SEC Gets Into the Non-Prosecution Agreement Act

Despite fierce Congressional scrutiny in recent years, the Justice Department's use of deferred-prosecution agreements and non-prosecution agreements continues to soar. And now the Securities and Exchange Commission is taking up the habit.

The SEC struck its first non-prosecution agreement in December with children's clothing retailer Carter's, eleven months after the launch of its Enforcement Cooperation Initiative, which opened the door to such agreements. The SEC's decision to use DPAs and NPAs is part of a broader effort by the Commission to encourage greater cooperation from individuals and companies in investigations and enforcement actions.

The non-prosecution agreement with Carter's resulted in charges of fraud and insider trading against its former executive vice president, Joseph Elles. By entering into the NPA and cooperating in the investigation against Elles, Carter's is off the hook for overstating net income for a period of five years.

According to the complaint, Elles inflated Carter's earnings by giving Kohl's, Carter's largest wholesale customer, massive discounts, which he then concealed by convincing Kohl's to defer subtracting the discounts from payments. Elles was able to pocket $4.7 million in profits through trading of Carter's common stock between May 2005 and March 2009, at which time he was terminated from the company.

The Commission said the NPA reflects the “relatively isolated nature of the unlawful conduct, Carter's prompt and complete self-reporting of the misconduct to the SEC, its exemplary and extensive cooperation in the investigation, including undertaking a thorough and comprehensive internal investigation, and Carter's extensive and substantial remedial actions.”

Mark Schnapp, co-chair of the white-collar criminal practice at law firm Greenberg Traurig, says the non-prosecution agreement signifies that the SEC is becoming more aggressive in its investigations and prosecutions. “The use of an NPA by the SEC both recognizes early cooperation by companies and requires continued corporate involvement in their enforcement efforts,” he says. 

The timing of the non-prosecution agreement with Carter's is also significant, says Steven Scholes, a partner in the law firm McDermott Will & Emery and a former attorney in the SEC's Enforcement Division. Carter's entered into the NPA just 30 days before the SEC brought charges against Elles. By that time, Carter's had already fully cooperated with the SEC. On a practical level, that means they were rolling the dice as to whether their cooperation would later be rewarded with an NPA. “Companies and their lawyers are going to have to make educated guesses as to whether they're going to get a non-prosecution agreement after they cooperate,” he says.

Historically, the SEC has rewarded cooperation more informally, based on several factors the SEC defense bar would consider. For instance, did the company police itself? Did it self-identify and remediate a particular problem? Did it report the problem to the SEC?

“The use of an NPA by the SEC both recognizes early cooperation by companies and requires continued corporate involvement in their enforcement efforts.”

—Mark Schnapp,

Co-Chair, White-Collar Criminal Practice,

Greenberg Traurig

 “It's a very savvy move by the SEC to adopt the use of NPAs, a very smart move,” says Scholes. “In exchange for agreeing not to prosecute, they are getting significant information out of the subjects of their investigations and will continue to do so.” He says companies that enter into these agreements must agree to strict compliance terms.

Carter's, for example, agreed to cooperate fully in any further SEC investigations and in the enforcement action filed against Elles, without any agreed upon termination date. That includes providing testimony by employees, former employees, officers, and directors, as well as producing non-privileged documents and other materials requested by the staff.

According to Scholes, the SEC will increase its use of NPAs and use DPAs as well. “You will see more and more of these in the future,” he says.

DPA-NPA Trends

In addition to the SEC, the Justice Department is experiencing records of its own in the DPA-NPA arena. The increase in the number of agreements stems from many factors, including the DoJ's increased resources and more aggressive stance on corporate crime; an increased emphasis on Foreign Corrupt Practices Act enforcement in particular; and the frequency of voluntary disclosure of potential misconduct by corporations. Thirteen of the 32 agreements in 2010 cited voluntarily self-disclosure of misconduct as a contributing factor to the agreement. 

Additionally, at the Justice Department, the number of DPAs to resolve potential FCPA prosecutions has also risen, accounting for 14 of the 32 agreements in 2010. By comparison, FCPA violations accounted for roughly 24 percent of the agreements in 2009, 26 percent in 2007, and only nine percent in 2006.

While DoJ spokesman Laura Sweeney declined to comment on the increase in deferred- and non-prosecution agreements, she referred to a speech by Assistant Attorney General Lanny Breuer in November in which he stressed the value of cooperation.

In that speech, Breuer cited a deferred prosecution agreement that freight forwarding company Panalpina World Transport entered into with the Justice Department over allegations of bribing foreign officials in numerous countries on behalf of several customers in the oil and gas industry. Five of Panalpina's customers also entered into agreements with the DoJ. “The Panalpina cases are also instructive for what they say about the value of cooperation. I told you last year that we would give corporations ‘meaningful credit' for voluntarily disclosing their conduct and cooperating with our investigation,” said Breuer.

DPA, NPA STATISTICS

Below are two charts from Gibson Dunn & Crutcher. The first chart shows the number of deferred- and non-prosecution agreements that were entered into by the Justice Department between 2000 and 2010; the second chart shows the fourteen different allegations that led to the thirty-two agreements entered by the Justice Department in 2010.

Source: Gibson Dunn & Crutcher DPA Analysis (Jan. 4, 2011).

Extensive cooperation played a large part in the ability of Panalpina to win a deferred prosecution agreement, said Breuer. Specifically, he said, Panalpina engaged counsel to lead investigations encompassing 46 jurisdictions, hired an outside audit firm to perform forensic analysis, and promptly reported the results of its internal investigation in over 60 meetings and calls with the DoJ and the SEC.

In addition, Noble Corp., one of the oil and gas service companies also involved in the DoJ investigation, voluntarily disclosed its conduct and also provided extensive cooperation to the DoJ and the SEC. “In part for those reasons, we entered into a non-prosecution agreement with the company, and Noble paid a criminal penalty substantially below the bottom of the guidelines range,” said Breuer.

In resolving these investigations, the Justice Department entered into five deferred-prosecution agreements, one non-prosecution agreement, and accepted two guilty pleas. No defendant was required to maintain a compliance monitor. “The global resolution of these cases shows … the range of options available to us. But, perhaps more importantly for you, it also shows the range of options available to corporations that are serious about cooperation and prevention,” Breuer said.

Contrary to the outcome of those cases, the GDC data finds that the use of corporate monitors is still fairly prevalent. Ten of the 32 agreements entered during 2010 required a monitor, whereas just one of the 21 agreements in 2009 required a monitor. Monitors were far more likely to be part of the terms of DPAs, as opposed to an NPA; of the 10 agreements that required a monitor in 2010, only three involved NPAs.

Agreements resolving allegations of Medicare fraud were the second most prevalent type of agreement in 2010, constituting eleven percent of the total agreements. The variation of offenses also increased in 2010. The 32 agreements entered in 2010 reflect 14 different types of allegations in the 32 cases.      

Despite coming under increased criticism and scrutiny, lawyers say the use of DPAs and NPAs will continue to rise. Some people look at these types of agreements as letting companies off the hook, says Joseph Warin, chair of Gibson Dunn & Crutcher's white-collar defense and investigations practice. “I think that's a naïve view.”

In cases where the government doesn't prosecute a company, they are going to set some strict compliance standards that a company must comply with for a period of time before the government dismisses a complaint, says Schnapp. “The requirements imposed on a company can be pretty onerous, and I think in many cases, they are very effective,” he says.