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SEC Publishes News Policy on Cooperation in Its Investigations

By James A. Meyers

On January 13, 2010, the SEC published its long-awaited Policy Statement Concerning Cooperation by Individuals in Its Investigations and Related Enforcement Actions. The new Policy Statement is set forth at 17 C.F.R. 202.12, and is also included in Section 6 (titled "Fostering Cooperation") of the revised version of the SEC Division of Enforcement's Enforcement Manual, released the same day. Though the Policy Statement on its face applies only to individuals, the enforcement staff will surely apply its principles to companies as well, under the overall framework of the Commission's October 2001 Seaboard Report, which stated the factors the Commission will consider in determining whether and to what extent it will give credit for cooperation to investigated companies. The new Policy Statement and the revised Enforcement Manual are important developments for anyone representing professional services firms or their associated individuals in SEC investigations.

Under the Policy Statement, the Commission's determination whether, how much, and in what manner to credit cooperation by individuals will involve four considerations:

  • The assistance provided by the cooperating individual in the investigation or related enforcement actions
  • The importance of the underlying matter in which the individual cooperated
  • The societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct
  • The appropriateness of cooperation credit based upon the profile of the cooperating individual

Under the "assistance" prong of the inquiry, the Commission and Enforcement Staff will consider the nature and value of the individual's cooperation. Specific factors include (1) the timeliness and quality of the assistance; (2) whether the assistance resulted in the initiation of an investigation; (3) whether the assistance conserved Staff time and resources; (4) whether the cooperation was voluntary; (5) whether the individual provided "non-privileged" information that was not requested or that otherwise might not have been discovered; and (6) whether the individual encouraged others to cooperate.

Notably, according to an earlier section of the revised Enforcement Manual, an assertion of attorney-client privilege or work product protection "will not negatively affect [a] claim to credit for cooperation. The appropriate inquiry in this regard is whether, notwithstanding a legitimate [privilege assertion], the party has disclosed all relevant underlying facts within its knowledge. By timely disclosing the relevant underlying facts, a party may demonstrate cooperation for which the staff may give credit, while simultaneously asserting privilege." The revised Manual also states that "[t]he staff must respect legitimate" privilege assertions of privilege and that the staff should not seek a waiver of privilege without the prior approval of the enforcement director or deputy director.

As to providing the SEC with privileged information obtained in corporate internal investigations, the revised manual states as follows:

To receive cooperation credit for providing factual information obtained from the interviews, the corporation need not necessarily produce, and the staff may not request without approval, protected notes or memoranda generated by the attorneys' interviews. To earn such credit, however, the corporation does need to produce, and the staff always may request, relevant factual information - including relevant factual information acquired through those interviews.

It is also noteworthy that, contrary to earlier rumors, the statement does not limit cooperation credit to an individual who is the "first one in" to proffer cooperation, though that will be one factor that the Commission will consider.

The "importance" prong of the analysis focuses on the character of the investigation (whether the subject matter is a Commission priority, the age, duration and type of conduct, the number of alleged violations, and whether the conduct is isolated or recurring), as well as the dangers to investors, both in nature and amount, presented by the alleged misconduct. As the Commission put it, cooperation "that involve[s] priority matters or serious, ongoing, or widespread violations will be viewed most favorably."

The "accountability" prong will assess the severity of the individual's alleged misconduct, whether the individual acted with the intent to deceive, whether the individual took steps to prevent the conduct from occurring or notified the SEC, other law enforcement authorities or members of management or the board of directors, whether the individual took other remedial steps, and whether the individual has been subjected to sanctions by other authorities.

Finally, the "individual profile" prong of the inquiry looks into the individual's history of lawfulness, acceptance of responsibility, and opportunity to commit future violations. These considerations are similar to the so-called Steadman factors that courts consider in deciding whether an injunction is appropriate in federal court actions. See Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979).

The SEC acknowledged that the Policy Statement involves a case-by-case inquiry and that, accordingly, there are no hard and fast rules. Yet, this statement is perhaps the most detailed, specific delineation of the criteria the Commission and its enforcement staff will use in deciding whether and to what extent to reward cooperation, and thus it provides a highly useful tool for counsel with clients who are the subject of a staff inquiry or investigation.

In the same release, the Commission also outlined five means it will use to facilitate and reward cooperation: proffer agreements; written cooperation agreements pursuant to which the staff will, among other things, agree to recommend that an individual or company receive credit for cooperation; deferred proffer agreements (DPAs); Non-Prosecution Agreements (NPAs); and immunity requests. While the SEC has used proffer agreements for some time, the other tools are new to the SEC. Tools such as DPAs, NPAs, and grants of immunity have more commonly been used by the Department of Justice in criminal investigation. Their use in SEC matters appears to be another example of change in the SEC Enforcement Division resulting from Director Robert Khuzami's former tenure as head of the securities fraud unit of the Southern District of New York U.S. Attorney's Office.

There are already numerous questions surrounding the Commission's stated new initiative. The new Policy Statement makes clear that, in order to receive a cooperation agreement, DPA, or NPA, the individual will have to give proffers that, in many cases, may entail admissions of violations of the federal securities laws. Cooperation agreements "should generally include" terms that "the cooperating individual or company agrees not to violate the securities law" (i.e., agrees to injunctive relief) and that "the cooperating individual or company acknowledges that the agreement does not constitute a final disposition of any potential enforcement action"; thus, cooperation agreements may not provide the finality that "targets" and their counsel seek.

The Policy Statement contains similar provisions for DPAs; it also (1) makes the payment of agreed-upon penalties and/or disgorgement and "additional prohibitions and undertakings" presumptive terms of DPAs and (2) states that one of the considerations the Commission will apply is whether the individual has made "[a]n admission or an agreement not to contest the relevant facts underlying the alleged offenses." NPAs should also "generally include" provisions for making agreed-upon disgorgement or penalty payments as well as "additional undertakings." Under these circumstances, and particularly in the absence of a track record of how the Policy Statement is to be applied, it is unclear how cooperating to obtain any of these forms of agreement will materially benefit a cooperating individual or company more than the current approach of negotiating consent orders that do not entail admissions of liability and that may already reward settling parties for their cooperation.

In the press release announcing the Policy Statement, Mr. Khuzami referred to the new cooperation initiative as "a potential game-changer for the Division of Enforcement," adding that "[t]here is no substitute for the insiders' view. . . . That type of evidence can expand our ability to conduct our investigations more swiftly, and to act quickly to file charges, freeze assets, and protect investors."

Of course, it remains to be seen whether the new initiative will in fact be a "game-changer." For the Commission and Enforcement Division to achieve this goal, it will have to apply the Policy Statement in a manner that in deeds as well as in words meaningfully rewards cooperation by individuals and companies. In that regard, it will be interesting to see how the Commission and the Division of Enforcement navigate the waters between giving meaningful credit for cooperation and carrying through on their promise to be a tough, vigorous prosecutor of alleged securities law violations.

Further resources:
The Commission's revised Enforcement Manual (The Policy Statement regarding cooperation is at pp. 119-136)
The press release announcing the Commission's new cooperation initiatives
The Seaboard Report

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