January 14, 2010
The SEC yesterday formally released an anticipated new initiative designed to encourage individual and company cooperation with SEC investigations and enforcement actions. The initiative, laid out in a new section of the enforcement manual for the Division of Enforcement entitled "Fostering Cooperation," (the "Initiative") establishes incentives for early, substantial, robust cooperation with the stated goal of ensuring "that potential cooperation arrangements maximize the Commission’s law enforcement interests." The Initiative provides guidance for evaluating an individual’s cooperation and authorizes new cooperation tools, including cooperation agreements, deferred prosecution agreements and non-prosecution agreements. While the new Initiative provides more options for the Enforcement Division and individuals, only time will tell if it proves to be the "game-changer" that Enforcement Director Robert Khuzami anticipates.
I. Features of the New Initiative
A. Standards for Evaluating an Individual’s Cooperation
The revised Enforcement Manual includes a policy statement detailing an advisory framework of standards with which to evaluate an individual’s cooperation. There are four general considerations: (1) assistance provided by the individual; (2) importance of the underlying matter; (3) interest in holding the individual accountable; and (4) profile of the individual. The standards track the typical Department of Justice considerations for evaluating cooperation.
1. Assistance Provided by the Individual
In evaluating the assistance provided by the individual, the Commission will consider, among other things, the value and nature of the individual’s cooperation. The value of the cooperation includes the extent to which the individual’s cooperation substantially assisted the investigation and the timeliness of the cooperation, including whether the individual was the first to cooperate and whether the individual cooperated before he or she had any knowledge of an investigation or related action. The value of the cooperation will also be assessed based on its quality — whether it was truthful, complete, and reliable — and the time and resources conserved as a result of the cooperation. The Initiative further details that assessing the nature of the cooperation should include an evaluation of whether the individual cooperated voluntarily, the types of assistance provided by the individual, whether the individual revealed information not otherwise obtainable, whether the individual encouraged or authorized others to assist the Division, and other unique circumstances.
2. Importance of the Underlying Matter
In evaluating the seriousness and importance of the underlying matter, the Commission will consider the "character of the investigation" and the dangers presented by the underlying violations to investors and others. The character of the investigation includes whether the subject matter is a Commission priority, the type of securities violations, the age and duration of misconduct, the number of violations, and the isolated or repetitive nature of the violations. The danger presented by the underlying violations will be assessed based on, among other things, the amount of harm or potential harm caused by the violations, the type of harm, and the number of individuals or entities harmed.
3. Interest in Holding the Individual Accountable
The Commission will also assess the societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct. The Initiative sets out that this will be evaluated by considering the severity of the individual’s misconduct, the culpability of the individual, the degree to which the individual tolerated illegal activity, the individual’s efforts to remedy the harm caused, and the sanctions imposed on the individual by other authorities. Additional considerations relevant to holding the individual accountable include the nature of the violations, the individual’s education, training, experience, and position of responsibility at the time the violations occurred, whether the individual acted with intent or knowledge of the wrongdoing, whether the individual took steps to prevent the violations, including bringing the misconduct to the attention of the Commission, other law enforcement entities, members of management, the board of directors, or a company’s auditors, whether the individual has agreed to pay or has paid disgorgement, and whether the individual assisted in the recovery of the fruits and instrumentalities of the violations.
4. Profile of the Individual
Finally, the Initiative provides criteria to evaluate the individual in terms of assessing the appropriateness of cooperation credit. The cooperating individual’s personal and professional profile should be assessed based on, among other things, the individual’s history of lawfulness, the individual’s acceptance of responsibility, and whether the individual will have an opportunity to commit future violations of the federal securities laws based on his or her occupation (e.g., persons in the securities industry, executives of public companies, accountants, attorneys, etc.) and any existing or proposed safeguards.
B. New Cooperation Tools
The new Initiative provides the Division of Enforcement with a nonexclusive list of tools to facilitate cooperation in investigations and enforcement actions.
1. Cooperation Agreements
The Initiative provides for cooperation agreements in which the Division agrees to recommend to the Commission that the individual or company receives credit for giving substantial assistance. The Division may also make specific enforcement recommendations to the Commission where appropriate. In return, the individual or company agrees, among other things, to cooperate fully and truthfully, and waive applicable statutes of limitations.
Before entering into a cooperation agreement, the Division staff is instructed to consider whether there are other timely and effective means of obtaining the desired cooperation, and whether the individual or company has entered or is likely to enter into a plea agreement with criminal prosecutors that will require the individual or company to cooperate in the Commission’s investigation and enforcement actions.
