Asked and Answered

Matthew P. Allen on SEC Cooperation Initiative

By Steve Thorpe
sthorpe@legalnews.com

The Securities and Exchange Commission was given more regulatory power after the securities and global market meltdown of 2008. Whether it’s money market funds, private equity funds or foreign private issuers, the SEC has stepped up its efforts to examine, investigate, and charge securities violations that it believes endangers investors. Some believe that the Commission’s budget hasn’t kept up with the increased scope of its duties, resulting in a reorganization of its divisions and reporting structure, new examination procedures and protocols, and increasing cooperation with settling defendants and other state, federal, and international civil and criminal regulators and authorities. Matthew P. Allen is a securities, intellectual property and business lawyer with Miller Canfield. He will moderate a panel discussing the topic at the 2013 American Bar Association Litigation Section’s Annual Conference in Chicago on April 26.

Thorpe: Give us a brief outline of the events that led to these changes.

Allen: Lehman Brothers’ implosion, Bernie Madoff, and the sub-prime mortgage-backed securities mess. Securities regulation tends to come in seasons. When it appeared securities class actions were harming the growth and success of the US securities and capital markets, Congress enacted the Private Securities Litigation Reform Act. Then came Enron and WorldCom, and Congress responded with more regulation in the form of Sarbanes-Oxley. After a few years critics began to argue that increased securities regulation risked the US losing its place as the leading global securities and capital market. Then came Madoff’s Ponzi scheme and the sub-prime mortgage concoctions, and Congress responded with the Dodd Frank Act. In Dodd Frank, Congress charged the SEC with regulating more markets, products, and funds, and mandated an unprecedented level of SEC rule-making in a relatively short timeframe. On top of this, the global securities market is bigger and faster than ever: there are more trading exchanges, increased daily trading volume, and more reliance on high-speed, fully automatic trading. Adding to the challenge is the lack of money available to the SEC to perform its many new jobs, though the most recent proposed budget tries to remedy this.

Thorpe: What is the SEC Cooperation Initiative?

Allen: The SEC developed the Cooperation Initiative in 2010 to facilitate and reward timely and quality assistance to permit the SEC to conserve its investigative resources by learning about complex schemes more quickly and achieving quick and successful resolutions to its enforcement actions. It has been described as a “series of measures designed to encourage greater cooperation by individuals and companies in SEC investigations and related enforcement actions.” It is an “analytical framework” used by the SEC to evaluate cooperation by individuals and companies, and the manner and extent to which the SEC should credit that cooperation. The SEC has always had and used cooperation tools and agreements. The Cooperation Initiative added some new tools and expanded the use of existing tools in a more formalized and streamlined framework.

Thorpe: The SEC is now using tools that have traditionally been in the toolbox of the criminal justice system. Tell us about some of them.

Allen: The most obvious are the SEC’s use of Non-Prosecution Agreements (“NPAs”) and Deferred Prosecution Agreements (“DPAs”), and its adoption of an Immunity Request procedure. NPAs and DPAs are agreements between the SEC and a cooperating entity or individual under which the SEC agrees to forego an enforcement action if the individual or entity agrees to, among other things, fully cooperate in the investigation, testify if needed, enter a tolling agreement, not contest the underlying facts in the investigation, and comply with various prohibitions and undertakings during a certain period of time. In 2010 the SEC also adopted a Framework for Evaluating Cooperation by Individuals, to complement its 2001 cooperation framework for companies, called the “Seaboard Report.”

The SEC also streamlined the process to obtain immunity from the DOJ for SEC witnesses. When a witness or defendant asserts his Fifth Amendment privilege against self-incrimination in an SEC investigation or enforcement action, the SEC can obtain or facilitate the witness’s testimony by seeking a court order, or an agreement with the DOJ, that the witness will be immune from criminal prosecution if he provides incriminating testimony or other evidence to the SEC. The SEC Enforcement Manual summarizes two types of immunity: statutory (or “formal”) immunity, and letter (or “informal” or “pocket”) immunity. But the Manual does not provide any additional guidance on immunity or how it relates to immunity in criminal cases. So understanding the various types of immunity conferred by the DOJ, and the rules and case law attendant thereto, is important. Needless to say, I am very blessed that my office is flanked by two of the finest criminal lawyers in the country in Tom Cranmer and Matt Leitman. So I have a built-in “cheat sheet” as to how all of this stuff works. The SEC’s Whistleblower Program in civil investigations can be compared to paying informants for information in criminal cases.

This streamlined and formalized cooperation arrangement between the SEC and DOJ also makes dual proffer sessions a more justifiable request in certain circumstances.

Thorpe: How has the SEC’s relationship with the Department of Justice changed?

Allen: I am not sure if the relationship has changed as much as it has been more streamlined and formalized. The DOJ has more experience using the cooperation tools more recently adopted by the SEC, so it makes sense that the SEC would leverage that experience. The idea behind the SEC Cooperation Initiative, according to the former SEC Enforcement Chief and federal prosecutor Robert Khuzami, was for the SEC to use DOJ techniques and tools to encourage individuals and companies to come forward and cooperate. Also, the Initiative was meant to provide more consistency and clarity for the regulated community. But “parallel proceedings” between the SEC and DOJ have always existed, and have been determined constitutional (if done the right way).

