SEC Commissioner Defends Section 404

8/15. Raul Campos, a member of the Securities and Exchange Commission (SEC), gave a speech in Boston, Massachusetts, titled "How to be an Effective Board Member". One of the topics that he addressed was the internal control burdens imposed by Section 404 of the Sarbanes Oxley Act.

Campos (at left) said that the "benefits of Section 404 have been enormous" and that the SEC is committed to a strong "tone at the top" culture. He also said that "the need for strong internal controls and a strong culture of compliance absolutely justify keeping Section 404 around".

Other Commissioners have discussed Section 404 regulation with less enthusiasm. See for example, story titled "Atkins Says SEC Seeks More Rational Approach to Section 404" in TLJ Daily E-Mail Alert No. 1,395, June 20, 2006.

The "Sarbanes-Oxley Act of 2002" was HR 3763 in the 107th Congress. It is now Public Law No. 107-204. Its main sponsors were Sen. Paul Sarbanes (D-MD) and Rep. Mike Oxley (R-OH).

Section 404 is titled "Management assessment of internal controls". It provides, in full, as follows:

(a) RULES REQUIRED- The Commission shall prescribe rules requiring each annual report required by section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) to contain an internal control report, which shall--
   (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and
   (2) contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.
(b) INTERNAL CONTROL EVALUATION AND REPORTING- With respect to the internal control assessment required by subsection (a), each registered public accounting firm that prepares or issues the audit report for the issuer shall attest to, and report on, the assessment made by the management of the issuer. An attestation made under this subsection shall be made in accordance with standards for attestation engagements issued or adopted by the Board. Any such attestation shall not be the subject of a separate engagement.

Small public technologies companies have argued that Section 404, and the SEC's implementation of it, is imposing huge burdens on them, with little benefit to investors. These arguments are supported by the May 8, 2006, Government Accountability Office (GAO) report [93 pages in PDF] titled "Sarbanes-Oxley Act: Consideration of Key Principles Needed in Addressing Implementation for Smaller Public Companies". See also, story titled "GAO Reports that Section 404 of Sarbanes Oxley Burdens Small Public Companies" in TLJ Daily E-Mail Alert No. 1,366, May 9, 2006.

In addition, legislators have begun to introduce bills on this subject. On May 17, 2006, Sen. Jim DeMint (R-SC) and other Senators introduced S 2824, the "Competitive and Open Markets that Protect and Enhance the Treatment of Entrepreneurs Act", or COMPETE Act, which would add a "Smaller Public Company Exemption" to Section 404 of the Sarbanes Oxley Act. See also, HR 5404, the companion bill in the House, introduced by Rep. Tom Feeney (R-FL) and others on May 17. However, most legislators are likely waiting until after Sen. Sarbanes and Rep. Oxley retire at the end of the current Congress before introducing their bills.

Campos stated that the SEC "has been immersed in trying to find a workable implementation plan for Section 404. For the past several months, we have been hearing everywhere -- the press, meetings, and in public forums -- about the extensive costs of Section 404. This has been an extraordinarily complex and difficult policy issue for the Commission since it is quite clear that both the costs and benefits of Section 404 have been enormous."

He continued that "after a series of meetings and a public roundtable on this thorny issue, we issued a ``roadmap´´ last May which outlined the steps that would be taken by the SEC and PCAOB to ease implementation burdens and reduce compliance costs. Much work has already been done -- we recently issued a concept release to solicit comment for forthcoming practical management guidance. And just a few days ago, we issued two releases that extended compliance dates for the auditor attestation portion of Section 404 compliance for foreign private issuers that are accelerated filers (but not large accelerated filers), and proposed to extend compliance dates for Section 404 compliance for all non-accelerated filers. We also proposed to give newly public companies a transition period to comply with the internal control requirements of Section 404." (Parentheses in original.)

