; A. Michiel Meurs, former CFO and executive board member; and Jan Andreae, former executive vice president and executive board member. The Commission also filed a related administrative action charging Roland Fahlin, a former member of Ahold's supervisory board and audit committee, with causing violations of the reporting, books and records, and internal controls provisions of the securities laws. The SEC's complaints allege that, as a result of the fraudulent inflation of promotional allowances at U.S. Foodservice, Ahold's wholly-owned subsidiary, the improper consolidation of joint ventures through fraudulent side letters, and other accounting errors and irregularities, Ahold's original SEC filings overstated: (a) net income by approximately 17.6%, 32.6%, and 88.1% for the fiscal years 2000, 2001 and first three quarters of 2002, respectively; (b) operating income by approximately 28.1%, 29.4%, and 51.3% for the fiscal years 2000, 2001 and first three quarters of 2002, respectively; and (c) net sales by approximately 20.8%, 18.6%, and 13.8% for the fiscal years 2000, 2001 and 2002, respectively. Ahold and three of the individual defendants have agreed to settlements with the Commission.

The Commission did not seek a penalty from Royal Ahold, with the Release offering the following explanation:

The Commission also did not seek a penalty from Ahold, among other reasons, because of the company's extensive cooperation with the Commission's investigation. Ahold self-reported the misconduct and conducted an extensive internal investigation. On its own initiative, Ahold expanded its internal investigation beyond the fraud at U.S. Foodservice and the improper joint venture accounting to analyze accounting practices and internal controls at seventeen operating companies. Ahold promptly provided the staff with the internal investigative reports and the supporting information and waived the attorney-client privilege and work product protection with respect to its internal investigations. Ahold also made its current personnel available for interviews or testimony, significantly assisted the staff in arranging interviews with, or testimony from, former Ahold personnel located in the United States and abroad. Ahold promptly took remedial actions including, but not limited to, revising its internal controls and terminating employees responsible for the wrongdoing.

If you are keeping a scorecard, the SEC credited Royal Ahold’s “extensive cooperation,” which included:

Self-reporting
Internal investigation that went beyond the narrow conduct discovered
Turn investigation report over to Commission
Waiver of attorney-client and work product privileges
Made current personnel available to testify.
Remedied internal controls
Terminated wrongdoers

Note that Royal Ahold conducted an internal investigation that went beyond the division where the misconduct that came to light.  The thinking must have been that a problem in one division is a red flag that similar problems might (barring reason to think otherwise) exist in other divisions.  This would be true particularly if the same processes and controls existed across divisions.  The message is that the Seaboard Report requires an organization to ask whether a detected violation indicates a weakness in the overall internal controls or compliance program, rather than treat assume that it as a discrete event.

Be Careful What You Wish For

According to an article in today’s Wall Street Journal, one of the federal government’s main initiatives against money laundering and terrorist financing may have become self-defeating.  The problem involves so-called Suspicious Activity Reports (SAR), which federal law requires banks to file when a customer completes a suspect transaction:

Banks have been required to file suspicious-activity reports since a 1992 amendment to the Bank Secrecy Act aimed at catching money launderers and drug smugglers. The Patriot Act expanded the requirement to include looking for signs of terrorist financial activity and increased banks' responsibility for monitoring their customers. It also extended suspicious-activity reporting requirements to brokerage firms, casinos and firms that cash checks or transfer money overseas.

Money-laundering laws also require banks to file currency-transaction reports on any deposit or withdrawal of more than $10,000 in cash. They file about 13.6 million of these reports a year, a number that has stayed consistent because these reports don't involve judgment calls.

The Financial Crimes Enforcement Network (FinCEN) (part of the Treasury Department) overseas the SAR submissions.  As one might suspect, recent high profile cases where banks were dinged for less than diligent SAR practices has caused banks to become a wee bit overcautious:

The government's use of the Patriot Act to force financial institutions to report suspicious transactions has resulted in an avalanche of unwanted paper and computer tapes that officials who collect the data say is undermining efforts to detect money flowing to terrorists.

The government's money-laundering crackdown in the past two years has ensnared a handful of banks that were fined for failing to report suspect transactions. This has prompted executives to file more "suspicious-activity reports" -- the majority of which involve activity that isn't suspicious at all, government and banking officials say.

