The SEC’s Director of Enforcement Robert Khuzami unveiled on January 13, 2010 a new set of policies and procedures for the Division of Enforcement to utilize in fostering cooperation of individuals and companies in the Enforcement Division’s investigations. Mr. Khuzami, a former criminal prosecutor, announced that the SEC will implement for the first time a number of tools long-utilized by United States Attorney’s Offices in criminal investigations. Among the new tools are formal Cooperation Agreements, Deferred Prosecution Agreements and Non-Prosecution Agreements. For individuals, the cooperation initiatives are nearly all new – they both establish for the first time a framework for analyzing the value of an individual’s cooperation and provide new tools for securing and rewarding that cooperation. With respect to corporate cooperation, the new initiatives rely on an analytical framework previously issued by the Commission in 2001 in the so-called Seaboard Report but, as with individuals, several of the new tools that have been announced would also apply for the first time to companies.
Describing the new initiatives as a “potential game-changer for the Division of Enforcement,” Mr. Khuzami appeared to highlight in particular the new incentives for individuals to cooperate early and substantially in its investigations. In a press statement accompanying the announced procedures, Mr. Khuzami said that “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.” Emphasizing the point that those first in the door will receive the most credit, Mr. Khuzami went on to say that “[l]atecomers 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.”
The extent to which individuals under investigation by the SEC will seek to avail themselves of this invitation to step forward in exchange for formal cooperation credit remains to be seen. If the frequency with which cooperation agreements are used in criminal investigations is any guide, the procedures at some point could become a staple of the SEC Enforcement staff. But the practical differences between investigations in the criminal context and civil investigations conducted by the SEC may make adopting these new cooperation tools more challenging in the civil context. Nevertheless, given the incentives the SEC is seeking to create for cooperation, these new procedures will have implications for companies and individuals responding to SEC investigations. In this memorandum, we review the new procedures that the SEC has announced and discuss some of the implications that these measures will likely have.
New Enforcement Manual Procedures. The cooperation principles and mechanisms are described in detail in a new section of the SEC’s Enforcement Manual entitled “Fostering Cooperation.”1 The Enforcement Manual, recently updated to include the new cooperation provisions, outlines the Division of Enforcement’s policies and procedures with respect to a number of topics and is publicly available on the SEC’s website.2 The cooperation policy first introduces the framework and principles that the SEC will consider in evaluating “whether, how much, and in what manner to credit cooperation” by individuals and companies. In subsequent sections of the policy, the SEC outlines the tools that the SEC staff may utilize to secure and reward cooperation.
Almost all of these procedures are new. Although the SEC previously had a process by which the staff could obtain an “assurance letter” from the Commission to assure a witness that the SEC does not intend to bring an enforcement action against the witness, the procedure was very rarely utilized. Moreover, in the first public iteration of the Enforcement Manual, the policy made clear that such letters were available only in “very limited circumstances.”3 Because the Commission’s formal approval had to be obtained and that process could be time consuming, Enforcement staff also had little incentive to seek to secure cooperation in exchange for such a grant of such “no action” assurance from the Commission. Given there is little procedural history to build upon, in implementing the cooperation procedures, the staff will have to determine how often and in what stages of investigations they will seek to utilize these new tools. Counsel for companies and individuals will also have strategic decisions to make regarding whether to come forward seeking cooperation credit and how to respond to requests for interviews or testimony in light of the potential protections available under the new procedures.
Framework for Cooperation. The SEC outlines in the Enforcement Manual the factors that it will consider in determining whether to give credit for cooperation for both individuals and companies. The factors for individuals are enumerated in the most detail, as the SEC invoked prior guidance issued in 2001 with respect to the cooperation factors to be considered when companies are involved. The distinction in the procedures may reflect the practical consideration that individuals, rather than companies, will most often be in a position to exchange information for cooperation credit. In addition, the SEC has had in place for a longer period a framework for rewarding cooperation by companies.
Individual Cooperation. For individuals, the Commission has established four factors it will consider in determining whether and to what extent cooperation credit should be recognized. The policy also enumerates a list of considerations under each factor to provide additional context for them. The factors are:
- • Assistance provided by the cooperating individual in the Commission’s investigation;
- • Importance of the underlying matter in which the individual is cooperating;
- Societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct; and
- Appropriateness of cooperation credit based upon the profile of the cooperating individual.
