From the first moment SEC Enforcement Director Robert Khuzami proposed an initiative to foster cooperation by individuals in investigations -- in an August 5, 2009 speech to the New York City Bar Association, Khuzami proposed a “Seaboard for individuals” standard that would provide credit to individuals for “extraordinary cooperation” 1 -- observers have eagerly anticipated the unveiling of this policy. The waiting is over. On January 13, 2010, the SEC empowered its Enforcement staff with several new policies designed to encourage individuals (and companies) to assist in investigations and revealed new standards for weighing cooperation credit for individuals that correspond with its longstanding policy of offering cooperation credit to companies. Now a new question weighs on the minds of SEC observers and practitioners – will these policies enable Khuzami to achieve his vision to “leverage [the SEC’s] limited resources by incentivizing cooperation for individuals, which is often the source of some of the most credible and valuable evidence.” Only time will tell.
In this historic announcement, which Khuzami described as a “potential game-changer for the Division of Enforcement,” the SEC for the first time set forth new standards to evaluate and potentially reward cooperation by individuals in enforcement actions. The full text is incorporated into the SEC’s Enforcement Manual in a new Section 6 titled “Fostering Cooperation.” In brief, the policy states that the Commission will focus on four considerations in evaluating an individual’s cooperation: (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 for his or her misconduct, and (4) the appropriateness of cooperation credit based upon the risk profile of the cooperating individual.
The Commission’s evaluation of the first factor -- the level of assistance provided by a cooperating individual -- will involve an assessment of, among other things, the value of the cooperation provided, (including whether the cooperation substantially assisted the investigation), the timeliness of the cooperation (including whether an individual had prior knowledge of a pending investigation before reporting any misconduct), the quality of the cooperation, and the time and resources conserved as a result of the individual’s cooperation. The Commission will also consider the nature of the cooperation, including whether the cooperation was voluntary and whether it involved providing information not requested or otherwise discovered by the staff and whether the individual encouraged others to cooperate as well.
The second factor -- consideration of the importance of the underlying investigation -- will involve a review of whether the subject matter is a Commission priority, the type and number of underlying violations and whether they are isolated or repetitive in nature, the age and duration of the misconduct, the amount of harm or potential harm caused, and the number of individuals affected.
The Commission will assess the third factor, societal interest in holding an individual accountable for misconduct, by considering the severity of the misconduct in the context of the individual’s knowledge, education, training, experience, and position of responsibility, whether the individual acted with scienter, the degree to which the individual either tolerated illegal activity or took steps to prevent the violations from occurring (e.g., notifying the Commission or the corporation’s board of directors), efforts taken by the individual to remediate the harm caused by the violations, and any sanctions imposed by other federal or state authorities or organizations.
And lastly, in examining the fourth and final factor of whether extending cooperation would be appropriate based on the individual’s professional profile, the Commission will consider the individual’s history of lawfulness, the degree to which the individual has accepted responsibility for past misconduct, and the degree to which the individual will have future opportunities to commit other securities violations by virtue of his or her occupation, including by serving as a licensed individual such as a lawyer or accountant, an associated person of a regulated entity, a fiduciary for individuals or entities regarding financial matters, an officer or director of public companies, or as a member of senior management.
This new policy initiative is among the most significant of the sweeping changes underway in the Enforcement Division at the SEC. Individuals often have little incentive to do more than lie low and wait for the SEC to work through its investigative process, since an enforcement action in many instances could be career-ending for an individual. In some instances, corporate employees with the most knowledge about conduct under investigation invoke their Fifth Amendment right to decline to testify before the SEC, thereby impeding the SEC’s ability to quickly gather relevant information. The prospect of receiving some form of cooperation credit may indeed prompt individuals to more readily share damaging information with the Commission. Of course, the key is how much credit is provided and what individuals must do to get it -- two major details that are not clear from the Division’s announcements.
Equally notable, the SEC adopted additional new tools to encourage and reward cooperation by individuals (and companies). These tools include the following agreements long used by the Justice Department in criminal investigations:
- Cooperation Agreements – The Enforcement staff will now provide formal written agreements in which the staff will agree to recommend to the Commission that a cooperating individual receive credit, providing the individual’s cooperation involves “substantial assistance such as full and truthful information and testimony.” These agreements will not be binding on the Commission, which may decide to go forward with an enforcement action in spite of the agreement.
- Deferred Prosecution Agreements – The Commission will agree under certain conditions to enter into a formal written agreement to forego an enforcement action providing an individual agrees to cooperate fully and truthfully and comply with express prohibitions and undertakings for a fixed period not to exceed five years. Under certain circumstances, individuals may need to admit or at least not contest the underlying facts.
- Non-prosecution Agreements – In limited circumstances, the Commission will enter into a formal written agreement agreeing not to pursue a cooperating individual providing the individual agrees, among other things, to cooperate fully and truthfully and comply with express undertakings. Individuals with prior securities violations on their record will, in virtually all cases, not be considered for a non-prosecution agreement.2
The SEC’s new cooperation policies and tools raise two particularly interesting issues for SEC defense practitioners. First, how will the new “cooperation credit for individuals” policy mesh with the SEC’s goal to hold individuals accountable for the securities violations of corporations? The SEC’s Enforcement Manual acknowledges that with any cooperation program, “there exists some tension between the objectives of holding individuals fully accountable for their misconduct and providing incentives for individuals to cooperate with law enforcement authorities.” The SEC’s recent enforcement actions against former executives of Countrywide Financial Corporation, American Home Mortgage Corporation, and Nature’s Sunshine Products Inc.,3 not to mention Judge Rakoff’s criticism of the SEC’s attempt to settle an enforcement action with Bank of America late last year without holding any executives accountable, portend an aggressive SEC pursuit of liability against individuals in conjunction with enforcement actions against corporations. It is unclear exactly how the SEC will balance the competing objectives presented in situations where an active participant in a company’s violation is the best source of the pertinent details necessary for the SEC to prove its case.
Second, what types of challenges will arise for company counsel where a company employee is eager to provide substantial assistance to the SEC in exchange for the possibility of receiving some tangible “credit”? For example, diverging interests could arise quickly in situations where a corporate executive is eager to earn cooperation credit for himself or herself, rather than for the company, by reporting possible wrongdoing to the SEC before the company does.
In the aftermath of the SEC’s cooperation initiatives, companies and their counsel may need to be prepared to quickly assess allegations of potential violations and develop a defense strategy in circumstances where employees are incentivized to directly approach the SEC, particularly in light of the agency’s push to pursue investigations promptly and aggressively.4