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Manatt, Phelps & Phillips, LLP

Ninth Circuit Rebuffs Software Licensee's Attempt To Police Own Use Of Software
Recently, the U.S. Court of Appeals for the Ninth Circuit held that a software licensee may not install the software onto a number of computers that exceeds the number of licenses it has purchased, even if the computers are configured such that the total number of workstations able to access the software does not exceed the total number of licenses purchased. Wall Data Inc. v. Los Angeles Cty. Sheriff’s Dep’t.

The Los Angeles County Sheriff’s Department purchased 3,663 licenses to Wall Data’s software. At first, the Sheriff’s Department installed the software manually onto 750 computers. Then, in an effort to save time, the Sheriff’s Department performed “hard disk imaging” and copied the entire contents of a single “master” hard drive simultaneously onto the remaining several thousand computers. Although the software was loaded onto 6,007 computers, the Sheriff’s Department configured the computers using a password-based security system such that the number of users who could access the software was limited to 3,663 – the same as the number of licenses purchased.

Wall Data sued the Sheriff’s Department in federal court in Los Angeles, CA for copyright infringement. Wall Data alleged that the Sheriff’s Department had “over-installed” the software.

The jury returned a general verdict finding the Sheriff’s Department liable for copyright infringement and awarding Wall Data $210,000 in damages. The trial court also granted Wall Data $516,271 in attorneys’ fees and approximately $38,000 in costs.

The Ninth Circuit affirmed, holding that software copying, in these circumstances, constitutes copyright infringement. The Ninth Circuit explained that “although hard drive imaging might be an efficient and effective way to install computer software,” the Sheriff’s Department’s conduct “would nonetheless lead to over-use of the software.” The Ninth Circuit also noted that the Sheriff’s Department’s system made copyright infringement easier because no physical installation was necessary, and made detection of over-use more difficult. The Ninth Circuit also reasoned that software is “extraordinarily vulnerable to illegal copying and piracy” and entitled to enhanced copyright protection for its inventors and developers.

The Wall Data case teaches that software licensees should be very cautious about practices that essentially ask the licensors to trust that their licenses are not being exceeded. Such practices may result in hefty monetary penalties, as the Sheriff’s Department bore in this case.

07-19-2006

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Jenner & Block LLP

District Court Rules the Government's Use of the Threat of Corporate Indictment Was Unconstitutional
"On June 26, 2006, the United States District Court for the Southern District of New York struck down a portion of a Department of Justice (""DOJ"") memorandum that requires consideration of whether a company is paying for the attorney's fees for its employees in determining whether to charge that corporation with a crime. United States of America v. Jeffrey Stein, et al., No. S1 05 Crim. 0888 (Judge Lewis A. Kaplan) (SDNY June 26, 2006) (slip op.). The basis for the court's decision was that the provision, part of the ""Thompson Memorandum,"" violated the employees' rights to a fair trial and effective assistance of counsel under the Fifth and Sixth Amendments of the United States Constitution.

Although the government may appeal the decision and it is not technically binding on other courts, Judge Kaplan's 80-page decision declaring the Thompson Memorandum's provision relating to legal fees, as well as the U.S. Attorneys Office's implementation of that policy, unconstitutional is a landmark opinion in the area of white collar criminal defense. Its sound rebuke of a significant provision in the Thompson Memorandum may result in a revision of DOJ policy regarding whether or how much to weigh payment of employees' legal fees in determining whether to indict a corporation. It may also cause other district courts to take a harder look at the government's manipulation of a company's interest in avoiding indictment to constrain individual's constitutional rights to a fair trial and effective assistance of counsel.

The Thompson Memorandum
On July 9, 2002, in the wake of a number of major corporate scandals, President Bush established the Corporate Fraud Task Force headed by then-United States Deputy Attorney General Larry D. Thompson. In January 2003, Mr. Thompson issued the Principles of Federal Prosecution of Business Organizations, commonly referred to as the ""Thompson Memorandum,"" which obligates U.S. Attorneys to consider certain factors in determining whether to indict a business entity. The Thompson Memorandum is similar in many respects to a memorandum by the Deputy Attorney General under the Clinton administration, with the most significant alteration being that the Thompson Memorandum requires its provisions be followed by all federal prosecutors, while the prior memorandum's guidance was discretionary.