The Director of the Division and senior officers designated by the Director have the authority to enter into cooperation agreements on behalf of the Division. If the Division agrees to make a specific enforcement recommendation to the Commission, the cooperating individual or company must provide substantial assistance, as assessed by the Division, and must agree to resolve the matter without admitting or denying the alleged violations.
If the agreement is violated, the Division of Enforcement may recommend to the Commission that it institute an enforcement action against the individual or company without any limitation. In addition, cooperation agreements entered into with the Division are not binding on the Commission. Only the Commission has the authority to approve enforcement dispositions and accept settlement offers.
2. Deferred Prosecution Agreements
The Initiative provides for deferred prosecution agreements in which the Commission agrees to forego an enforcement action against the individual or company, and the individual or company agrees, among other things, to cooperate fully and truthfully, waive applicable statutes of limitations, comply with prohibitions and undertakings, pay any agreed disgorgement or penalty amounts, and admit or agree not to contest the relevant facts underlying the alleged offenses. Deferred prosecution agreements are for a set amount of time that cannot exceed five years. If the cooperating individual or company satisfies the terms of the agreement during the specified time, the Commission agrees not to pursue any further enforcement action concerning the subject of the agreement.
Deferred prosecution agreements must be approved by the Commission, and unless the Commission directs otherwise, these agreements will be made available to the public upon request. If the agreement is violated during the period of deferred prosecution, the Division may recommend to the Commission an enforcement action against the individual or company without limitation. Notably, the agreement will require the cooperator to agree that, if the Commission authorizes an enforcement action, any factual admissions made by the cooperator may be used against him. The Initiative indicates that this provision is generally appropriate for persons in the securities industry, fiduciaries, executives of public companies and licensed professionals, such as accountants and attorneys.
3. Non-Prosecution Agreements
The Initiative provides for non-prosecution agreements in which the Commission agrees not to pursue an enforcement action against the individual or company. In return, the individual or company agrees, among other things, to cooperate fully and truthfully, comply with express undertakings, and pay any agreed disgorgement or penalty amounts. The Initiative makes clear that these agreements should generally be used in limited circumstances and not early in investigations or for individuals with prior violations of the securities laws.
Before entering into a non-prosecution agreement, the Division staff should consider whether there are other timely and effective means of obtaining the desired cooperation, and whether the individual or company has entered or is likely to enter into a plea agreement with criminal prosecutors that will require the individual or company to cooperate in the Commission’s investigation and enforcement actions.
Non-prosecution agreements must be approved by the Commission. If the agreement is violated, the Division may recommend to the Commission an enforcement action against the individual or company without limitation. Additionally, if the Commission authorizes an enforcement action, any statements, information, and materials provided pursuant to the agreement may be used against the cooperator.
4. Expedited Immunity Requests
The Initiative also provides for expedited immunity requests to the Department of Justice in order to provide a cooperator with protection against criminal prosecution. In the past, this has been accomplished in limited circumstances by the Commission requesting a letter of immunity from the Department of Justice. The revised enforcement manual delegates to the Director the authority to make immunity requests to the Department of Justice. By eliminating a level of review, this delegation of authority streamlines the immunity request process.
In addition, unless the court and/or the Commission directs otherwise, immunity letters and orders will be treated as public documents. It is unclear whether this means that the immunity letters or orders will be affirmatively made public, or whether they will be available to the public upon request.
5. Proffer Agreements and Oral Assurances
The Division has used proffer agreements for many years as a means for both the staff and potential cooperators to assess the value and benefits of cooperation. The new Initiative codifies guidelines on the use of proffer agreements which generally provide that statements made by a person may not be used against that individual in subsequent proceedings except as a source of investigative leads or for impeachment or rebuttal if the person testifies inconsistently in a subsequent proceeding. The Commission may share the information provided by the proffering individual with the appropriate authorities in a prosecution for perjury, making a false statement and obstruction of justice.
In a related tool, the Initiative also authorizes the use of "oral assurances" to inform an individual or company that the Division does not currently anticipate recommending an enforcement action against the individual or company. These assurances can be given by Assistant Directors with the approval of a supervisor at or above the level of Associate Director. Oral assurances are based upon the evidence currently known to the Division staff, and the Division’s enforcement recommendations may change if new evidence comes to light. In addition, the oral assurances are not binding on the Commission, which has final authority to accept or reject enforcement recommendations.
