You may have missed it among the orgy of SEC enforcement news this week, but over at the U.S. attorney’s office in Manhattan, the lead prosecutor of the Galleon Group insider-trading case is quitting—to start his own practice in white-collar defense.

Joshua Klein, an assistant attorney in the Southern District of New York for 10 years, had been taking point on the Galleon case since October when the Justice Department arrested Galleon founder Raj Rajaratnam on insider-trading. The case has exploded since then, with more than 20 arrests keeping plenty of lawyers and newspaper headline writers busy. The first plea-bargains seem likely to arrive any day now, although Klein may not be around to see them. He reportedly will be out of the U.S. attorney’s office by the end of next week.

Let me be clear that I don’t know Klein, and don’t fault him one bit for wanting to pursue a line of work that pays him well for his talents. Most of us would do the same, especially if we had a family to raise. Nevertheless, he is a reminder of that revolving door between public and private law practice that Congress, regulators, and nattering nabobs in the media such as myself keep complaining about.

We see that door operating all the time, at all levels: from the young lawyers who do a stint at the SEC or at Justice to spiff up their resume and then crash the partner track at a big firm in Washington or New York; to heavyweights like Attorney General Eric Holder, who went from a high-level job at Justice during the Clinton Administration, to a high-level job at the law firm Covington & Burling, back to a highest-level job in the Obama Administration. Democrats do it, Republicans do it, and everyone wrings their hands about it.

In the Galleon case specifically, all indicators are that the prosecution will continue to hum along without Klein in particular as the lead prosecutor. But it does demonstrate yet again the dilemma regulators have with employee turnover: on a personal level it’s often the correct move for the employee, and you can’t begrudge him that—but in the whole it adds uncertainty to enforcement efforts.

Compliance headaches have gone global this week, from Nigeria to China.

First, Royal/Dutch Shell finally blinked and settled a civil lawsuit against the company about to start in New York. Relatives of Ken Saro-Wiwa, a Nigerian civil-rights activist hanged by authorities there in 1995, had sued Shell under the U.S. Alien Tort Claims Act for alleged complicity with the government in Saro-Wiwa’s death. Shell agreed to pay $15.5 million to Saro-Wiwa’s family and the survivors of eight other activists executed along with him.

Second, China has announced rather Orwellian plans to require all personal-computer makers that sell PCs the country to include special Web-blocking software with each unit. Ostensibly this is to block citizens’ access to pornography sites, but practically this system will allow Chinese authorities to “update” the list of blocked sites much like your central IT department sends out security patches to your desktop.

To my thinking, both of these events are near-misses for corporate compliance departments: mildly ominous developments that expand, yet again, the list of worries you need to keep in mind. The Alien Tort Claims Act, for example, has gone from a historical chestnut on the law books (it was passed in 1789 and hardly used for centuries) to something rather like a right to private action under the Foreign Corrupt Practices Act: anyone, living anywhere, can sue any company in U.S. courts for providing assistance to a government that does something the plaintiff claims is dangerous.

I recently conducted a podcast interview on the case with Jonathan Drimmer from the law firm Steptoe & Johnson, and man, this stuff seems hazy. How do you craft a code of conduct to insulate yourself from Alien Tort lawsuits? How do you enforce compliance?

The Chinese ruling could also be a ticking time bomb. You can’t wave off compliance with regulations from the world’s largest consumer market—especially one where various government agencies have very cozy relationships with each other, that Westerners often can’t quite perceive. Compliance with the rule itself should be simple enough; either install the blocking software onto the PC’s hard drive, or include a disk carrying the software with the PC’s packaging. That’s a hassle, but it’s not really hard to do.

But there’s something decidedly un-American about cooperating with another government’s censorship efforts. I could even foresee some crafty dissidents from Tibet or Taiwan suing U.S. companies for their cooperation under the Alien Tort Claims Act. And all for a rule that, I’m sure, clever Chinese hackers will be able to circumvent in less than an hour.

Welcome to the global village, folks.

From the I’d-rather-watch-paint-dry department: That conservative outfit still arguing that the Sarbanes-Oxley Act is unconstitutional has, yet again, lost a court dispute and vowed to appeal. 

Earlier this week, the U.S. Court of Appeals for Washington, D.C., voted 5-4 not to review the case, which argues that the structure of the Public Company Accounting Oversight Board violates the appointments clause of the U.S. Constitution. And because SOX lacks a severability clause, if that section of the law establishing the PCAOB ever were ruled unconstitutional, the whole of Sarbanes-Oxley would go out the window.

This is the third consecutive legal defeat for the plaintiffs, the Washington D.C.-based Free Enterprise Fund and Las Vegas accounting firm Beckstead & Watts. They lost in federal court last year and lost an appeal to a three-judge panel of the D.C. Circuit in August. Now they’ve lost again, and (naturally) they have vowed to appeal to the U.S. Supreme court. Beckstead & Watts, by the way, was once previously discplined by—you guessed it—the PCAOB.