This defensive filing by banks is clogging the database of the Treasury Department's Financial Crimes Enforcement Network, which collects the reports, say current and former officials of the network, also known as FinCEN.

In 2004, 689,414 suspicious-activity reports were filed, up from 507,217 in 2003 and 281,373 in 2002, FinCEN data show. In the first half of this year, roughly 400,000 reports were filed.

The volume indicates that banks' tactic for avoiding regulatory scrutiny is "to file more reports, regardless of whether the conduct or transaction identified is suspicious," said FinCEN Director William J. Fox in an April report. These defensive filings "have little value, degrade the valuable reports in the database and implicate privacy concerns." Law-enforcement and intelligence officials can get detailed information about individuals from the database without having to request and justify subpoenas.

If you think about it, this reaction is predictable.  The cost to the bank of generating a SAR is relatively slight compared to the potential cost (discounted by the probability) of missing a transaction that, though innocent on its face, turns out to be money laundering or terrorist-related.  The cost and probability are likely exaggerated by a few high profile cases have the banks spooked:

Running afoul of regulators carries risks. In January, Riggs Bank in Washington pleaded guilty to a criminal count of not filing proper suspicious-activity reports involving foreign officials and was fined $16 million; it since has been bought by PNC Financial Services Group Inc. AmSouth Bancorp. of Birmingham, Ala., last year agreed to pay $50 million to avoid criminal charges in a deferred-prosecution deal with the Justice Department for failing to file suspicious-activity reports, including on some transactions used in an alleged Ponzi scheme.

So while FinCEN presses banks to be more selective, the banks say they are being pressured by regulators to report anything that technical criteria suggest may be suspicious, rather than analyzing transactions individually. FinCEN data show that some file reports simply because a customer made heavy use of an ATM or received or sent international wire transfers, or because the bank didn't know the source of deposited money.

And hindsight always being 20-20, the bank will be blamed for missing supposed red flags.  The real cost is on the government regulators who have to wade through this morass of paperwork, because the banks will have done relatively little pre-screening.  Then again, what did the government expect?  This may be one of the few areas where over-compliance is actually cheaper for the regulated than the regulator.  This irony would be funny if it didn’t affect such a serious matter:

The increased volume of suspicious-activity reports "is bad for the war on terrorism," said Steve Bartlett, who heads the Financial Services Roundtable, a financial-services trade group. But "until some alterations are made in the system, I believe defensive filings will get worse."

Happy Fourth

Here is a token posting for the day.  The SEC has posted the number and title of a release for the re-adoption of its mutual fund corporate governance rules: No. IC-26985, Commission Response to Remand by Court of Appeals (Jun. 30, 2005).  There is still no link to the text of the release, though.

In Your Face!

That seems to be the message from outgoing SEC Chair William Donaldson to the DC Circuit.  Last week (on June 21), the D.C. Circuit remanded the mutual fund director independence rules to the SEC for further consideration.  Yesterday (June 29), on his way out the door (today is Donaldson's last day on the job), Donaldson joined with the two Democrat commissioners (Roel Campos and Cynthia Glassman) to re-adopt the mutual fund rules.  The D.C. Circuit summarized its conclusions as follows:

We hold the Commission did not exceed its statutory authority in adopting the two conditions, and the Commission’s rationales for the two conditions satisfy the APA. We agree with the Chamber, however, that the Commission did violate the APA by failing adequately to consider the costs mutual funds would incur in order to comply with the conditions and by failing adequately to consider a proposed alternative to the independent chairman condition.

(Slip Opinion at p. 2)  Apparently, Donaldson and his staff were able to rectify the problem in about a week.  In a statement issued yesterday, Donaldson both explained the basis of the decision to re-adopt and defended the decision's timing:

Before turning to today's proposals, I would like to underscore an important point. The recent opinion of the Court of Appeals upheld the validity of the fundamental rationale underlying the Commission's fund governance rules. The Court agreed with the Commission that strengthening the role of independent fund directors was a reasonable response to the risks of further abuse in the mutual fund industry. Moreover, as I noted a moment ago, the Court found that the governance rules fall within the Commission's statutory authority under the Investment Company Act and, specifically, that the emphasis on independent directors is consistent with the structure and purpose of the Act.

