Companies, corporate executives, and their lawyers will want to keep a close watch on efforts underway at the Securities and Exchange Commission to foster individual cooperation.
SEC Enforcement Director Robert Khuzami has proposed creating a “Seaboard standard” for individuals, modeled after a policy the SEC adopted in 2001 that set forth the Commission’s expectations for cooperation by companies. The new policy is one of many that Khuzami wants to implement as part of his effort to revive the agency’s tarnished reputation, and many say it could be a most significant policy change.
Khuzami
“This has the potential to be one of most significant of all the changes being contemplated, because it has the potential to materially advance investigations,” says Mark Schonfeld, a partner with Gibson Dunn & Crutcher and former director of the SEC’s New York office.
A cooperation standard for individuals would be a major development because the corporate executives who usually know the most about conduct under SEC investigation also usually decline to testify under Fifth Amendment protections—which blocks the SEC from obtaining information to move a case forward.
Diver
“It’s standard defense practice for corporate officers involved in wrongdoing to keep their heads down, assert the Fifth Amendment if the conduct raises criminal concerns, and wait to be called on to provide information because they’re likely facing career-ending enforcement action,” says Michael Diver, a partner in the law firm Katten Muchin Rosenman and a former SEC branch chief.
With a Seaboard for individuals and the other expected changes, “investigations will take a different tone and tenor, no question.”
—Nader Salehi,
Lawyer,
Bingham McCutchen
The Seaboard move (the name comes from Seaboard Corp., the company originally under investigation that spurred the 2001 policy) is one of several Khuzami is pushing to foster greater cooperation with the SEC. Khuzami has also indicated that he wants to process immunity requests more quickly, so executives won’t worry that cooperation exposes them to criminal liability. The staff will also recommend that the SEC enter into its own version of deferred-prosecution agreements, foregoing enforcement action against a company if it agrees to settlement terms.
Those changes are part of a larger effort to help the SEC speed up its investigations. Other changes coming: letting the enforcement director issue formal orders of investigation, creating specialized investigative units, reassigning branch chiefs to conducting investigations, and creating an Office of Market Intelligence to collect and analyze tips and complaints.
Salehi
With a Seaboard for individuals and the other expected changes, “investigations will take a different tone and tenor, no question,” says Nader Salehi, a former SEC enforcement attorney now with the law firm Bingham McCutchen.
Schonfeld says the SEC has long struggled with how to encourage cooperation from individuals, since the costs to the individual of not cooperating are relatively limited. The SEC’s civil enforcement sanctions—money, injunctions, and a bar from practicing in the industry—often aren’t enough of a threat to induce people to cooperate, he says. At the same time, he says the benefits of cooperating “aren’t sufficient to motivate people to cooperate.”
The agency has historically been reluctant to give people a free pass to encourage their help, Schonfeld says. “Merely offering to reduce someone’s suspension isn’t sufficient incentive to cooperate, when any suspension is a career-ending event for an individual,” he says.
Even with immunity or leniency from the SEC, he continues, cooperating witnesses still face collateral consequences, such as losing their jobs or getting blackballed from other employment.
Fighting Seaboard
Of course, a “Seaboard for individuals” could cause headaches for companies, which may suddenly find its employees are much more chatty with the SEC than they previously were. Richard Morvillo, a partner at the law firm Mayer Brown and a former SEC branch chief, says the move could create a race between companies and executives to tell the SEC about possible wrongdoing.
FOSTERING COOPERATION
Taken from SEC Director of Enforcement Robert Khuzami’s Speech: Fostering Cooperation by Individuals:
… I consider it critical that we increase our incentives to individuals to cooperate in SEC investigations. We have an enormous task—the SEC has anti-fraud jurisdiction over 30,000 issuers, advisors, broker-dealers, transfer agents and issuers, as well as anyone who commits securities fraud—and yet we have only 1,100 Enforcement staff nationwide. It is thus critical that we leverage our limited resources by incentivizing cooperation by individuals, which is often the source of some of the most credible and valuable evidence.
To this end, we are working on four initiatives. Previously, in the “Seaboard” case, the Commission set standards to evaluate cooperation by corporations in enforcement actions. The Division is now seeking to create a “Seaboard” for individuals, a public policy statement that will set forth standards to evaluate cooperation by individuals in enforcement actions. Second, the Division is seeking an expedited process by which the Division Director is delegated the authority to submit immunity requests to the Department of Justice. Third, the Division is exploring ways to provide witnesses in the appropriate cases with oral assurance early on in a case that we do not intend to file charges against them. Fourth and finally, the Division will be prepared to recommend to the Commission that the SEC enter into Deferred Prosecution Agreements, in which we agree in the appropriate case to forego an enforcement action against an individual or entity subject to certain terms, including full cooperation, a waiver of statutes of limitations, and compliance with certain undertakings.
Let me make one observation. While I believe in giving credit for cooperation that results in tangible benefits for investors and the Enforcement program, I don’t believe in being lenient for the sake of leniency, or for rewarding persons for simply complying with routine or expected requests. For that reason, the purpose of these tools is primarily to reward extraordinary cooperation. So if your client has broken the law, and has not provided the requisite level of cooperation, don’t expect leniency. Arguments such as “our competitors do it” or “we’ve always done it this way,” will not be credited.
Source
Robert Khuzami’s First 100 Days as Enforcement Director (Aug. 5, 2009).
“This will put corporations on the defensive in the early stages of investigation, at the very least,” he says. “It will put pressure on a corporation … to move more quickly to make a decision on whether and when to self-report,” rather than risk letting the SEC hear about it from an unhappy worker.
Likewise, Diver says it raises a “host of issues that individuals and their counsel will have to wrestle with, including how to address the officer’s internal reporting and confidentiality obligations.”
Schonfeld
Schonfeld says another challenge for the SEC will be demonstrating to the public and the defense bar that cooperation really does bring meaningful credit—a claim many still find dubious. “It has to be clear to people what would’ve happened but for someone’s cooperation,” he says.
The U.S. Sentencing Guidelines do let people see what the potential outcome might be with (or without) cooperation in criminal investigations, he notes, but nothing similar exists in civil law. And since no reliable record exists of when a person wasn’t charged because he cooperated, individuals have few ways to determine what the possible outcomes might be.
Morvillo
Morvillo says another major concern will be how SEC enforcement lawyers actually apply the factors. “It requires significant amount of discipline and objectivity to evaluate the credibility of [cooperators],” he says. “It's extremely important for SEC officials to weigh all of the evidence and not rush to judgment.”
If the SEC does adopt a Seaboard policy for individuals, Morvillo says the Enforcement Division should also change its policy to identify so-called targets of its investigations. “If they’re rewarding people for coming in and providing information, it’s also important that they give those individuals and their lawyers fair notice, so they understand what the staff’s preliminary views may be,” he says.
Salehi and others say many of the factors in the original Seaboard report—the nature and duration of the misconduct, the amount of harm done, the degree to which the individual was involved and whether he or she personally gained from the misconduct—can all be applied to individuals.
Schonfeld says it should be less complicated than the original Seaboard policy for corporations, since individuals really only need to make themselves available for interviews and to procure documents when asked. Corporations must do much more to meet the same threshold of “being cooperative.”
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