Here’s the painful truth, folks: As much as you may detest the Sarbanes-Oxley Act, it’s here to stay. Congress does not want to revisit this can of worms. The judiciary doesn’t want to revisit this can of worms. Even if the plaintiffs do appeal to the Supreme Court, and by some miracle the court decides to hear the case, arguments won’t happen at least until late 2009, and by then we’ll probably have at least one new justice anyway pulling the court back from its rightward tilt.

This case is going nowhere. One wonders what the Free Enterprise Fund’s stance is about frivolous litigation …

Corporate America had its first glimpse into the Obama Administration’s thinking yesterday with the news that Eric Holder, a partner at the law firm of Covington and Burling, will be nominated to be our next attorney general. Sure, we’re still in the rumor phase of this news, but the Obama team hasn’t made any mistakes yet and isn’t going to bungle its first Cabinet announcement now. This guy is in.

The appointment is a telling one for compliance executives. Holder spent his early years as a federal prosecutor, U.S. attorney, and judge in Washington, D.C. In the Clinton Administration, he rose to be deputy attorney general (that is, No. 2 in the Justice Department under Attorney General Janet Reno), overseeing all the department’s litigation and enforcement matters. Holder has also been a high-level adviser to the Obama campaign. Regardless of your particular political views, you have to admit that he has the chops to be attorney general under a President Obama.

Of real import to us, however, is what Holder did while working at the Justice Department in the 1990s: He drafted the “Holder Memo” on the criminal prosecution of corporations—the Justice Department’s first-ever attempt to articulate how it evaluated a company’s cooperation in a criminal investigation.

Many would say the department has been trying to do a better job of that ever since. The Holder Memo (1999) begat the Thompson Memo (2003), which begat the McNulty Memo (2006), which begat the Filip Memo in place today. Each memo has successively tried to weaken what general counsels hate the most: the concept that waiving attorney-client and work-product privilege is necessary to be deemed “cooperative” and avoid prosecution. (The Filip Memo isn’t even a memo, but a series of revisions to the Principles of Federal Prosecution of Business Organizations that U.S. attorneys use.)

Like all good former Justice Department officials now in private practice, Holder insists that he never intended the waiver provision to metastasize into what it is today. For the sake of argument, however, we’ve dug up the relevant original text:

In determining whether to charge a corporation, the corporation’s timely and voluntary disclosure of wrongdoing and its willingness to cooperate with the government’s investigation may be relevant factors. In gauging the extent of the corporation’s cooperation the prosecutor may consider the corporation’s willingness to … disclose complete results of its internal investigation, and to waive the attorney-client and work-product privileges.

What does that language really mean? I have no idea, and neither do you. But the important thing for compliance officers is that Holder does know what it means; he wrote it. Presumably he’ll abide by the current practices of the Filip Memo (at least, until some other deputy attorney general pens yet another memo in the future) which dictate that any request to waive privilege be approved by some high-level official in the Justice Department. Holder will be able to tell his deputies and U.S. attorneys exactly what he expects for waiver requests—and while Corporate America might not like what he communicates, at least we should have clarity. That would be better than what we have now.

Behind every spectacular corporate meltdown, there’s an auditing firm sweating bullets.

Little surprise, then, that when the entire financial sector melts down, all four of the Big 4 auditing firms start to sweat. Each one has (or had) at least several clients in the financial sector that have recently been forced into acquisition, government oversight, or bankruptcy. That means greater litigation risk—as you can see from this story in Compliance Week, the sub-prime lawsuits have barely begun—and the probable loss of a client engagement. That can’t be fun. For our amusement here, however, I’ve compiled a short list of recent financial failures and who the auditing firms were:

• AIG: PricewaterhouseCoopers
• Bear Stearns: Deloitte
• Countrywide Financial: KPMG
• Fannie Mae: Deloitte
• Freddie Mac: PricewaterhouseCoopers
• HBOS (Bank of Scotland): KPMG
• IndyMac Bancorp: Ernst & Young
• Lehman Brothers: Ernst & Young
• Merrill Lynch: Deloitte
• Wachovia: KPMG
• Washington Mutual: Deloitte

That’s four failures for Deloitte, three for KPMG, and two each for Ernst & Young and PwC. Deloitte looks particularly bad here, since it has the distinction of auditing the largest bank to fail so far (WaMu), the investment bank that started this panic (Bear Stearns) and one of the two largest banking companies in the whole mess (Fannie Mae).

Deloitte confirmed in August that it was laying off 900 people, about 2 percent of its total staff. Over at the ever-popular blog Re:The Auditors, rumors are running rampant of a much larger wave of layoffs coming sometime soon.

Stay tuned, folks. The Sarbanes-Oxley Act was supposed to start an era of lifetime employment at the Big 4; the credit crisis seems to have ended it.

Compliance Week Editor-in-Chief Matt Kelly is in China. This blog posted by Compliance Week Publisher Scott Cohen:

Regulatory developments in the financial services sector are coming fast and furious, but one caused us to raise our eyebrows. On Monday, the SEC expanded its investigation of potential market manipulation, noting that hedge fund managers, broker-dealers, and institutional investors with significant trading activity in financial issuers or positions in credit default swaps “will be required, under oath, to disclose those positions to the Commission and provide certain other information.”