Thorpe: The SEC and Justice Department are not allowed to “improperly commingle” their investigations. How is that prevented?

Allen: In a sentence, by the SEC ensuring that its investigation has an independent civil investigative purpose and is not being initiated with the sole aim of helping the DOJ obtain evidence for its criminal case. A federal district court case styled US v. Scrushy found that the SEC and DOJ investigations “improperly merged” when: (1) the SEC changed defendant’s deposition location in the civil case to accommodate a DOJ request to conduct the deposition in a more favorable jurisdiction for a false statement prosecution; (2) the SEC refrained from asking certain questions at the deposition at the DOJ’s request so as not to reveal the subjects of the criminal investigation; and (3) the SEC participated in interviews of witnesses in the criminal case.

Some may take issue with the Scrushy decision. But the fact is the DOJ and SEC are entitled to and do share information, and may sit in on each other’s interviews, among other things. The SEC Enforcement Manual contains an entire section entitled “Cooperation with Criminal Authorities” that sets forth the framework of proper parallel investigations.

It is a separate question and analysis altogether as to whether the SEC or a civil defendant asks the court to stay the civil SEC case while the DOJ’s criminal case is pending, or whether a DOJ lawyer can use in US courts evidence obtained from an interview of a defendant by a foreign regulator in a foreign country that does not have a direct equivalent of the US Fifth Amendment right against compelled self-incrimination.

Thorpe: How has the US Supreme Court’s recent decision in Gabelli v. SEC affected the SEC’s use of cooperation tools?   

Allen: During oral argument in Gabelli, two Justices of the Court made some interesting comments on the increasingly “prosecutorial” state of the SEC, without the concomitant constitutional safeguards typically associated with the serious consequences attendant to criminal penalties. In Gabelli, the Court held that the SEC could not use the “discovery rule” to extend the 5-year statute of limitations when the SEC seeks monetary penalties. The Court found the SEC had too many tools at its disposal to discover fraud within five years of its commission to warrant an extension, and specifically referenced SEC “cooperation agreements” as one of those tools. What’s interesting is the oral argument transcript in Gabelli, where Justices Scalia and Breyer expressed concern about the “quasi-criminal” extent of SEC penalties, but without having to prove them beyond a reasonable doubt and without constitutional criminal protections like a right to appointed counsel and the right to remain silent without an adverse inference from that silence. The following question from Justice Scalia to the SEC’s lawyer seemed to sum up the mooring of the Court’s decision denying the discovery rule to the SEC in penalty cases: “You just call it a civil penalty and you don’t have to prove it beyond a reasonable doubt, and you get the benefit of this [discovery rule] extension that you are arguing for?” The Court did not decide the issue of whether the SEC civil penalties could be construed as criminal penalties because the question was not before the Court. But it will be interesting to see whether the SEC’s Cooperation Initiative creates cases that raise the question.

It will also be interesting to see how Gabelli affects the decision of witnesses in SEC investigations to enter “Tolling Agreements” with the SEC to stop the limitations period while the parties negotiate settlement, or as part of a witness’s cooperation agreement with the SEC. In Gabelli, the SEC waited to file its case while it discussed settlement with defendants without a Tolling Agreement in place.

Thorpe: What is the difference between a “civil” and “criminal” securities violation?

Allen: To be criminally liable under the securities laws, a defendant must “willfully” violate them. That’s what the statute says. But this leads to several questions that must be determined: What makes a violation “willful”? Why do criminal authorities prosecute some seemingly “willful” violations but not others? What is the difference between civil and criminal securities laws, procedures, and remedies? While there not hard answers to some of these questions, certain parameters and guiding principles can be observed that indicate when a securities investigation is likely to include a parallel criminal component. Parallel criminal and civil proceedings can also provide excellent opportunities for corporate counsel to creatively structure civil settlements and criminal plea deals that preserve the underlying business operations (and thus the jobs of the many innocent employees and value of innocent shareholders). Critics have been frustrated by the DOJ not indicting corporate entities for criminal securities violations. Others argue that there is little utility in charging a corporate entity as opposed to the individual employees or officers who actually commit the crime. They argue that charging a company only hurts innocent employees and shareholders by damaging or destroying the value of the business and any required charters or licenses that may be revoked upon a felony conviction.

But sometimes lawyers for companies can have a subsidiary or affiliate of the parent entity enter a criminal plea, which is a conviction. But the conviction of the separate subsidiary entity does not affect the parent company’s licenses or exchange listing. The parent can enter a Non-Prosecution Agreement with the DOJ, and also enter a civil settlement with the SEC to pay fines, disgorgement, and penalties. The DOJ and SEC are also free to separately pursue the individuals who engaged in the offending conduct.

Thorpe: What else will be covered in the upcoming panel discussion at the ABA conference?

Allen: The panel I am moderating at the ABA conference in Chicago will be a candid and real-world discussion of the rules, principles, and challenges summarized in this Q&A by the people on the front lines of these issues: SEC Regional Director Merri Jo Gillette; DOJ Financial Crimes chief Julie Porter; and Jack Sena of Bank of America’s Regulatory Inquiries Group. These folks represent some of the finest and most capable parts of the U.S. securities law enforcement process. And it will be instructive to hear their views on the subjects above and more.