The first factor is the one with respect to which a cooperating individual has the most control. The factor relates to the “value” and “nature” of the individual’s cooperation. Among other things, the SEC will consider whether the investigation was “initiated based on information or cooperation provided by the individual,” and what “time and resources [were] conserved” as a result of the cooperation. Notably, in keeping with Mr. Khuzami’s public statements, the SEC expressly includes as a consideration the “timeliness of the individual’s cooperation, including whether the individual was first to report the misconduct to the Commission or to offer his or her cooperation in the Investigation, and whether the cooperation was provided before he or she had any knowledge of a pending investigation.” The SEC will also consider whether the individual offers information that was not directly requested or otherwise might not have been discovered in assessing the value of the cooperation provided. In light of this factor, individuals aware of wrongdoing may be in a position to secure substantial cooperation credit if they come forward early in an investigation.
The second factor relates to the type of case at issue. Not surprisingly, the higher priority the case, the more likely the SEC will be to reward cooperation. The guidance on this factor contains a footnote stating “[c]ooperation in Investigations that involve priority matters or serious, ongoing, or widespread violations will be viewed most favorably.” For individuals and their counsel, recognizing whether (1) the misconduct at issue may be ongoing, and (2) whether the subject matter involved relates to a priority investigative area for the SEC will likely be considerations in determining whether and when an individual may want to come forward with in a given investigation. The third and fourth factors relate to countervailing considerations that the SEC may tend to weigh against an individual receiving credit for his or her assistance. The third factor pertains to the “societal interest in holding the cooperating individual fully accountable for his or her misconduct.” In assessing that interest, the SEC considers the nature and severity of the individual’s misconduct in the context of his or her “education, training, experience, and position of responsibility” and whether the individual acted with scienter in his or her own misconduct. The SEC will also consider in this factor whether the individual took steps to report or stop the misconduct and any actions taken to remediate the misconduct for which the individual is responsible.
The fourth factor – the “profile of the individual” – provides additional context for the individual’s conduct. The SEC will consider whether the cooperating individual has a history of “lawfulness” and the extent to which the individual accepts responsibility for past misconduct. The SEC will also consider in this factor the nature of the individual’s responsibilities relative to the misconduct and his or her opportunity to commit future violations in light of his or her occupation. The SEC will consider whether the individuals at issue are “licensed individuals” such as attorneys and accountants, a person associated with a regulated entity such as brokers or dealers, or others who have fiduciary duties or responsibilities such as corporate officers and directors.
The SEC will collectively assess these factors and determine whether it deems the cooperation worthy of credit and reward. The SEC’s guidance states that the credit for cooperation may range from the SEC taking no enforcement action to pursuing reduced charges and sanctions in connection with enforcement actions. If it is determined that the cooperation is worthy of credit, the SEC now has a range of tools to seek to recognize this cooperation.
Corporate Cooperation. In contrast with the new guidance on individual cooperation, the SEC cited in the new procedures prior guidance it has issued to address a corporation’s cooperation. The SEC refers in the new procedures to the Section 21(a) Report of Investigation the Commission issued in 2001 known as the “Seaboard Report.”4 The new guidelines recognize that the Commission “articulated an analytical framework for evaluating cooperation by companies” in the Seaboard Report and cites four factors from it that will be considered for purposes of determining whether a corporation should receive credit for cooperation. Practitioners before the SEC will find these factors familiar territory – (1) self-policing prior to discovery of the misconduct, (2) self-reporting of misconduct by a company, (3) remediation efforts, and (4) cooperation with law enforcement authorities. In the updated manual, the SEC also refers the Enforcement staff to the Seaboard Report itself for “greater detail regarding the analytical framework used by the Commission to evaluate cooperation by companies.”
Cooperation Tools. After setting out the framework for assessing the value of an individual’s or company’s cooperation, the SEC’s new guidance identifies five primary tools that may be used in connection with the cooperation program: (1) proffer agreements, (2) cooperation agreements, (3) deferred prosecution agreements, (4) non-prosecution agreements and (5) criminal immunity requests. Three of these tools – cooperation, deferred prosecution and nonprosecution agreements – have not been used before by the staff. The other tools existed before, but the SEC has for the first time integrated them into a comprehensive package aimed at securing cooperation.