The Court identified two specific issues that required further consideration by the Commission. First, with respect to costs, the Court stated that the Commission should give further consideration to the potential costs of the 75 percent independent director condition and the independent chair condition. Prior to adopting the fund governance rules, the Commission sought and received comment on the costs associated with these conditions, and we concluded that the costs were minimal in relation to the benefits. As instructed by the Court, today's proposal provides a detailed estimate of these potential costs, based on a variety of different possible approaches of complying with the new rules, and the Commission has carefully considered the potential impact of these costs. I will leave it to the staff to explain the numbers in greater detail, but suffice it to say that our analysis strongly confirms the conclusion that the potential costs to mutual funds of appointing independent chairmen, and ensuring that 75 percent of their directors are independent, are minimal when compared to the substantial benefits that these governance rules can bring in terms of reducing conflicts of interest and protecting investors.

Second, with respect to alternatives, the Court asked the Commission to give further consideration to an alternative to the independent chair condition that would require funds simply to disclose whether or not they have independent chairmen. This is an issue on which we received comment prior to adopting the independent chair rule last year, and today's proposal explains our reasons for rejecting the disclosure alterative. While many of our other rules are based on disclosure requirements, there are important reasons for taking a stronger, more substantive approach in the context of mutual fund governance. As I noted a few moments ago, the very structure of the typical mutual fund gives rise to serious conflicts of interest between the adviser and the shareholders, and this is the reason that Congress established flat prohibitions on certain types of fund transactions. For the Commission to grant exemptions from these prohibitions, we must see to it that investors are given assurances that their interests will be protected. As adopted, the independent chair condition will go a long way toward providing those assurances. Relying solely on disclosure, on the other hand, would allow a flawed governance structure to continue in many funds to the detriment of fund shareholders.

Concern has been raised about the timing of the Commission's actions today. The Commission's actions today are fully consistent with the opinion of the Court of Appeals and with the other legal requirements applicable to Commission rulemaking. The issues raised by the Court are clearly defined, and the existing rulemaking record and other publicly available materials have permitted the Commission to address them in the manner contemplated by the Court without further notice and comment. Indeed, by not vacating the governance rules, but instead remanding them to the Commission without ordering any particular procedures, the Court contemplated that any deficiencies in the initial rulemaking could be cured without unnecessarily reversing course or restarting the rulemaking process.

Moreover, there are compelling policy reasons for the Commission to act expeditiously on these matters. As I have stated, the governance rules are a critical component of our reform efforts, and any further delay or ambiguity surrounding their implementation would disadvantage not only investors but fund boards and management companies, most of which have already begun the process of coming into compliance with the rules. By acting swiftly and deliberately to respond to the Court's concerns, the Commission will facilitate better decision-making and ultimately serve the interests of fund shareholders.

I would also point out that it is in the best tradition of this institution, and not at all unusual, for the Commission to act swiftly on important initiatives in response to market developments and other factors. In this case, the staff and this Commission have a strong foundation of experience with the fund governance rules, and that experience has enabled us to address the issues raised by the Court within a relatively short period of time, albeit with the assistance of truly Herculean efforts on the part of our staff.

There is another important reason for us to act today. Our failure to act would, I fear, throw the future of this rulemaking into an uncertain limbo until a new Chairman is confirmed and the new Chairman is able to familiarize himself with the rulemaking record and the policy considerations weighing for and against the decision that we made last year. Today, however, we have intact the full complement of Commissioners who have spent the last year-and-a-half thinking about the issues raised in this rulemaking, and with my imminent departure from the Commission, today is the last opportunity to bring the collective judgment and learning of we five Commissioners to bear on the important questions presented to us by the Court.

In conclusion, I would like to thank the staff who have worked strenuously to bring this recommendation to us today. In particular, I would like to thank Mike Eisenberg, Bob Plaze, Hunter Jones and Penelope Saltzman of the Division of Investment Management; Giovanni Prezioso, Jake Stillman, Meridith Mitchell and John Avery in the Office of the General Counsel; and Chester Spatt and Jonathan Sokobin of the Office of Economic Analysis.

Ok -- so now we know that Donaldson "considered" both the costs and alternatives.  But, unfortunately, that is not enough -- the consideration must be "adequate" to the decision made.  I have little doubt that this one is going back to court.  The bad facts here are that (1) the rules were re-adopted so quickly, and (2) the there is a blatant political motive -- re-adopt the rules before a new, premuptively less sympathetic chair takes office.  That said, adequate consideration was not physically impossible.  Having done time at a big law firm (that shall remain nameless), I know that an awful lot of people hours can be packed into a single week.  A question will be how well the SEC documented its consideration.