Campos concluded that "What all of this means is that we at the SEC are committed to a strong ``tone at the top´´ culture throughout Corporate America. Notwithstanding the extensive costs of Section 404, we have made the policy determination that the need for strong internal controls and a strong culture of compliance absolutely justify keeping Section 404 around. As a result, you -- as directors -- should also commit yourself to encouraging and implementing a pro-active and responsible board culture. You are at the front-line -- therefore, we will look to you to set and implement the proper tone and compliance environment at your respective companies."

Georgelas Sentenced in Islamic Cyber Crime Case

8/15. The U.S. District Court (NDTex) sentenced John Georgelas to 34 months of imprisonment, and ordered him to pay $44,808.00 in restitution, following his plea of guilty to one count of knowingly and intentionally accessing a protected computer without authorization, and recklessly causing damage to that computer, in violation of 18 U.S.C. §§ 1030 (a)(5)(A)(ii) and (a)(5)(B)(i).

The U.S. Attorneys Office for the Northern District of Texas added in a release that Georgelas "has been in custody since his arrest on April 14, 2006 on related charges outlined in a sealed complaint". The USAO release does not identify what those other charges are.

TLJ spoke with a spokesman for the USAO who said that that complaint remains sealed, and the USAO will not disclose its contents.

The USAO release states that Georgelas was a Datacenter Operations Technician at Rackspace Managed Hosting at the Dallas/Fort Worth (DFW) Datacenter facility in Grapevine, Texas, near the airport. The charge to which he plead guilty is based upon his accessing, without authorization, Rackspace servers to obtain the password of a customer, American Israeli Public Affairs Committee (AIPAC).

The USAO release also states that "Georgelas's unauthorized access of Rackspace was motivated by his desire to deface the website of AIPAC.org due to his fundamentalist Muslim beliefs. The government was able to recover chat logs in which Georgelas communicated with a Canadian woman concerning his desire to support Al Qaeda, and he provided technical support to a pro-jihad website, jihadunspun.com, which was used as a propaganda vehicle to promote Osama Bin Laden and Al Qaeda."

The Rackspace web site states that it offers "Fanatical Support". In addition, Rackspace holds U.S. Trademark No. 78754570 for this term.

DC Circuit Upholds FCC's Forbearance Order Regarding Unbundling Obligations Under § 271 in Earthlink v. FCC

8/15. The U.S. Court of Appeals (DCCir) issued its opinion [22 pages in PDF] in Earthlink v. FCC, denying Earthlink's petition for review of the Federal Communications Commission's (FCC) order granting the regional bell operating companies' (RBOCs) petitions for forbearance from enforcement of the FCC's rules that would impose obligations to share, or unbundle, certain parts of their new fiber networks with competitors, such as Earthlink, on regulated terms and conditions.

Verizon, SBC, Qwest, and BellSouth all filed petitions for forbearance with the FCC pursuant to 47 U.S.C. § 160(c). It provides, in part, that "Any telecommunications carrier, or class of telecommunications carriers, may submit a petition to the Commission requesting that the Commission exercise the authority granted under this section with respect to that carrier or those carriers, or any service offered by that carrier or carriers. ... The Commission may grant or deny a petition in whole or in part and shall explain its decision in writing."

Section 160(a) provides that the FCC "shall forbear from applying any regulation or any provision of this chapter to a telecommunications carrier or telecommunications service, or class of telecommunications carriers or telecommunications services, in any or some of its or their geographic markets, if the Commission determines that --- (1) enforcement of such regulation or provision is not necessary to ensure that the charges, practices, classifications, or regulations by, for, or in connection with that telecommunications carrier or telecommunications service are just and reasonable and are not unjustly or unreasonably discriminatory; (2) enforcement of such regulation or provision is not necessary for the protection of consumers; and (3) forbearance from applying such provision or regulation is consistent with the public interest."

The FCC decided to forbear from applying the unbundling obligations listed in 47 U.S.C. § 271 for fiber-to-the-home loops, fiber-to-the-curb loops, packetized functionality of hybrid copper-fiber loops, and packet switching.

