The SEC's Division of Enforcement issued its first-ever manual this week. Intended as a reference for Enforcement Division staff, the Manual provides important insight into SEC decision-making and processes on such key matters as evaluating possible investigations, opening and closing matters, issuing Wells letters, communicating with senior SEC officials, responding to document subpoenas, "witness assurance" letters, contacting current and former employees, and respecting the attorney-client privilege during an investigation. It will be an essential guide for anyone with a matter before the Division of Enforcement.
The Manual memorializes in one place staff policies that have developed over decades but which were applied principally on the basis of oral tradition or internal, unpublished memoranda. A few highlights of the Manual follow. The full text is available on the SEC website: http://www.sec.gov/divisions/enforce/enforcementmanual.pdf.
Purpose and Scope
The Enforcement Manual is designed as a reference for Division of Enforcement staff. The Manual states that it is "not intended to, does not, and may not be relied upon to create any rights, substantive or procedural, enforceable at law by any party in any matter civil or criminal." Nevertheless, the Manual serves two very useful purposes. First, it informs persons requested to provide information to the SEC staff of the staff's expectations. Second, it also provides boundaries that, for the first time, publicly define normative behavior for the SEC staff itself and that potential reviewing courts can use to determine whether agency action is appropriate, whether under an "arbitrary and capricious" or other standard of legal review.
Evaluating Possible Investigations
Historically, the decision whether to open an investigation has been left to the discretion of the staff, often at a junior level. Once begun, investigations can remain open indefinitely. For the first time, the Manual publishes standards for opening an inquiry or investigation and mandates a regular review of open investigations.
The Manual suggests that the staff rank investigations in order of importance, identifying investigations deemed to be "critically important" (of the highest priority) as well as those considered "significant" (the second-highest level of import). In ranking investigations, staff should consider:
(1) "the programmatic importance of an enforcement action" (i.e. whether the subject matter is an SEC priority or would address a problematic industry practice);
(2) "the magnitude of the potential violations involved in the investigation" (including the egregiousness of the alleged conduct, the length of time involved, and the potential harm); and
(3) "the resources required to investigate the potential violations" (the SEC staff and budgetary resources required to pursue a potential matter).
Opening Matters Under Inquiry ("MUIs") and Investigations
A Matter Under Inquiry ("MUI") is a preliminary examination of possible violations. MUIs "typically involve incomplete information," because "the purpose of a MUI is to gather additional facts to help evaluate whether an investigation would be an appropriate use of resources." Opening a MUI is appropriate when "a sufficiently credible source or set of facts suggests that a MUI could lead to an enforcement action that would address a violation of the federal securities laws." Some of the basic considerations in determining whether to open a MUI include, among other things, "[t]he egregiousness of the potential violation"; "[w]hether the potentially harmed group is particularly vulnerable or at risk"; and "[w]hether the conduct is ongoing."
To open an investigation, staff must analyze what the Manual calls "threshold issues" and "supplemental factors." Threshold issues include whether the facts suggest a violation involving "fraud or other serious conduct," and whether an investment of resources is merited by the magnitude or nature of the purported violation or the size of the victim group. Supplemental factors include whether the SEC has designated the subject matter of the action to be a "priority," or the case fulfills a "programmatic" goal of the Commission.
Critically, opening a MUI requires a written analysis of the threshold issues and supplemental factors and approval by one of two different sets of senior officials—either an associate director in the headquarters office or a head of enforcement in a regional office and a deputy director of the Division of Enforcement. A similar process is required for opening an investigation without a preliminary MUI.
Ongoing Review of Open Enforcement Investigations
The Manual requires a detailed ongoing review of open investigations. It requires each Associate Director of Enforcement and each Regional Director of Enforcement to make formal, quarterly reports to the Division Director identifying the top three "critical" and top ten "significant" investigations in his or her portfolio based on specified criteria regarding the programmatic importance of the investigations, the magnitude of the potential violations, and the resources required to conduct the investigations.
The Manual then requires that each investigation be evaluated every six months after the investigation is opened to enable senior staff to assess whether the investigation should be pursued and to evaluate the allocation of resources to the investigation.
The new case opening and review procedures should help assure that Commission investigations are resolved promptly, a result which should benefit the Commission and investors by putting resources into the highest priority matters and which should also better assure that potentially innocent persons are relieved of the anxiety of a pending investigation which will, ultimately, be closed.
The "Wells" Process
A "Wells" notice advises persons involved in an investigation of its general nature, allowing the recipient to prepare and submit a statement to SEC staff before the staff submits a recommendation concerning whether to commence a proceeding. Wells submissions afford a potential defendant to an enforcement action an invaluable opportunity to present his or her perspective on why an enforcement action is not warranted and factual and legal arguments that may mitigate the claims that the Commission may ultimately bring.