Among other factors, the Thompson Memorandum requires that U.S. Attorneys consider a company's advancement of legal fees, unless required by law, as a factor to be weighed in deciding whether to charge a corporation with a criminal violation. Judge Kaplan noted that Mr. Thompson was quoted in the press defending companies cutting off payment of legal fees for their employees because the employees ""don't need fancy legal representation"" if they were not guilty of criminal wrongdoing. Stein at 6, n. 13 (quoting Laurie P. Cohen, In the Crossfire: Prosecutors' Tough New Tactics Turn Firms Against Employees, Wall. St. J., June 4, 2004, A1. The court did not share Mr. Thompson's opinion, finding it ""misguided, to say the least,"" and stating that ""even the innocent need substantial resources to minimize the chance of an unjust indictment and conviction.""

Implicit Threat Regarding Legal Fees
The essential facts that led to the Kaplan decision are these. KPMG, concerned about an IRS investigation into its involvement in developing, marketing, and implementing allegedly abusive tax shelters, hired an outside law firm to devise a ""cooperative approach"" with the government in the hopes of avoiding indictment.1 During a February 25, 2004 meeting between the government and KPMG’s representatives, including outside counsel, one of the Assistant U.S. Attorneys warned that KPMG's payment of legal fees for employees being investigated would be viewed as rewarding their ""misconduct"" and that if KPMG had any discretion in not paying fees, KPMG's actions would be placed ""under a microscope."" Although the government argued that KPMG's decision to cap the legal fees it paid to employees was not made at the government's behest, the court concluded that no one at the meeting could have failed to draw the conclusion that the U.S. Attorney's Office wanted KPMG to limit its financial support to its employees' legal defense.

KPMG Limited Employees Legal Fees
While KPMG had a long history of voluntarily advancing and paying its employees legal fees, in an effort to avoid indictment the company heeded the government's warning and limited legal fees it would pay to an employee to $400,000 and further limited the payment, requiring that the employee ""cooperate"" fully with the government or face having support withdrawn (failure to cooperate was understood to include, among other actions, invoking the Fifth Amendment privilege against self-incrimination). KPMG also made clear that it would cut off all support if an employee were charged by the government with criminal wrongdoing. KPMG also steered its employees to attorneys who would cooperate with the government investigation, as opposed to fighting it.

On August 29, 2005, KPMG entered into a deferred prosecution agreement with the government, thereby avoiding a criminal indictment, absent breach of the agreement. Shortly after this agreement was reached, a number of KPMG employees were criminally indicted.

Finding of Unconstitutional Interference with the Payment of Legal Fees

The opinion issued on June 26 was in response to the employees' motion to dismiss the indictment or for payment of fees on the ground that the government had improperly interfered with their right to receive KPMG’s support in the form of advancement of attorney's fees. The court held that the Thompson Memorandum's requirement that U.S. Attorneys consider payment of legal fees in making charging decisions violates the Constitution’s Fifth Amendment Due Process clause. The court did allow that consideration of the payment of legal fees where the payments were made solely as part of a scheme to obstruct an investigation could be permissible, opening the door to a revision of the legal fees provision of the Thompson Memorandum. The Court also concluded that the U.S. Attorney's Office ""compounded the [due process] problem that the Thompson Memorandum created"" with regard to legal fees by placing the issue of KPMG's payment of its employees' legal fees near the top of its agenda in discussions with KPMG's counsel and making clear it would not be looked upon favorably.

In addition, the court agreed with the defendants that the government's implementation of the Thompson Memorandum infringed their Sixth Amendment right to counsel, stating:

The government here acted with the purpose of minimizing these defendants' access to resources necessary to mount their defenses or, at least, in reckless disregard that this would be the likely result of its actions. In these circumstances, it is not unfair to hold it accountable.2

After a lengthy discussion of the appropriate relief in which the court declined to dismiss the indictments and determined sovereign immunity prevented it from ordering that the United States pay the defendants' legal fees, the court stated that KPMG, which was not a party to the criminal case but which had appeared voluntarily, could either agree to pay the defendants or the defendants could file a civil complaint against KPMG within 14 days requesting a summary proceeding in which the court could order KPMG to advance the fees.

Conclusion
This ground-breaking decision places important limitations on the government's power to influence corporate policy by explicit or even implicit threats of indictment. Interestingly, it came in the same week that the Supreme Court ruled the Department of Defense's procedure for trying prisoners held in Guantanamo Bay was illegal, and could be part of a larger trend towards stricter judicial review of Executive Branch actions.