The FCC adopted, but did not release, this Memorandum Opinion and Order (MOO) on October 22, 2004. See, story titled "FCC Announces Report and Order Regarding Unbundling Obligations Under § 271" in TLJ Daily E-Mail Alert No. 1,005, October 27, 2004. The FCC's Report and Order is FCC 04-254. The FCC released the text [26 pages in PDF] of this MOO on October 27, 2004.

The FCC's proceeding is titled "In the Matters of Petition for Forbearance of the Verizon Telephone Companies Pursuant to 47 U.S.C. § 160(c), SBC Communications Inc.'s Petition for Forbearance Under 47 U.S.C. § 160(c), Qwest Communications International, Inc. Petition for Forbearance Under 47 U.S.C. § 160(c), BellSouth Telecommunications, Inc. Petition for Forbearance Under 47 U.S.C. § 160(c)". It is numbered WC Docket Nos. 01-338, 03-235, 03-260, and 04-48.

Earthlink, an internet service provider that benefited from the unbundling rules at issue, filed a petition for review of the order granting the petitions for forbearance. The Court of Appeals unanimously denied the petition.

Judge Janice Brown (at right), a recent appointment, wrote the opinion of the Court of Appeals. Judges Sentelle and Edwards joined.

The Court of Appeals concluded that "the FCC's decision (1) survives Chevron analysis, (2) is neither arbitrary nor inconsistent with FCC precedent, and (3) is supported by the record."

Earthlink sought de novo review. The FCC argued in its brief [50 pages in PDF] that the FCC's action is subject to Chevron deference. See, Chevron U.S.A., Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984). The Court of Appeals agreed with the FCC and applied Chevron deference.

The forbearance "statute imposes no particular mode of market analysis or level of geographic rigor". The Court of Appeals continued that "Seizing on the phrase ``geographic markets´´ in § 160(a), EarthLink contends the decision to forbear on a nationwide basis -- without considering more localized regions individually -- is per se improper. This argument is tenuous, at best. In context, the language simply contemplates that the FCC might sometimes forbear in a subset of a carrier’s markets; it is silent about how to determine when such partial relief is appropriate. Similarly, the statute does not require consideration of specific services."

The Court of Appeals also concluded that "Nothing in § 160 prohibits weighing such considerations in assessing the impact of forbearance on rates, consumers, and the public interest."

The Court also wrote that 47 U.S.C. § 706 "explicitly directs the FCC to ``utiliz[e]´´ forbearance to ``encourage the deployment on a reasonable and timely basis of advanced telecommunications capability to all Americans.´´ As the precise interplay between section 706 and the three-part forbearance inquiry is not self-evident from the text, it is precisely the type of ambiguity entrusted to reasonable agency construction. The language of section 706 suggests a forward-looking approach and, reading the two statutory provisions together, we cannot fault the FCC for interpreting it to inform the § 160 analysis."

The Court next rejected Earthlink's argument that the FCC's order "arbitrarily assessed broadband competition in an irrational and ad hoc manner."

And finally, the Court rejected Earthlink's argument that the record does not support the FCC's forbearance determination. It explained that "Given the FCC's forward-looking interpretation and application of the statute, the agency only needed to show that the positive short-term impact of unbundling would be outweighed by the longer-term positive impact that not unbundling would have on rates, consumers, and the public interest. The record here is up to the task."

This case is Earthlink, Inc. v. FCC and USA, respondents, and BellSouth, Corporation, et al., intervenors, U.S. Court of Appeals for the District of Columbia Circuit, App. Ct. No. 05-1087, a petition for review of a final order of the FCC.

Diego Ruiz to Move from FCC to SEC

8/15. Diego Ruiz was named Executive Director of the Securities and Exchange Commission (SEC). He replaces Jim McConnell, who retired. He will be the SEC's chief operating officer, and will oversee the SEC's programs relating to budget planning and execution, preparation of the agency's financial statements, human resources and employee relations, and administration of agency facilities.

On February 2, 2006, Ruiz was named Deputy Chief of the Federal Communications Commission's (FCC) Office of Strategic Planning and Policy Analysis (OSP). See, FCC release [PDF]. Catherine Bohigian remains head of the OSP.

