Recently, the U.S. Securities and Exchange Commission (SEC) announced a new, and potentially powerful, tool in its enforcement program that may have significant ramifications for companies. For the first time in the SEC’s history, the Division of Enforcement is authorized to further SEC investigations and enforcement actions by using tools similar to those routinely used by federal prosecutors. In light of this new program, companies need to establish a culture and procedures that encourage employees to report internally potential wrongdoing.
The goal of the SEC’s new program is to provide incentives for wrongdoers, including corporate insiders, to cooperate in SEC investigations. In announcing the new initiative, Robert Khuzami, Director of the Division of Enforcement stated: “This is a potential game-changer for the Division of Enforcement. There is no substitute for the insiders’ view into fraud and misconduct that only cooperating witnesses can provide. That type of evidence can expand our ability to conduct our investigations more swiftly, and to act quickly to file charges . . . .”
The new tools, now available to the Division of Enforcement, include the following:
Cooperation Agreement: A formal written agreement in which the Division of Enforcement agrees to recommend to the Commission that a cooperator receive credit, and under certain circumstances, to make specific enforcement recommendations. Among other things, the cooperator must provide “substantial assistance” and agree to cooperate “truthfully and fully” in an investigation and related enforcement action.
Deferred Prosecution Agreement: A written agreement in which the SEC agrees to forego an enforcement action against a cooperator. Among other things, the individual must cooperate truthfully and fully, enter into long-term tolling agreements, comply with express prohibitions and/or undertakings during a period of deferred prosecution, and under certain circumstances, agree to admit or not contest underlying facts that the SEC could assert to establish a violation of the federal securities laws. If the agreement is violated during the deferred prosecution, the SEC can file an enforcement action against the cooperator for the original misconduct and any additional misconduct.
Non-Prosecution Agreement: A written agreement in which the SEC agrees not to pursue an enforcement action against a cooperator. Among other things, the individual must cooperate truthfully and fully, and, under certain circumstances, comply with express undertakings. If the agreement is violated, the SEC retains the ability to file an enforcement action against the cooperator. In light of the other cooperation tools, non-prosecutions will rarely be used.
In evaluating whether and in what manner it will credit an individual’s cooperation, the SEC identified four general factors it will consider: the assistance provided by the cooperating individual, the importance of the underlying matter in which the individual cooperated, the societal interest in ensuring the individual is held accountable for his or her conduct, and the appropriateness of cooperation based upon the risk profile of the cooperating individual.
While the SEC’s new program is focused on cooperation of individuals, the same cooperation tools can be used with companies as well. For example, if a company is a party to, or has knowledge of, a securities law violation by another entity or person, the company may cooperate and receive any resulting benefits to the same extent as an individual cooperator under the program.
Cooperation with regard to a company’s own securities laws violations will continue to be assessed by the SEC pursuant to the so-called “Seaboard Report” issued by the SEC in 2001. The Seaboard Report sets forth the factors the SEC will consider in determining what, if any, benefit, including charging and sanction decisions, the SEC may agree to based on the conduct, self-reporting, cooperation and remediation of a company.
The new cooperation program and the previously issued Seaboard Report together provide the total framework for cooperation in SEC investigations and enforcement actions.
The practical ramifications of the SEC’s individual cooperation program for companies can be significant. The SEC has now provided strong incentives for wrongdoers within a company to go directly to the SEC in the hope of cutting the best deal possible. A company may have no inkling of any problem (especially if wrongdoers are covering up their activities), let alone any opportunity to discover, self-report and remediate, before it is confronted by SEC Enforcement staff. Moreover, investigations predicated on the assistance of cooperating insiders are often fast moving and may involve parallel criminal investigations by the U.S. Department of Justice.
Additionally, SEC Chairman Mary Schapiro has indicated that the SEC is considering adopting a program to offer cash bounties to private sector whistleblowers who help expose financial wrongdoing. Such a bounty program would provide financial incentive to whistleblowers who witnessed but did not participate in wrongdoing to go to the government first rather than to report issues internally within a company.In the current enforcement environment, with its focus on cooperation of insiders and investigative speed, companies must have strong internal controls, procedures and internal audits to detect problematic conduct as early as possible. Just as important, companies must promote a tone that encourages employees to come forward, without fear of retaliation or retribution, to report suspicious or troublesome activity. For example, companies may want to establish programs that allow employees to report potential fraud on an anonymous basis. If companies fail to adopt vigorous internal controls and fail to promote a culture of internal communication, they may find themselves involved in fast-moving SEC investigations triggered by cooperating witnesses in the new SEC program.