Sentencing Commission to Take Up Booker, Waiver of Attorney-Client Privilege

In a recent Federal Register notice, the United States Sentencing Commission sought comment on its proposed priorities for the next year.  The list included seven items, two of which are relevant to compliance personnel:

For the amendment cycle ending May 1, 2006, and possibly continuing into the amendment cycle ending May 1, 2007, the Commission has identified the following tentative priorities:

. . .

(2) continuation of its work with the congressional, executive, and judicial branches of the government and other interested parties on appropriate responses to United States v. Booker, including any appropriate guideline changes;

. . .

(5) review, and possible amendment, of commentary in Chapter Eight (Organizations) regarding waiver of the attorney-client privilege and work product protections;

. . . .

The Commission hereby gives notice that it is seeking comment on these tentative priorities and on any other issues that interested persons believe the Commission should address during the amendment cycle ending May 1, 2006, including short- and long-term research issues. To the extent practicable, comments submitted on such issues should include the following: (1) a statement of the issue, including scope and manner of study, particular problem areas and possible solutions, and any other matters relevant to a proposed priority; (2) citations to applicable sentencing guidelines, statutes, case law, and constitutional provisions; and (3) a direct and concise statement of why the Commission should make the issue a priority.

Diamonds Are a Money-Launderer’s Best Friend

Last week, the Financial Crimes Enforcement Network (FinCEN) issued its Anti-Money Laundering (AML) compliance program rules for dealers in precious metals, stones, and jewels.  The rules flesh out the requirement in section 352 of the USA PATRIOT Act that:

[E]ach financial institution shall establish anti-money laundering programs, including, at a minimum--
(A) the development of internal policies, procedures, and controls;
(B) the designation of a compliance officer;
(C) an ongoing employee training program; and
(D) an independent audit function to test programs.

“Financial institution” is defined quite broadly, including used car dealers, insurance companies, banks, and pawn brokers.  These are the first rules for dealers in precious metals, stones, and jewels.  The rule is actually an “interim final rule,” which an FAQ accompanying the rule describes as follows:

FinCEN is issuing this rule as an interim final rule to give us the flexibility to more narrowly tailor certain aspects of the rule in response to our request within this rule for additional public comment on four discrete issues, while still ensuring that dealers immediately begin to develop anti-money laundering programs. Through the course of the rulemaking process and in developing a final rule, FinCEN has identified several important issues that would affect the scope of the regulation but on which it received little or no public comment.

FinCEN will accept comments for 45 days.

The rule defines three classes of covered goods – “jewel,” “precious metal,” and “precious stone.”  Also, the regulation exempts certain retailers based on either volume of business attributable to the covered goods or whether the retailer’s supply is mainly domestic or foreign.

The required compliance program elements should be no surprise:

AML risk assessment
Policies, procedures, and internal controls
Compliance officer
Education and training
Independent testing

The FinCEN release notes that the AML compliance program must go beyond a narrow focus on the federal requirement to report currency transactions exceeding $10,000.  Rather, the AML compliance program must examine each transaction for signs that the dealer is being used to launder money or further terrorist financing. The FinCEN release and the rule offer some guidance on what additional topics the compliance program should include, citing examples of suspicious conduct as well as conduct involved in recent cases.  For example, it says the following about training:

Appropriate topics for an anti-money laundering program include, but are not limited to: BSA requirements, a description of money laundering, how money laundering is carried out, what types of activities and transactions should raise concerns, what steps should be followed when suspicions arise, and the need to review OFAC and other government lists.

The FinCEN release also explains that the agency is considering whether to require suspicious activity reports, though it encourages dealers to do so:

[D]ealers are encouraged to adopt procedures for voluntarily filing Suspicious Activity Reports with FinCEN and for reporting suspected terrorist activities to FinCEN using its Financial Institutions Hotline . . . .
FinCEN has not at this time proposed a suspicious activity reporting rule for dealers. However, given the importance of ensuring that information relevant to the use of covered products for financial crime or the financing of terrorism is provided to law enforcement, we are considering proposing a suspicious activity reporting rule in the future. We will work closely with law enforcement and the industry as we consider whether such a rule is appropriate.

When the rule becomes final, I will post and update.