Investigations and White Collar Defense

SEC Enforcement Division Announces Cooperation Initiative:  Something New or Tried and True?

At a press conference held on January 13, 2010, the Director of the Division of Enforcement of the Securities and Exchange Commission (SEC), Robert Khuzami, announced a new policy framework of incentives that he characterized as a potential “game-changer for the Enforcement Division.” 

The initiative is designed to encourage early and voluntary cooperation from those individuals and companies that have discovered evidence of potential securities law violations. While the component parts of this initiative may change the manner in which the SEC conducts its investigations, strikingly similar methods have been extensively employed for almost a decade by the United States Department of Justice (DOJ) in its efforts against corporate crime.  Khuzami, a former Assistant United States Attorney for the Southern District of New York, acknowledged the adoption of enforcement tools traditionally employed by federal law enforcement and expressed confidence in the ability of cooperator testimony to provide insider evidence that will aid investigators in building stronger cases more quickly and efficiently.  While cooperation with the SEC may result in leniency in its civil prosecutions, the decision to cooperate, as discussed below, should only be made with the advice of experienced counsel, as it may involve increased risk of criminal liability.   

Three types of formal agreements will be entered into by the SEC with both companies and individuals when warranted by the circumstances of the specific investigation and the quality of cooperation. 

First, cooperation agreements between the Division of Enforcement and the cooperator will provide the cooperator with a recommendation to the Commission that he be given credit for his cooperation in an investigation or related enforcement action if the cooperation amounts to substantial assistance. An example of such assistance is full and truthful information and testimony about the conduct of all those involved in the alleged wrongdoing. These cooperation agreements are similar to plea agreements offered by prosecutors requiring substantial assistance or cooperation from the defendant in return for a possible reduction of sentence, and, like plea agreements, they are recommendations to be considered in the determination of the appropriate mitigation of the penalty in the event of an enforcement action.     

Second, deferred prosecution agreements with cooperators are those in which the Commission defers an enforcement action for a specified period of time during which cooperating individuals or companies not only agree to fully cooperate with the Division of Enforcement, but also to abide by express conditions designed to ensure present and future compliance with securities laws and regulations.  If complete cooperation is provided and the conditions are met, the Commission will forgo any enforcement action. Nevertheless, under the guidelines in the SEC’s Enforcement Manual, the cooperating individual or company will, in all likelihood, be required to agree that any information provided while fully and completely cooperating may be used against the cooperating individual or company if they violate the agreement. Moreover, if the cooperator is a licensed attorney or accountant, broker, dealer, fiduciary, officer or director of a public company, or has previously violated securities laws, an admission or an agreement not to contest the relevant facts will almost certainly be included in the agreement. In the event of a breach of the agreement by the cooperator and the initiation of an enforcement action, the admission may be used against the cooperator by the SEC.  

The DOJ began extensive use of deferred prosecution agreements with cooperating corporations after it announced the formation of its Corporate Fraud Task Force in 2001.  According to a Government Accounting Office (GAO) report issued on January 11, 2010, 130 deferred and nonprosecution agreements had been entered into by federal prosecutors between fiscal years 2004 and 2009. Federal prosecutors are guided primarily by the DOJ’s Principles of Federal Prosecution of Business Organizations when deciding what cases and companies are appropriate candidates for deferred and nonprosecution agreements.  The United States Attorney’s Office that executed the largest number of these agreements was the former office of the SEC’s Director of Enforcement. The agreements contain many of the same kinds of provisions and conditions in the deferred and nonprosecution agreements anticipated by the SEC, and it is common practice for federal prosecutors to include the kind of statement of admitted or uncontested facts called for by the SEC as an attachment to the deferred prosecution agreements they negotiate.

Notably, the Justice Department has negotiated deferred prosecution agreements in securities fraud cases. For example, in United States v. America Online (AOL), a criminal complaint was filed in the Eastern District of Virginia alleging securities fraud related to the accounting for certain transactions. Action on the complaint was deferred in return for AOL’s agreement to fully cooperate, admit wrongdoing, pay a substantial penalty, provide a compensation fund for injured parties, and establish a code of business conduct designed to prevent future wrongdoing. 

In the context of corporate crime, the Justice Department has not encouraged deferred prosecution agreements with individuals. A notable exception is the case of the former CEO of a corporation accused of backdating stock options for its employees.

The third type of agreement is a nonprosecution agreement. While nonprosecution agreements have been negotiated less frequently, their numbers include an agreement with a  medical device company during a healthcare fraud investigation. According to its guidelines, on rare occasions the SEC, like the Justice Department, will enter into a nonprosecution agreement and forgo prosecution of a cooperator without requiring a specified time period within which it can judge the completeness of the cooperation and the cooperator’s compliance with agreed-upon undertakings. 

There are many similarities between the initiative undertaken by the SEC and the use of deferred and nonprosecution agreements by the Justice Department, but a significant difference is that the SEC has adopted an enforcement policy that encourages the consideration and negotiation of those kinds of agreements with cooperators who are individuals.  The SEC promulgated guidelines in 2001 to encourage companies to 1) engage in swift and decisive action when learning of misconduct and 2) voluntarily provide the results of any internal investigation to the Enforcement Division.  However, up to now, absent from its Enforcement Manual have been criteria for the evaluation and crediting of cooperation by individuals and a framework for formal agreements. Four general factors will be considered when evaluating the cooperation of an individual: 1) the assistance provided by the cooperating individual 2) the importance of the underlying matter in which the individual cooperated 3) the societal interest in ensuring that the individual is held accountable and 4) the appropriateness of the credit given the individual cooperator in light of the cooperator’s prior history of offending conduct and the risk of recidivism. 

Responding to a question during his news conference announcing the new initiative, Director Khuzami said that when both SEC civil investigations and Justice Department criminal investigations are ongoing, parallel agreements with those negotiated and executed by prosecutors, rather than joint agreements, will be the norm. Because any violation of federal securities law may result in a criminal prosecution if the requisite intent can be proven,  individuals or companies considering volunteering information about their conduct and seeking a cooperation, deferred prosecution, or nonprosecution agreement must understand the implications of that cooperation beyond potential mitigation of any civil penalty.  Of paramount concern is that the information given to the SEC can be shared with the DOJ and other law enforcement agencies. Thus, any individual or company with even the slightest risk of criminal liability lured by the prospect of a quick and less painful resolution should consult with a criminal defense lawyer.

Another change in policy adopted to accelerate the progress of investigations was announced. Requests to the Justice Department for immunity for witnesses who provide substantial assistance no longer require the approval of the Commission. Authority has been delegated to the Director of the Division of Enforcement. Because the SEC has no power to grant immunity to a witness, it must request formal immunity from the U.S. Attorney General. The immunity obtained protects the witness from the use of any of the witness’s statements or any evidence derived from those statements in a criminal investigation and prosecution. If there is any risk of exposure to a criminal prosecution, the individual who chooses to cooperate with the SEC should seek immunity.

The desire of the SEC to detect and investigate (and have others detect and conduct investigations of) violations and reach speedy resolutions has a renewed sense of urgency because of the intense criticism the SEC received in the Madoff matter. Despite this new enforcement initiative and the potential for leniency attendant to it, companies and individuals, as always, should remain vigilant in their efforts to prevent securities law violations, but should proceed with appropriate caution when considering cooperating with the SEC.  



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