On June 28, 2006, Ruiz testified before the House Commerce Committee's Subcommittee on Oversight and Investigations regarding regulation and censorship of internet service providers and social networking web sites. He asserted then that the FCC's CALEA orders stand as authority for the proposition that the FCC has authority to implement "programs governing the transmission of content by ISPs." See, prepared testimony [6 pages in PDF].

Before his brief employment at the FCC, he worked for Univision Communications, Inc., a Spanish language media company, in a variety of positions, including as President/General Manager of Univision Online. See, SEC release.

More People and Appointments

8/15. Mike Gallagher (at left) joined the Progress and Freedom Foundation (PFF) as an adjunct fellow. He remains a partner in the Washington DC office of the law firm of Perkins Coie. He was previously the head of the Department of Commerce's (DOC) National Telecommunications and Information Administration (NTIA). See, PFF release.

8/15. President Bush announced his intent to appoint three people to be members of the Congressional Executive Commission on the People's Republic of China: Christopher Hill (At Large Representative), Franklin Lavin (Representative of the Department of Commerce), and Barry Lowenkron (Representative of the State Department). See, White House release.

8/15. President Bush announced his intent to appoint Marta Pérez to be Chief Human Capital Officer at the Department of Homeland Security (DHS). She is currently Associate Director of the Human Capital Leadership & Merit System Accountability Division at the Office of Personnel Management. See, White House release.

8/15. James (aka Chip) Burrus was named Assistant Director of the Federal Bureau of Investigation's (FBI) Criminal Investigative Division. See, FBI release. Burrus testified before the Senate Commerce Committee on January 19, 2006 regarding internet related crimes against children. See, Burris' prepared testimony [4 pages in PDF] and partial transcript.

More News

8/15. The Department of Commerce's (DOC) National Telecommunications and Information Administration (NTIA) announced that it has entered into another contract [32 pages in PDF] with the Internet Corporation for Assigned Names and Numbers (ICANN) to perform technical functions supporting the Internet Domain Name system. The NTIA's present contract with the ICANN expires on September 30, 2006. The new contract takes effect on October 1, 2006. See, NTIA release.

9th Circuit Addresses Trademark Abandonment

8/14. The U.S. Court of Appeals (9thCir) issued its opinion [18 pages in PDF] in Electro Source v. Pelican Products, a case regarding trademark abandonment.

The Court of Appeals reversed the summary judgment of the District Court for Pelican Products, the defendant and alleged infringer.

This case involves a registered trademark of a backpack luggage manufacturing and sales business. Ultimately, the business was a failure, and stopped manufacturing more backpacks. However, the owner continued to sell his inventory. The Court of Appeals wrote that he "kept plugging, selling a few backpacks and promoting them at trade shows for several years until he assigned" the trademark to a third party.

15 U.S.C. § 1127 provides, in part, as follows:

"A mark shall be deemed to be ``abandoned´´ if either of the following occurs:
  (1) When its use has been discontinued with intent not to resume such use. Intent not to resume may be inferred from circumstances. Nonuse for 3 consecutive years shall be prima facie evidence of abandonment. ``Use´´ of a mark means the bona fide use of such mark made in the ordinary course of trade, and not made merely to reserve a right in a mark.
  (2) When any course of conduct of the owner, including acts of omission as well as commission, causes the mark to become the generic name for the goods or services on or in connection with which it is used or otherwise to lose its significance as a mark. Purchaser motivation shall not be a test for determining abandonment under this paragraph."

The Court of Appeals held that there is no abandonment of a trademark when a troubled business continues to transport and sell trademarked goods in the ordinary course of trade as part of a good faith effort to deplete inventory. Abandonment requires "both discontinuance of all bona fide trademark use in the ordinary course of trade and an intent not to resume such use. ... Legitimate commercial transport or sales of trademarked goods, even for a failing business, are sufficient to defeat a claim of abandonment."