Proffer Agreements. Proffer agreements allow the SEC to interview a witness in circumstances in which the statements made in the interview cannot be used directly against the individual. The SEC can use the statements to pursue other leads in the case, but generally may not use the statements against the individual unless the person later testifies inconsistently with the statements made during the proffer. Historically, the SEC utilized proffer agreements most often when a witness was appearing jointly before the SEC and criminal authorities, and the criminal authorities also decided to extend the witness a proffer agreement (also known as a “Queen for a Day” Letter). Now, however, the SEC’s guidance provides that the staff “should require a potential cooperating individual to make a detailed proffer before selecting and utilizing other cooperation tools.” As a result, the staff is likely to utilize proffer agreements more often as the first step in assessing whether and how to reward someone for their cooperation.
The SEC guidance pertaining to proffer agreements also arms the staff with a related new procedure. The staff is now explicitly empowered to provide “Oral Assurances” to an individual or company that the Enforcement Division does not anticipate recommending an enforcement action against them based on the evidence known at the time. Such assurances sometimes could be obtained informally in the past, but the staff is now explicitly empowered to provide them without Commission approval. Presumably, the SEC contemplates providing such assurances in the context of discussing whether an individual or corporation will seek a cooperation agreement of some kind. As a practical matter, however, it seems likely that practitioners before the SEC may seek to utilize this procedure beyond that context. For example, attorneys with clients who have been asked to provide an interview or testimony to the staff may seek oral assurances about the status of their client before agreeing to make the witness available.
Cooperation Agreements. Next in the hierarchy of agreements, the new guidance provides details regarding cooperation agreements that the staff may enter into with individuals and companies. In such agreements, the Enforcement staff agrees to recommend that the individual or company receive credit for their cooperation and “under certain circumstances” to make “specific recommendations to the Commission” in exchange for assistance provided by the individual or company. Although the types of “specific recommendations” the staff may make are not identified in the guidance, cooperation agreements would presumably be used when some recommendation against an individual or company is forthcoming, but the charges or sanctions recommended would be reduced in light of cooperation. In contrast, non-prosecution and deferred prosecution agreements would be used when the cooperation would result in no charges against the individual or company.
Cooperation agreements can be approved by the Director of Enforcement and “those senior officers designated by the Director.” Consequently, the staff need not go through the process of getting Commission approval to enter into them. The cooperation agreements will include a number of standard terms that are typical of criminal cooperation agreements. The individual or company will be required to cooperate fully and truthfully with the investigation, appear for interviews and testimony, waive the statute of limitations, and not commit further violations. Notably, however, the agreement is not binding on the Commission itself and it will be up to the Division of Enforcement to determine whether the cooperating individual or company ultimately satisfied the agreement and rendered substantial assistance to the investigation.
Deferred and Non-Prosecution Agreements. Similar to their criminal analogs, the SEC can now utilize deferred and non-prosecution agreements in an effort to secure cooperation. These agreements are similar in purpose and effect. Both types of agreement have the result that, if the individual or company satisfies the terms of the agreement, no action will be taken against them by the Commission. The primary difference is that, in deferred prosecution agreements, the cooperating individual or corporation normally admits or agrees not to contest certain facts underlying specified offenses such that, if the agreement is violated, the SEC can use the admissions against the individual or company in bringing an Enforcement action.5 Nonprosecution agreements do not include such admissions. Both of these types of agreements must be approved by the Commission, so the staff does not have delegated authority to enter into them. Under the SEC guidance, these agreements are required to include certain enumerated terms that concern, among other things, the nature of the cooperation and the consequences for violating the agreement.
Immunity Requests. The final weapon in the SEC’s new cooperation arsenal is a streamlined procedure under which the SEC may seek to obtain immunity from criminal prosecution for witnesses who refuse to testify before the SEC by invoking their Fifth Amendment privilege against self-incrimination. Historically, if a witness asserted his or her Fifth Amendment rights, the SEC was often effectively blocked from obtaining the individual’s testimony. Although there was (and still is) a process to seek immunity from prosecution from the Commission with approval from the Department of Justice, it was very infrequently used. Under the new process, the SEC has delegated authority to the Director of Enforcement to make immunity requests to the Department of Justice so that an individual can testify without fear of criminal prosecution.
