SEC Enforcement Division Gets Sweeping Makeover

The Securities and Exchange Commission is making good on its promise to galvanize its enforcement efforts, implementing new policies to win cooperation from individuals and corporations during its investigations and a revamped personnel structure aimed at helping the agency ferret out complicated wrongdoing more quickly.

The reforms include deferred- and non-prosecution agreements for targets of SEC probes; a so-called “Seaboard Memo for individuals” spelling out how they will be rewarded if they cooperate in investigations; and five specialized enforcement units to tackle crimes such as Ponzi schemes, bribery, and insider trading. The measures are described as the most significant reorganization of the Enforcement Division in more than 30 years, and legal experts say the potential impact on all parties involved in SEC probes is enormous.

Carney

“These changes have the capacity to radically change the way that companies and their officers and employees defend in SEC investigations,” says John Carney, a partner with Baker Hostetler who formerly worked at both the Department of Justice and the SEC.

SEC Enforcement Director Robert Khuzami unveiled the reforms last week. They come in response to a torrent of criticism over how the SEC failed to identify the massive Ponzi scheme carried out by Bernard Madoff for decades, despite numerous warnings from tipsters. The scandal produced in a damning report by the SEC’s inspector general and dozens of recommendations from both the inspector and the Government Accountability Office to improve enforcement.

Philip Khinda, a former SEC enforcement official now at the law firm Steptoe & Johnson, described the announcements as “a great message from the top and a great step forward.” Khuzami, he says, has given the Enforcement Division “both the structure and the tools to be as effective an enforcer as possible.”

Most notable is the SEC’s “Seaboard Memo” that for the first time sets a policy of how the agency will credit individuals who cooperate in investigations. The new guidance is similar to the SEC’s now famous Seaboard Report published in 2001, which explained how the Commission evaluates cooperation from companies. A Seaboard Memo for individuals has been on the wish list of white-collar defense lawyers for years.

The memo identifies four general considerations: the assistance provided; the importance of the underlying matter in which the individual cooperated; society’s interest in ensuring that the individual is held accountable; and the appropriateness of cooperation credit based on the cooperator’s risk profile.

Ryan

Russell Ryan, a partner with the law firm King & Spalding, says the policy is vital because executives in the middle of a corporate crime previously saw no clear benefit to alerting the SEC. “Individuals rarely had any incentive to come forward with information unless and until asked for it, especially if they knew they had potential liability,” he says. “This could really change the dynamic in many investigations.”

Along with the new policy for individuals, Khuzami also said the SEC will begin using deferred- and non-prosecution agreements to move cases along more quickly. DPAs and NPAs are already a common tool the Justice Department uses in criminal cases; the SEC now essentially wants to do the same for the civil cases it pursues.

“These changes have the capacity to radically change the way that companies and their officers and employees defend in SEC investigations.”

—John Carney,

Partner,

Baker Hostetler

The SEC’s version will range from Enforcement Division staff recommending credit for cooperators (corporations and individuals alike) who provide “substantial assistance” in a probe, such as testimony; to DPAs where the Commission will forego enforcement action in exchange for specific reforms; and to rare NPAs, where the SEC agrees not to pursue any enforcement action at all.

In remarks last week, Khuzami described the reforms as “a potential game-changer” that will let SEC enforcement lawyers resolve cases “from a position of strength.” Cooperating witnesses could also help the SEC uncover fraud or other wrongdoing that otherwise might never come to light, he added.

And lastly, the SEC has also streamlined its process to help cooperators get immunity from criminal investigation by the Justice Department. Previously the SEC’s five commissioners had to vote on making such requests; now Khuzami will have the authority to send them to the Justice Department himself.

Doty

James Doty, a partner in the law firm Baker Botts, and former SEC general counsel, says requests for immunity have historically been a rare event at the agency; the new policy might signal that the SEC will be open to using them more often. That, in turn, might lure more cooperators out of the shadows, as they jockey to cut the best deal for themselves.

TOOLS OF THE TRADE

Below are some of the remarks delivered by SEC Enforcement Division chief Robert Khuzami, outlines new tools that will revamp the enforcement regime:

The primary three new tools available are as follows:

First, Cooperation Agreements. They are formal written agreements in which the Division of Enforcement agrees to recommend to the Commission that a cooperator receive credit for cooperating in its investigations or related enforcement actions. Such credit will only be extended if the cooperator provides substantial assistance in those investigations and enforcement actions.