This case is Electro Source LLC v. Brandess-Kalt-Aetna Group, Inc., Pelican Products, Inc., U.S. Court of Appeals for the 9th Circuit, App. Ct. Nos. 04-56648, 04-55909, and 04-56648, appeals from the U.S. District Court for the Central District of California, D.C. Nos. CV-02-07974-NM.

People and Appointments

8/14. Erik Sirri was named Director of the Securities and Exchange Commission's (SEC) Division of Market Regulation. He is a professor of finance at Babson College in Massachusetts. See, SEC release.

8/14. Nathan Koble joined the National Association of Manufacturers (NAM) in the new position of Director of Internet Strategies. He previously worked for Lockheed Martin. He will supervise the NAM's web team and oversee the day to day operation of the NAM web site.

9th Circuit Addresses Aesthetic Functionality Doctrine in Trademark Law

8/11. The U.S. Court of Appeals (9thCir) issued its opinion [PDF] in Au-Tomotive Gold v. Volkswagen, a trademark case involving the nebulous doctrine of aesthetic functionality. The District Court held that the unlicensed sale of keychains and license plate covers with car makers' trademarked logos was not trademark infringement. The Court of Appeals reversed.

Volkswagen (VW) and Audi make cars. They also make parts and accessories, including key chains and license plate covers. They also hold trademarks. Au-Tomotive Gold (AG) makes key chains and license plate covers that incorporate some of these trademarks, without permission from the car makers.

AG filed a complaint in U.S. District Court (DAriz) against VW and Audi seeking declaratory judgment that its activities did not constitute trademark infringement or trademark counterfeiting under 15 U.S.C. § 1114, unfair competition under 15 U.S.C. § 1125(a), or trademark dilution under 15 U.S.C. § 1125(c). VW and Audi filed counterclaims for trademark infringement under 15 U.S.C. § 1114(1)(a), false designation of origin under 15 U.S.C. § 1125(a), trademark dilution under 15 U.S.C. § 1125(c), consumer fraud under the Arizona Consumer Fraud Act, tortious interference with contract, tortious interference with business expectancy, and trademark counterfeiting under the Arizona Consumer Fraud Act.

The District Court ruled for AG on cross motions for summary judgment. It held that AG's products are not trademark infringements or trademark counterfeiting because they are protected by the aesthetic functionality doctrine. It also enjoined VW and Audi from enforcing their trademarks against AG or its customers.

VW and Audi brought this appeal. The Court of Appeals reversed, vacated and remanded. It held that VW and Audi established a prima facie case with respect to infringement.

The Appeals Court noted that consumers sometimes buy products bearing marks such as Mercedes tri-point star for the appeal of the mark itself, and without regard to whether it signifies the origin or sponsorship of the product. In this case, AG argued that consumers bought its products with VW and Audi logos, not because the logos designated the origin of the products, but because the consumers wanted the aesthetic quality of the products. Hence, AG argued that its products are not subject to trademark protection.

The Court of Appeals concluded that AG's position "would be the death knell for trademark protection. It would mean that simply because a consumer likes a trademark, or finds it aesthetically pleasing, a competitor could adopt and use the mark on its own products. Thus, a competitor could adopt the distinctive Mercedes circle and tri-point star or the well-known golden arches of McDonald’s, all under the rubric of aesthetic functionality."

This case is Au-Tomotive Gold, Inc. v. Volkswagen of America, Inc., et al., U.S. Court of Appeals for the 9th Circuit, App. Ct. No. 04-16174, an appeal from the U.S. District Court for the District of Arizona, D.C. Nos. CV-01-00162-WDB and CV-01-00508-WDB, Judge William Browning presiding.

More News

8/11. The Research Institute of Telecommunications and Economics, Japan (RITE) and the National Institute of Information and Communications Technology (NICT) are relocating their Washington DC offices, effective August 11, 2006. The new address is 1020 19th Street, NW, Suite 880, Washington, DC, 20036. The phone numbers and e-mail addresses remain the same.

Go to News from August 6-10, 2006.