SEC Cooperation Initiative

A Cooperation Agreement is a written agreement with the Enforcement Division, preferably entered into after a proffer, which provides that the Division will recommend to the Commission that a cooperating party receive credit for cooperation in the Commission's enforcement decision-making process if he: 1) provides or is likely to provide substantial assistance in an investigation; 2) agrees to cooperate truthfully in the investigation and related enforcement actions and waives the applicable statute of limitations; and 3) satisfies his obligations under the agreement. The SEC Enforcement Manual emphasizes that there is no guarantee that the Division's recommendation will be adopted by the Commission. Specifically, it states that “the staff should advise potential cooperating individuals or companies that cooperation agreements entered into with the Division do not bind the Commission and that the Division cannot, and does not, make any promise or representation as to whether or how the Commission may act on enforcement recommendations made by the Division.”

A Serious Limitation

This caveat is potentially a serious limitation on the value of a cooperation agreement to the target of an SEC investigation, as corporate insiders divulging information to the Enforcement Staff will have no guarantee whether or how the Commission will credit their efforts. While some commentators ' and undoubtedly the architects of the SEC Cooperation Initiative ' analogize this to the fact that criminal prosecutors cannot guarantee the extent to which the court will credit a defendant's cooperation in imposing sentence, there is an institutional ' indeed, a constitutional ' reason for this in the criminal arena, because the court is a separate, independent branch of the government that cannot be bound by the Executive Branch. Moreover, from the perspective of defense counsel, there is a large existing body of sentencing precedent that gives counsel a basis for rendering informed, even if not certain, advice on the potential benefit of cooperation on sentencing. Neither of these points is true in the context of an SEC proceeding.

That being said, there are obviously compelling institutional reasons for the Commission to give great weight to the Enforcement Division's recommendations. A pattern of rejection would undermine the Enforcement Division's initiative and, with it, the Commission's “Policy Statement Concerning Cooperation by Individuals in Its Investigations and Related Enforcement Actions.“

At the end of the day, the bigger problem for counsel representing an individual in an SEC investigation and analyzing the benefits and risks of cooperation is the classic dilemma: although failure to cooperate and “taking the Fifth“ can lead to an adverse inference in the civil matter, providing information ' absent negotiated protections ' can have negative consequences on a parallel criminal investigation.

Deferred-Prosecution Agreements

Deferred-prosecution agreements are written agreements pursuant to which the SEC agrees to forgo an enforcement action if a party agrees to: 1) cooperate fully and truthfully; 2) enter into a long-term tolling agreement; 3) comply with express prohibitions and undertakings during a period of deferred prosecution; and 4) under certain circumstances, agree either to admit or not contest underlying facts that the Commission could assert to establish a violation of the federal securities laws in the event the agreement is violated. If the agreement is violated, the Division can recommend enforcement action, and any statements made to the SEC during the investigation can be used in any enforcement proceeding. The Enforcement Manual provides that the term of a deferred-prosecution agreement should not exceed five years. It also provides: “Unless the Commission directs otherwise, deferred prosecution agreements will be made available to the public upon request.“

Deferred-prosecution agreements have long been an available tool for resolving criminal investigations, first historically as to individuals and more recently as to corporations. One frequently used provision in such corporate agreements is the hiring of a corporate compliance monitor. Such monitors have also been a feature of SEC settlements. Controversy surrounding the use of monitors by the DOJ has led to the establishment in the so-called “Morford Memo“ of nine guidelines for the use and selection of compliance monitors. The extent to which monitors become a staple of SEC deferred-prosecution agreements remains to be seen, as does the extent of the monitor's duties and any attendant oversight by the Commission.

Non-Prosecution Agreements

Non-prosecution agreements are written agreements, made in limited circumstances, pursuant to which the SEC will agree not to pursue an enforcement action in exchange for full cooperation with the Commission's investigation, and compliance with express undertakings by a cooperating party. As is the case with deferred-prosecution agreements, the Commission itself must approve such an agreement.

The Enforcement Manual generically sets forth terms that the Enforcement Division should generally include in non-prosecution agreements. Not surprisingly, the terms include complete cooperation, disgorgement or penalty payments, “additional undertakings designed to protect the investing public,“ and provisions that, if an individual violates the agreement, the Commission can use all the provided information in a subsequent enforcement action. Furthermore, if an agreement is violated, the Commission may pursue an action against an individual without limitation and “not subject to the applicable statute of limitations.”

