Joining forces

As regulatory proceedings increase on both sides of the Atlantic, the pressure is on for legal advisers to work together to protect their clients, say Graham Simkin and Sarah Thomas

Regulatory issues are a genuine concern for both UK and US businesses. A litigation trends survey conducted by Fulbright & Jaworski reveals that 40 per cent of UK companies listed regulatory issues as a primary litigation concern, compared with 21 per cent in the US. Forty-four per cent of the UK respondents claimed to have faced at least one regulatory proceeding where $20m (£10.35m) or more was at stake. Almost three out of five (58 per cent) of UK respondents stated that they had faced a regulatory proceeding over the past 12 months, compared with 51 per cent in the US.

The increase in regulatory investigations conducted on both sides of the Atlantic has been fuelled in part by alignment and cooperation between the Securities and Exchange Commission (SEC) in the US and the Financial Services Authority (FSA) in the UK. Regulators have secured efficient communication channels to enable them to work together across two jurisdictions: legal advisers must achieve the same to gain the best outcome for their clients.

Regulatory inquiries impact on companies, individual directors and, potentially, employees. Both the FSA and SEC have the ability to impose civil penalties and to prosecute individuals in the criminal courts. These powers have been put to effective use. In the UK in October 2005, two directors of software firm AIT were handed prison sentences of to three and a half years and two years respectively for breaches of the market abuse provisions of the Financial Services and Markets Act 2000 (FSMA). In the US, former Enron chief executive officer Jeffrey Skilling was sentenced to 24 years when he was found guilty in a jury trial following the investigation into Enron, which began in 2001.

Strong relationships

On 14 March 2006 the SEC and FSA signed a Memorandum of Understanding to enhance “consultation, cooperation and the exchange of information related to the supervision of financial services firms and market oversight”. The regulators billed this gateway as marking an unprecedented level of cooperation and information-sharing designed to improve the effectiveness and comprehensiveness of regulation. The SEC said: “In view of the globalisation of the world’s financial markets and the proliferation of globally active financial services firms, establishing and maintaining strong relationships and co-operative efforts with our counterparts in the area of supervision and oversight, in addition to enforcement, is becoming equally important.”

Representatives of the Office of International Affairs at the SEC have said that from 2006 onwards there will be an increase in cross-border cases tackled by the SEC, and the SEC and FSA see their dual enforcement action against Royal Dutch Shell in 2004 as a precedent towards further coordinated investigations.

Section 165 of the FSMA sets out the FSA’s powers of investigation and information gathering. Section 169 empowers the FSA to exercise those powers in order to provide assistance to an overseas regulator. This ‘gateway’ enables the FSA to provide the information obtained from regulated companies to the SEC. Section 21(a)(2) of the Securities Exchange Act 1934, adopted in 1988, gives the SEC similar powers.

In representing clients who face the prospect of a transatlantic investigation by regulators, legal advisers on both sides of the Atlantic will need to coordinate closely to ensure that any decision or steps taken in one jurisdiction do not have an adverse direct or indirect effect on outcomes and strategy in another. This is not only a UK/US issue: the 2002 International Organisation of Securities Commissions (IOSCO) Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information ensures that such cooperation extends to a multitude of national regulators. All 108 members of IOSCO are required to have signed the memorandum by 2010 – many have already.

Differences in privilege

Although the privilege provisions in the FSMA (Section 413) prevent the FSA from requiring copies of privileged documents, companies often supply documents attracting privilege under the Section 348 confidentiality provision in order to cooperate with the FSA. Section 348 protects the confidentiality of the documents, and therefore the privilege can remain intact against parties other than the FSA – there is a ‘limited waiver’. Where the FSA provides those documents to the SEC, there may be an argument under US law that the SEC is not bound by the privilege, or that the documents did not attract privilege under US law in the first place.

Privilege rules under US and English law differ in several respects – the same document may be privileged in one jurisdiction but not in the other. A regulator who cannot obtain privileged documents in their own jurisdiction may be able to obtain them from another regulator in a jurisdiction where they are not privileged. There are differences in this area.

  • In the US, attorney client privilege can apply to communications to third parties if the purpose is to help the attorney provide legal advice to the client. This may include communications with a financial adviser hired by an attorney to assist the attorney in understanding the client’s financial information. Such communications would not be protected under English law as it currently stands.
  • English law privilege allows for the concept of ‘selective waiver’, which enables a legally privileged document to be provided to an individual party in confidence without losing the privilege generally. In the US it is thought that such a limited waiver cannot be asserted.# The US definition of ‘client’ is broader than the English law definition following the Court of Appeal decision in the Three Rivers District Council and ors v Governor and Company of the Bank of England (2004) (which dictum the House of Lords declined to review). The Court of Appeal held that only employees of the defendant bank who had been assigned to a special unit created by the bank to deal with external lawyers could be defined as part of the ‘client’ for the purposes of privilege. US law takes the opposite position. When presented with a similar argument, the Supreme Court stated: “Such a view, we think, overlooks the fact that privilege exists to protect not only the giving of professional legal advice to those who can act on it but also the giving of information to the lawyer to enable him to give sound and informed advice.”

    Points of consideration

    The high risk of civil class actions in the US brought by shareholders, and arising out of regulatory investigations, adds a further dimension to the strategy a company must adopt in responding to its regulator. Considerations include:

  • US class actions plaintiffs are international: they frequently include shareholders who bought their shares on the London Stock Exchange. This increases the pool of potential litigants dramatically;
  • the evidential burden on a company of managing both a regulatory investigation and a class action is complex and extensive. Regulators’ requests for information are often very broad and the impact of decisions to provide documents on their availability to class action litigants must be planned. Further, the contents of submissions, the way the media reports on an investigation and the conduct of participants during the investigation will all require careful consideration; and
  • an outcome of any regulatory inquiry will have reverberations through any class action taking place alongside or commenced after the conclusion of regulatory proceedings.

    Shareholder derivative actions (in which minority shareholders can require a company to bring litigation against one of its officers or directors in the name of the shareholders) have been prevalent in the US for some years. English law currently makes such claims difficult to bring. The Civil Procedure Rules do provide for a form of class action to be brought in England, but the latest draft of the Company Law Reform Bill introduces a new statutory basis for claims against directors for negligence, breach of duty and breach of trust. The combination of the two will add stimulus to the filing of claims in England, and the prospect of competing claims, on both sides of the Atlantic, is now in sight.

    Graham Simkin is a partner and Sarah Thomas is an associate at Fulbright & Jaworski