07-19-2006

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Greenberg Traurig, LLP

Department of Homeland Security Proposes Federal Regulations Aimed at Improving Worksite Enforcement: How Should Employers Respond to Social Security No-Match Letters?
This has been a year of increased worksite enforcement. In April alone, Immigration and Customs Enforcement (ICE) arrested more people (including both employers and employees) for unauthorized employment then they had in the entire previous year.

07-19-2006

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Fenwick & West, LLP

New Prop 64 Decision Affects Class Actions Under California's Unfair Competition Law: Pfizer Inc. v. Superior Court
Under the California Court of Appeal's July 11, 2006 decision in Pfizer Inc. v. Superior Court, class action plaintiffs seeking to bring unfair business practices or false advertising claims against California businesses now face a greater preemptive challenge.

07-19-2006

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Dorsey & Whitney, L.L.P.

SOX 404 Start Date Arrives for Non-US Issuers
The controversial Section 404 requires companies to, in effect, audit the internal control systems that they rely upon to generate their public disclosures, and disclose certain shortcomings that may be discovered in their internal controls. Larger non-US companies that are subject to SOX will have to make their initial Section 404 certifications and disclosures in respect of their first fiscal year ending after July 15, 2006. Smaller non-US companies that are subject to SOX will have to make their initial certifications and disclosures in respect of their first fiscal year ending after July 15, 2007, although the SEC has indicated that it expects to extend this deadline further. Once companies become subject to Section 404, they must make new certifications and disclosures on an annual basis.

Section 404 has been taking effect for different types of companies on various dates during the past two years. As this latest Section 404 start-up date was about to pass, the SEC signaled its continuing desire to make the cost and administrative burdens of Section 404 bearable for companies. On July 11, 2006, the SEC released a “Concept Release Concerning Management's Reports on Internal Control Over Financial Reporting”. This concept release follows on from two live “roundtables” that the SEC has held, as well as an on-going consultation process that the SEC has engaged in with issuers, issuers' counsel, the auditing community and others, on the subject of how best to structure cost-effective Section 404 compliance.

In the concept release, the SEC states that it expects issue additional guidance on how to comply in a cost-effective manner with Section 404. The SEC anticipates that its forthcoming guidance will cover at least these areas:

How companies can identify risks to financial statement and disclosure accuracy and the internal controls that can be improved to better address these risks, including how management might use company-level controls to address these risks;
What objectives companies should have in evaluating their internal controls, and what methods or approaches management can use to substantiate its evaluation;
What factors management should consider to determine the nature, timing and extent of its evaluation procedures; and
Documentation requirements, including the overall objectives of documentation efforts and factors that might influence documentation requirements.

Non-US companies that are listed in the US or registered with the SEC should currently be doing their best to be ready to issue Section 404 certifications and make Section 404 disclosures under the specific Section 404 deadline applicable to them. In the meantime, the hope remains that the SEC will take concrete steps to ameliorate the harsher aspects of Section 404 compliance and help make compliance less expensive and time-consuming.

07-19-2006

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Bricker & Eckler LLP

What are ILC's?
The application of Wal-Mart to charter an Industrial Loan Company (“ILC”), the proposed acquisition by Home Depot of a Utah ILC, and the media coverage of the industry firestorm surrounding those proposals, has resulted in a focus on the once-quiet world of the ILC and it’s role in the banking and financial services arena. The fact of the matter is that ILC’s have been operating quietly in the background for years and have grown, according to government statistics, from approximately $3 billion in assets to over $160 billion in assets from 1987 to 2004. Six ILC’s have in excess of $3 billion in assets, and one has in excess of $66 billion in assets (and deposits in excess of $50 billion) according to government figures.

The proposals have generated significant industry and consumer advocate interest and commentary, and are the genesis for an extensive GAO study and report on ILC’s and their impact on the financial services industry (GAO-05-621, September 15, 2005; “Industrial Loan Corporations-Recent Asset Growth and Commercial Interest Highlight Differences in Regulatory Authority”). The GAO report was in response to a request by Congressman Jim Leach in consideration of the Wal-Mart application, and has brought a new focus and prominence to the ILC issue as a whole.

So just what are ILC’s, how are they different from banks and thrifts, and what is their future in the financial services market?