Historically, defense counsel have sought to learn the factual bases for the staff's proposed recommendation, but the extent to which the staff chooses to share information obtained in the investigation has varied widely. The Manual expressly gives the staff the discretion, upon request, "to allow the recipient of the notice to review non-privileged portions of the investigative file, including documents that the recipient likely would receive during discovery if the Commission were to file a recommended action or proceeding." Such "open file" prelitigation discovery is invaluable as it permits counsel to more intelligently advise clients of the risks of possible enforcement action, facilitates the preparation of more focused and helpful Wells submissions, and may also encourage better and quicker resolutions of enforcement actions.
The Manual memorializes the Division's existing policy to notify individuals and entities at the earliest opportunity when the staff has determined not to recommend an enforcement action against them to the Commission.
Communications with Senior Enforcement Officials
Prompted, perhaps, by a recent report of the SEC's Inspector General regarding the conduct of an investigation, the Manual sets forth "best practices" for external communications between senior enforcement officials and persons outside the agency.
The Commission staff has long encouraged persons subject to investigations to contact the senior staff with grievances as a way to remedy treatment that is perceived as unfair.
The Manual permits such contacts, but admonishes senior officials to remember "the need to preserve the impartiality of the Division in conducting its fact-finding and information-gathering functions," and encourages them to include the staff involved in such investigations in the contact and to be "particularly sensitive" to the possibility that an "external communication may appear to be or has the potential to be an attempt to supersede the investigative team's judgment and experience."
Document Production Under Subpoena
Document production is an essential part of any SEC investigation. However, neither the Securities Exchange Act of 1934, which authorizes SEC investigations, nor the Commission's Rules of Practice defines the manner in which the documents are to be produced.
The Manual sets forth detailed standards for document production and subpoena compliance. Since the Manual is not a rule and does not carry the force of law, the standards are non-binding on the subpoena recipient. Nevertheless, they set forth the Commission's expectations and should be kept in mind by a counsel who seeks to show that his or her client is cooperating with the Commission's investigation.
Standards for document production include the following:
- Documents should be produced in electronic format, including OCR text.
- The respondent must maintain the originals of all documents responsive to the subpoena.
- Where documents are maintained on proprietary systems, staff may consider, on a case-by-case basis, web-based production or review on a dedicated laptop computer.
Witness Assurance Letters
Heretofore, the Commission has had no procedure by which it could offer "civil immunity" to a potential witness who may have valuable information for the agency but whose cooperation may not be compelled, often because the witness is outside the Commission's territorial jurisdiction. The Manual provides a mechanism by which the staff, in limited circumstances and with the specific authorization of the Commission, may provide a witness with a letter assuring him or her that the SEC does not intend to bring an enforcement action. Some of the questions to be considered in authorizing a witness assurance letter include:
- Is the Commission unable to seek testimony from the witness in any other fashion?
- Will the witness provide evidence against others? Is it impractical to obtain the evidence from other sources?
- Based on current knowledge, should the witness be the subject of a recommendation for an enforcement action?
Contacting Employees of Issuers
The Manual also addresses the nettlesome and recurring question of when the staff may contact employees of a corporation about the business of that corporation without first communicating with corporate counsel. In the absence of a compelling reason to contact an individual directly, the Manual states that staff should go through corporate counsel to contact corporate employees:
- who have a managerial responsibility on behalf of the organization;
- "who supervise, direct, or regularly consult" with corporate counsel on "the matter that is the subject of the investigation" or who have the power to settle the matter;
- "whose acts or omissions may be imputed to the organization" for civil or criminal liability purposes; and
- whose statements are admissible on behalf of or legally binding upon the organization.
Contacting former employees without first contacting corporate counsel is generally permissible, unless corporate counsel (or the employee) has affirmatively stated that corporate counsel has been retained by that particular former employee. Nevertheless, Commission staff "should be sensitive to potentially privileged corporate communications when seeking information from the former employee."
Waiver of Privilege
When, if ever, the government should request that a corporation waive the attorney-client privilege or attorney work product doctrine has been one of the hottest subjects in government enforcement during the past decade. The Manual provides that where entities or individuals provide significant cooperation in investigations by voluntarily disclosing relevant information, voluntary disclosure need not include a waiver of privilege to be an effective form of cooperation, as long as all relevant facts are disclosed.
"The staff should not ask a party to waive the attorney-client or work product privileges and is directed not to do so." (emphasis in original) All decisions regarding a potential waiver of privilege are to be reviewed by supervisory staff. The Enforcement Division’s central concern is whether the party has disclosed all relevant facts within the party’s knowledge that are responsive to the staff’s information requests, and not whether a party has elected to assert or waive a privilege.
The Manual provides that waiver of a privilege is not a prerequisite to obtaining credit for cooperation. A party’s decision to assert a legitimate privilege will not negatively affect a claim to credit for cooperation. The appropriate inquiry in this regard is whether, notwithstanding a legitimate claim of privilege, the party has disclosed all relevant underlying facts within its knowledge.
There are two exceptions to the guidance generally supporting assertion of privilege:
- In order to rely on advice-of-counsel as a defense, a party must waive the attorney-client privilege and work product protection to the extent necessary to enable the staff to evaluate the defense.
- Staff should consider whether there may be other circumstances that negate assertions of privilege, such as the crime-fraud exception and a prior non-privileged disclosure.
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