Subpoenas are also mentioned in the SEC announcement, so one would assume that the “oath” mentioned above would be in the form of written statements. At least that is the contention of Fried, Frank, Harris, Shriver and Jacobson in a recent client alert; the firm mentions the SEC’s reference of Section 21(a)(1) of the ‘34 Act, in which the SEC may “require or permit any person to file with it a statement in writing, under oath or otherwise as the Commission shall determine, as to all the facts and circumstances concerning the matter to be investigated.”

Written statements, of course, harken back to WorldCom, Enron, and the Sarbanes-Oxley Act of 2002.

It will be very interesting to see what transpires here. Fried Frank provides some interesting commentary on the topic, noting that the SEC’s power may be somewhat limited. Not only do individuals have consitutional rights, (they cannot be forced to incriminate themselves) but there is not much precedent. “Due to the SEC’s infrequent use of this enforcement tool,” writes Fried Frank, “market participants will have little guidance on this issue.” In addition, privilege will likely come in to play, as entities “have the right to protect, as privileged, communications with their lawyers.”

The SEC is under a lot of pressure to address alleged misconduct; it will be interesting to see how this enforcement tactic evolves, and–if deemed successful–whether it will he a harbinger of future approaches.

Compliance Week Editor-in-Chief Matt Kelly is in China. This blog posted by Compliance Week Publisher Scott Cohen:

Perfectly timed with my blog from yesterday accusing the SEC of inaction in the financial crisis, the Commission has banned “naked” short selling of the securities of all public companies, effective 12:01 a.m. Thursday, Sept. 18.

The move is extraordinary because—unlike the temporary ban that applied to 19 financial services stocks over the summer—the new rules apply to all public company securities.

As most Compliance Week subscribers know, a short seller bets that a company’s stock price will fall. To profit, the seller borrows shares and sells them; once the stock price drops, the seller buys cheaper shares to cover the borrowed one, pocketing the difference. But in a naked short transaction, the seller doesn’t actually borrow the stock. This “abusive” short selling, as the SEC calls it, can allow manipulators to drive prices down lower than would be possible in legitimate short-selling conditions. More specifically, companies and regulators believe that short sellers have contributed to the financial crisis by spreading false rumors and selling stock short to profit.

The new rule includes an exception for market makers and includes penalties for short sellers and broker-dealers who violate new “close out” requirements (securities must be delivered on “T+3,” or three days after the sale transaction date). Also adopted was a short selling antifraud rule, which targets short sellers who “lie about their intention or ability to deliver securities in time for settlement.”

Two key questions, of course, relate to whether the SEC is too late, and whether the actions will have any impact. Specifically, some are arguing (quite vociferously) that the Commission should re-institute the “Uptick Rule,” which stated that short selling was only allowed on an uptick (in other words, a security can not be sold short unless the last trade prior to the short sale was at a price lower than the price at which the short sale is executed).

We’ll keep tracking this issue for readers; look for an article in next Tuesday’s edition of Compliance Week that looks at the impact of this short-selling ban on all public companies.

Compliance Week Editor-in-Chief Matt Kelly is in China. This entry posted by Compliance Week Publisher Scott Cohen:

 If there was any doubt that that the Commission is serious about disgorging profits from executives charged with fraud, one need only look to the latest settlement with former KB Home CEO Bruce Karatz.

Karatz, whose company was being investigated for backdating of stock options two years ago, will pay more than $6.7 million in disgorgement and prejudgment interest, plus a $480,000 penalty. He will also be barred from serving as an officer or director of a public company for five years. According to the complaint, Karatz not only signed false SOX certifications, but he actively “aided and abetted KB Home’s violations of the financial reporting, recordkeeping, and internal controls requirements.”

As Compliance Week has reported for the past few years, the Commission is actively seeking disgorgement whenever possible—a trend that gained momentum during Chairman Donaldson’s regime, when Stephen Cutler ran the enforcement division. Back in 2003, for example, shortly after Donaldson was named Chairman, six former Xerox officers agreed to pay $22 million in penalties and disgorgement payments to the SEC; numerous settlements have followed. Other executives have been pressured to return gains: Former Vivendi CEO Jean-Marie Messier relinquished his claims to about $26 million, and 12 executives at Nortel agreed to return about $8.6 million in bonuses after an incident involving “inappropriate provisioning.”

As Compliance Week reported back in 2005, the Commission is even, in some cases, seeking disgorgement of base salary, not just the bonuses and equity awards that are typically sought.

The same day that the Commission announced the Karatz settlement, it also disclosed that it would disgorge $751,978 from the former CEO of the Kansas City-based American Italian Pasta Company, who had been charged with accounting fraud; the CEO also got a permanent D&O bar, plus penalties.

Compliance Week will continue to track this trend; readers should keep an eye on our ongoing list of investigations, both internal and external, at U.S. public companies.