The SEC filed its first up-the-ladder enforcement action since the passage of Sarbanes-Oxley on Sept. 23, 2004. The wrongdoer: John E. Isselmann Jr., former general counsel of Portland, Ore.-based Electro Scientific Industries Inc. (ESI). His misconduct: participating in a scheme to artificially inflate ESI's quarterly numbers.
Ironically, Isselmann himself was the one who blew the whistle on the company. But the SEC believes--despite a weak attempt to stop the misconduct and ultimately reporting the illegal activity five months later--his noble effort came a little too late.
The SEC claims Isselmann failed to notify ESI's audit committee, board of directors and auditors when senior executives decided to eliminate benefits for employees in Japan, Taiwan and Korea, and apply the money to the company's bottom line. This allowed the equipment-manufacturing company to report a profit--a net income overstated by 28 percent--rather than a loss, for its third quarter results in 2002.
But Isselmann wasn't present when senior management made the decision, and he claims his CEO didn't consult him beforehand. When Isselmann learned that the company wanted to eliminate benefits in Asia, he consulted Japanese counsel, who informed Isselmann the act would be illegal. Although Isselmann claims he attempted to raise the legality issue in a meeting, he says the company's CFO cut him off. Isselmann didn't press the issue, and the company filed the incorrect results.
Although Isselmann ultimately reported the misconduct and resigned from ESI in August 2003, the SEC still decided to take action against him--an act some experts believe to be a warning signal sent out by the SEC to all general counsel.
"In the past, the SEC seems to have been pretty understanding of the pressures on in-house and outside counsel in cases like this," says Christopher Barry, partner in Dorsey & Whitney's Seattle and Toronto offices. "And enforcement actions against lawyers have been rare. The Isselmann case may be a signal that the SEC is going to scrutinize the actions of lawyers a lot more carefully."
Barry believes this case is a good example of the pressures GCs face when working for a hard-driving, goal-oriented CEO who wants to control the information that is given to the board.
"Almost everyone would agree that in-house counsel owes a duty not to knowingly permit management to present false information to the audit committee or the board," he says. "I'm sure that in retrospect, all concerned wish Isselmann had spoken up as soon as he knew about the problem. But if he had done so, I think there's a pretty good chance he would have been fired."
Isselmann recently settled with the SEC--agreeing to pay a $50,000 civil penalty and consenting to a cease-and-desist order. He is currently looking for another job.