Practical Considerations In Light of the New Procedures. The SEC’s Enforcement Division appears committed to adopting these new mechanisms in Enforcement investigations. As a practical matter, however, it may prove difficult for the SEC to make frequent use of these procedures due to the inherent differences between SEC investigations and the criminal investigations from which they have borrowed these tools. In addition, because there are some established practices for rewarding cooperation in the settlement context, it is not clear that these new procedures will be seen by defense counsel as sufficiently useful to supplant the more traditional processes.
Adequate Rewards? One consideration is whether the rewards are adequate in the civil SEC context to justify the risks that would be incurred by an individual in making the types of admissions necessary to secure cooperation credit. The SEC has the power to (1) obtain certain financial sanctions (in the form of disgorgement, interest and penalties); (2) obtain injunctions against future misconduct or administrative cease-and-desist Orders; and (3) bar certain professionals from the securities industry or from practice before the SEC. In negotiating with cooperators, therefore, the SEC has a relatively limited set of bargaining chips compared to the criminal authorities which have the more significant power to seek to incarcerate wrongdoers.
In the context of cooperation agreements, for example, it appears the SEC contemplates obtaining full cooperation from an individual in exchange for a reduction in the sanctions that the SEC would otherwise seek in an Enforcement action against that person. Such a reduction could take the form of a reduced charge or reduced financial sanctions. It is not clear, however, whether this type of reduction will be sufficient incentive for individuals to admit wrongdoing or to implicate others in wrongdoing. This is particularly true when the cooperation agreement does not bind the Commission and, notwithstanding full cooperation, an individual could find that the Commission will not agree to accept Enforcement’s recommendations for reduced sanctions. As a result, it may take some time for the SEC to establish a track record for using these agreements successfully and consistently before they become widely relied upon.
Corporate cooperators? Although the new procedures contemplate that the various tools and agreements can be used to secure corporate cooperation as well as individual cooperation, it is difficult to envision the circumstances in which corporations would seek to avail themselves of cooperation credit through these new tools. Certainly, companies will continue to seek to obtain credit for actions that they take in investigations such as self-reporting violations, remedial measures, and efforts to hold individual employees accountable for misconduct. But it is not clear that corporations will be in a practical position to provide prospective cooperation in an investigation to warrant the provision of a cooperation, deferred prosecution or non-prosecution agreement. Moreover, because corporations are often essentially required to cooperate with SEC investigations through routine investigative measures, there may not be much incentive for Enforcement staff to agree to seek reduced sanctions or to take no action against a company in order to secure its cooperation.
New considerations for multiple representations. Defense counsel representing companies under investigation by the SEC also often represent employees of the company who are called to testify. From a client cost perspective, this is often the most efficient and preferred way to proceed. There can also be defense strategy reasons for this approach – this type of representation can better enable counsel to present a united front in defending the clients. Multiple representations are usually not problematic so long as there is not a conflict between the interests of an employee and the interests of the company. In the event of a conflict, however, corporate employees typically need to obtain separate counsel.
Counsel considering whether to undertake multiple representations in SEC investigations, however, may now need to evaluate even more carefully the potential that the availability of cooperation credit for an individual employee may affect the alignment of the individual’s and the companie’s interests. If an employee could obtain credit by revealing misconduct at the company, a conflict may arise and separate counsel will need to be considered. Mr. Khuzami highlighted this issue in a speech in December 2009 in which he previewed the cooperation initiatives, stating that “the broader availability of cooperation credit will increase the risk of conflicts of interest in situations where counsel seeks to represent multiple clients.”6 Mr. Khuzami noted that conflicts can arise, for example, when it may be in the interest of one client to be the first to report misconduct – but, he noted, “only one client can be first.”
In addition to the consideration of the existence of potential conflicts, defense counsel undertaking multiple representations may also now need to consider whether additional advice and disclosures should be provided to individuals about the existence of potential cooperation credit. Increased disclosures may have the effect of causing more employees to consider separate representation. In light of these considerations, one by-product of the new cooperation procedures may be increased costs for companies over time in responding to SEC investigations because more employees ultimately will need separate representation and may seek to cut separate deals with the SEC for cooperation.
Conclusion. The Division of Enforcement’s adoption of new cooperation procedures is a significant step that may provide the staff greater leverage in discovering wrongdoing and prosecuting cases. Time will tell, however, whether the procedures will be as significant in the SEC context as they are in criminal investigations. Even if they are not utilized as often, these new measures will have implications for those responding to SEC investigations and those under investigation are well advised to familiarize themselves with the parameters of the staff’s new options in this arena.