Next are Deferred Prosecution Agreements. These are formal written agreements in which the Commission agrees to forego an enforcement action against a cooperator -- if the individual or company agrees to cooperate fully and truthfully and to comply with certain reforms, controls and other undertakings.

The last are Non-prosecution Agreements. These are formal written agreements, entered into under very limited and appropriate circumstances, in which the Commission agrees not to pursue an enforcement action against a cooperator. Here too the agreement would only be entered if the individual or company agrees to cooperate fully and truthfully in connection with an investigation or enforcement action and to comply with express undertakings.

With these new tools comes a new reality for would-be wrongdoers.

That reality is that when you engage in misconduct, you now have to think even harder about the possibility of others coming forward to report to the SEC your secret conversations, your hushed plans, your schemes and deceptions.

And for those thinking about cooperating, you should seriously consider contacting the SEC quickly, because the benefits of cooperation will be reserved for those whose assistance is both timely and necessary.

Latecomers rarely will qualify for cooperation credit, so there is every reason to step forward—before someone else does—while you are in a position to benefit from your knowledge of wrongdoing.

Source

SEC (Jan. 13, 2009).

One unanswered question, Doty says, is whether the new cooperation tools will allow a person who otherwise would be subject to SEC sanction to get off the hook in exchange for testimony that exposes the company (or its executives) to private civil litigation or SEC enforcement—something that wasn’t possible in the prior regime, Doty says.

Ryan, however, notes a potential catch for would-be cooperators: The cooperation agreements are between the cooperating party and the Enforcement Division only; they are not binding on the Commission itself. Since the five SEC commissioners have the ultimate charging authority, they could theoretically disagree with the Enforcement Division’s judgment “and disregard the agreement entirely,” he says.

Team Approach

Khuzami

In addition to the cooperation reforms, Khuzami also announced the heads of five new, national specialized units to investigate corporate wrongdoing, as well as the head of the SEC’s newly created Office of Market Intelligence. The thinking is that with specialized teams, SEC employees will be better able to fight the ever-more subtle and complex scams in Corporate America—where the perpetrators often have far more money and resources than your standard-issue, overworked government lawyer.

The new teams are:

The Asset Management Unit, led by co-chiefs Bruce Karpati, head of the SEC’s Hedge Fund Working Group, and Robert Kaplan, assistant director of the Enforcement Division. It will focus on investment companies, investment advisers, mutual funds, hedge funds, and private equity funds.

The Market Abuse Unit, headed by Daniel Hawke, director of the SEC’s Philadelphia regional Office. It will focus on large-scale, organized insider-trading and market manipulation schemes.

The Structured and New Products Unit, led by Kenneth Lench, an assistant director in the Enforcement Division. This team will monitor all structured products, including cash and synthetic collateralized debt obligations, credit default swaps, securitized instruments and other structured products, as well as developing products.

The Foreign Corrupt Practices Act Unit, led by Cheryl Scarboro, associate director in the Enforcement Division. This unit will focus on enforcing the rules that ban bribery of foreign officials to win business.

The Municipal Securities and Public Pension Unit, led by Elaine Greenberg, associate regional director of the Philadelphia office and co-chair of the Division’s national Municipal Securities Working Group. It will focus on misconduct in the municipal securities market and public pension funds.

The SEC’s new Office of Market Intelligence will exist separately from the five teams, and be responsible for the collection, analysis, and monitoring of tips the SEC receives. It will be led by Thomas Sporkin, who most recently served as deputy chief in the SEC’s Office of Internet Enforcement.

Gorman

Thomas Gorman, a former SEC attorney now at law firm Porter Wright Morris & Arthur, says the specialized units take the Enforcement Division “back to its roots” and should help concentrate SEC expertise. He also praises the idea of a Market Intelligence Office; the Commission gets thousands of tips every year, he says, and having a “formalized office and set of procedures to work through those should be very beneficial.”

How the teams will interact with the SEC’s existing supervisory and reporting structure remains unclear. Gorman says it will also be important to see how the teams interact with SEC branch offices around the country (the team chiefs are all on the East Coast), and to see who else works on the team staffs.

“What will be critical moving forward is to integrate them into the division to obtain the potential benefits,” he says. “At present, the groups are little more than an idea with a new chief.”