Background

The mix of banking and commerce in the U.S. has been severely restricted for decades. ILC’s represent one of the few remaining “loopholes” to entering the banking business without being classified as a “bank” for Bank Holding Company Act (“BHCA”) purposes. In other words, large industrial and commercial companies can (and do) own and operate ILC’s without being classified as a “bank holding company” for BHCA purposes, thereby avoiding Federal Reserve supervision and regulation and the restrictions on commercial activities that being a bank holding company bring.

ILC’s are cut from the same basic cloth as other “non-bank banks” which resulted primarily from certain specific exceptions to the definition of “bank” contained in the Competitive Equality Banking Act of 1987. Those exceptions spawned a variety of “limited purpose” institutions, including “credit card banks” and pure trust companies. ILC’s also successfully escaped the banking and commerce “loophole” closings contained in the Gramm-Leach-Bliley Act in 1999, and continue to represent one of the few remaining exceptions to the general prohibition on combining commerce and banking.

How are ILC’s Structured?

Despite the name, ILC’s are basically state-chartered “banks” which secure FDIC insurance for deposits. Presently a number of states charter ILC’s, the most prominent of which are Utah, Colorado, Nevada and California. ILC’s have branching rights similar to federal thrifts, subject to state law constraints. Both pending proposals involve FDIC-insured Utah ILC’s.

What Products do ILC’s Offer?

ILC’s may engage in traditional banking activities and offer virtually all kinds of traditional bank products including commercial, mortgage, credit card, and consumer lending products; payment-related services (including fedwire and ACH); and FDIC-insured time and savings deposits (subject to the limitation that they may not offer checking accounts if the ILC is larger than $100 million in assets), all with no restriction on type or location of customer.

Who Owns and Operates ILC’s Today?

It often comes as a surprise to learn that, according to government reports, such large and well-known multinational companies as General Electric, General Motors, Pitney-Bowes, Morgan Stanley, Goldman Sachs, Volkswagen, BMW, and Volvo own and operate ILC’s. Again, ILC’s have grown quietly with little fanfare, becoming significant potential competitors in the financial services market.

What Does This Mean to Banks and Thrifts?

The primary issues of concern to banks are those of competitive equality and safety. While bank holding companies are subject to extensive Federal Reserve oversight and significant restrictions on the activities which may be engaged in by the holding company and affiliates, ILC’s and their affiliates are not subject to the same restrictions although their financial products and services are similar if not identical. Some argue that the failure to implement the same restrictions and regulatory safeguards for ILC’s make them inherently more risky to the insurance fund than other FDIC-insured institutions. Other issues raised by opponents include the potential for excessive concentration of resources resulting from combining banking and commerce, the potential for expansion of the federal bank “safety net” to ILC affiliates, and potential unfair allocation of credit by ILC’s to related organizations.

What Happens Now?

FDIC consideration of the Wal-Mart application continues, and multiple hearings have been conducted by the FDIC as a result of unprecedented commentary on the proposal by industry participants, trade associations, consumer advocates, and regulatory agencies. Wal-Mart has committed to limit its activities to those specifically referenced in the application and not to seek expanded banking powers. The Home Depot application process has just begun, and involves broader lending activities. Against this backdrop, there are legislative proposals at the federal level to expand, not restrict, ILC powers to include more commercial bank authority and nationwide de novo branching authority, while maintaining the BHCA exemption. Former Federal Reserve Chairman Alan Greenspan authored a letter to Congressman Leach dated January 20, 2006, citing the GAO report and urging Congress to carefully consider the ongoing appropriateness of the ILC “loophole”.

While Congress is likely to continue to debate whether ILC’s are properly outside of the restrictions of the BHCA, states are still able to charter ILC’s without restriction (subject to the FDIC process). The public policy and industry implications are significant, and whether (and for how long) ILC’s will continue to be able to operate outside of the BHCA, and Federal Reserve supervision, remains to be seen.

07-19-2006

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Leonard, Street and Deinard

Leonard, Street and Deinard highlighted in Compliance Week article regarding SEC compliance
Leonard Street and Deinard was recognized for publishing a survey of Securities and Exchange Commission (SEC) letters in connection with the Form 10-Q in the article, "10-Q Comments; Nasdaq Rules Reshuffled," published in the July 18 issue of Compliance Week. Steve Quinlivan is quoted in the article, which discusses strict corporate compliance with SEC requirements in relation to the Form 10-Q.

07-19-2006

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