II. Observations and Analysis
With the Enforcement Division’s new policy in its nascent stage, we offer below our initial observations and analysis of the Initiative and its implications. For a more detailed discussion of the challenges the SEC faces in motivating individual cooperators, see our article "Courting Cooperators: The SEC’s Effort to Motivate Individual Cooperation."
To cooperate or not? That remains the question. The decision whether to cooperate or not to cooperate in any case involves a highly fact-specific balancing of the risk-adjusted costs and benefits of each alternative. The Enforcement Division’s Initiative on cooperation provides new options for the staff and defense counsel to explore as potential alternatives to the historically limited options of an enforcement action or nothing. However, the alternatives still come with costs, including admissions to (or agreements not to contest) facts, risks of collateral exposure, such as civil litigation, loss of current and future employment opportunities, and adverse publicity, just to name a few. Further complications may arise as the Commission considers whether cooperation would merit the forgiveness of disgorgement in the face of investor losses. The real question is whether the SEC will be able, in specific cases over time, to provide sufficient rewards for cooperating to overcome the costs. Only time will tell.
The issue of waiver. In a separate section, the Enforcement Manual notes the Commission’s policy that assertions of the attorney-client privilege and work-product protection will be respected by the staff, and voluntary disclosure of information need not include a waiver of privilege to be considered an effective form of cooperation. These provisions must now be assessed in the context of the cooperation guidelines recently announced and the expectations of the staff under such agreements. The same concerns that prompted the Commission’s announcement of policy as to privilege remain, and both respondents and the staff will have to proceed particularly carefully in this area.
In evaluating cooperation, timeliness counts. While the Initiative announces many factors to guide the evaluation of cooperation, Mr. Khuzami has emphasized timeliness above all else. In his remarks announcing the new cooperation guidelines, Mr. Khuzami reiterated the importance of early cooperation: "And 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. Latecomers 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." This means that the decisions about cooperation needs to be addressed early and often in order to maximize credit.
The criminal authorities. The staff’s emphasis on early cooperation does not address the continuing issue of coordination between the Commission’s investigations and potential interest on the part of the criminal authorities. Each often runs on a very different timeline and respondents may find themselves between the competing interests of two separate enforcement interests, making early reporting to the staff extremely difficult without the benefit of the grant of immunity by the criminal authorities — a process, even if expedited, that may itself delay or preclude early reporting.
For individuals in the securities industry, expect greater consequences to cooperating. One theme running through the Initiative is that the there will be less leniency afforded certain categories of individuals based on their role in the securities industry, including individuals associated with broker-dealers and investment advisers, officers and directors of public companies, and licensed professionals, such as accountants and lawyers. For example, the Commission is more likely to demand from such individuals an admission to (or agreement not to contest) adverse facts and perhaps other conditions as part of a deferred or non-prosecution agreement.
Transparency has its costs (and benefits for some). One of the obstacles the SEC has faced in encouraging cooperation has been the lack of transparency in SEC settlements that makes it difficult for the public to see the benefits of cooperation. In order to address this issue, the Initiative contains a section advising the staff to provide sufficient information to the public about the nature of the Commission’s cooperation program and its significant benefits, consistent with the existing duties of confidentiality. The Initiative also states that many of the cooperation tools will result in publicly available documents. This means that potential cooperators need to consider that cooperation may result in publicity and the consequences that will follow. But others, including experienced defense counsel, will get the benefit of reviewing resolutions which become public.
It’s not just about individuals. Although the Initiative is directed primarily at individuals, the Initiative also reiterates the Commission’s policy on cooperation by corporations contained in the so-called "Seaboard" report. In addition, each of the new cooperation tools may apply to companies as well as individuals. Thus, the additional options, such as deferred prosecution agreements and non-prosecution agreements, are now potential options by which corporations may seek to resolve investigations short of enforcement actions.
In the near term, the staff will likely grapple with the contours of the Initiative, just as defense counsel and putative defendants will. Only the application of the Initiative to matters over time will answer the question of whether the Initiative provides sufficient incentives to change the game for cooperators.
 "SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations," (Jan. 13, 2010), http://www.sec.gov/news/press/2010/2010-6.htm.
 Enforcement Manual, section 6, http://www.sec.gov/divisions/enforce/enforcementmanual.pdf.
 Robert Khuzami, Director of Division of Enforcement, U.S. SEC, "Remarks at Press Conference," (Jan. 13, 2010), http://sec.gov/news/speech/2010/spch011310rsk.htm.
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