Both with respect to cooperation agreements and non-prosecution agreements, the Enforcement Manual recognizes that, in many cases, the Commission may not need to use these tools to “buy“ cooperation given the practical dynamic of a parallel investigation with the DOJ. The Manual provides that the staff, when attempting to determine whether to recommend that the Commission enter into either type of agreement, “should consider whether the individual or company has entered into or is likely to enter into a plea agreement with criminal prosecutors that will require them to cooperate in the Commission's investigation and related enforcement actions ' “

Advising Your Clients

If your clients are considering cooperating with the SEC under the Cooperation Initiative, keep these tips in mind when formulating your advice:

• Assume that criminal authorities can obtain access ' by subpoena if necessary ' to any information disclosed to the SEC.
• Be timely in any effort to reach a cooperation agreement with either the SEC or DOJ. Both authorities put a premium on a party stepping forward early as a factor in deciding whether to enter into a cooperation agreement.
• Do not rely on any oral representations. Get it in writing and clearly define with specificity the obligations your client is undertaking.
• Assume that any agreement with the SEC will be on the first page of The Wall Street Journal and that the text will be publicly available.
• In determining whether you can represent multiple parties, you must always analyze the possibility that one prospective client has information adverse to another client or prospective client, so one client might some day be be compelled to give testimony adverse to the other. This analysis is now complicated by the fact that the opportunity to obtain a cooperation, deferred-prosecution, or non-prosecution agreement can create an incentive to provide such adverse evidence about others.

Conclusion

Although the SEC's Cooperation Initiative Program aims to enhance the Commission's ability to detect violations by providing incentives to cooperating parties, potential cooperators should proceed with caution. The SEC's Policy Statement notes the “tension between the objectives of holding individuals fully accountable for their misconduct and providing incentives for individuals to cooperate with law enforcement authorities.” It remains to be seen whether the SEC's cooperation tools, as presented in the Enforcement Manual, will be sufficiently beneficial to parties to induce their cooperation and thus “change the game.”

Howard W. Goldstein ([email protected]), a member of this newsletter's Board of Editors, is a partner at Fried, Frank, Harris, Shriver & Jacobson LLP in New York and a former federal prosecutor. Sujata Jhaveri, an associate at the firm, assisted in the preparation of this article.

With the hope of encouraging corporate insiders to cooperate during investigations, the SEC issued a new Enforcement Cooperation Initiative in mid-January. The Initiative, which Enforcement Division Director Robert Khuzami heralded as a “potential game-changer,” mirrors cooperation tools successfully used by the Department of Justice (DOJ). Specifically, it embraces the use by the SEC of proffer agreements, cooperation agreements, deferred-prosecution agreements, and non-prosecution agreements in exchange for cooperation.

Yet, the SEC's ability to attract cooperating insiders differs in significant respects from that of the DOJ. The incentive for an individual to cooperate with the DOJ, which wields the heavy hammer of both fines and incarceration, is obvious. The advantages of cooperating with the SEC are more nuanced. For those companies and individuals subject to SEC oversight and licensing, the potential penalties for failing to cooperate already virtually require cooperation. For those not in this category, the benefits of cooperation are less clear, particularly if the DOJ is lurking in the background and not yet prepared to negotiate. This article discusses some of the SEC's newly announced cooperation tools and provides some tips for practitioners whose clients are considering cooperating with the SEC.

Cooperation Agreements

A Cooperation Agreement is a written agreement with the Enforcement Division, preferably entered into after a proffer, which provides that the Division will recommend to the Commission that a cooperating party receive credit for cooperation in the Commission's enforcement decision-making process if he: 1) provides or is likely to provide substantial assistance in an investigation; 2) agrees to cooperate truthfully in the investigation and related enforcement actions and waives the applicable statute of limitations; and 3) satisfies his obligations under the agreement. The SEC Enforcement Manual emphasizes that there is no guarantee that the Division's recommendation will be adopted by the Commission. Specifically, it states that “the staff should advise potential cooperating individuals or companies that cooperation agreements entered into with the Division do not bind the Commission and that the Division cannot, and does not, make any promise or representation as to whether or how the Commission may act on enforcement recommendations made by the Division.”

A Serious Limitation

This caveat is potentially a serious limitation on the value of a cooperation agreement to the target of an SEC investigation, as corporate insiders divulging information to the Enforcement Staff will have no guarantee whether or how the Commission will credit their efforts. While some commentators ' and undoubtedly the architects of the SEC Cooperation Initiative ' analogize this to the fact that criminal prosecutors cannot guarantee the extent to which the court will credit a defendant's cooperation in imposing sentence, there is an institutional ' indeed, a constitutional ' reason for this in the criminal arena, because the court is a separate, independent branch of the government that cannot be bound by the Executive Branch. Moreover, from the perspective of defense counsel, there is a large existing body of sentencing precedent that gives counsel a basis for rendering informed, even if not certain, advice on the potential benefit of cooperation on sentencing. Neither of these points is true in the context of an SEC proceeding.

That being said, there are obviously compelling institutional reasons for the Commission to give great weight to the Enforcement Division's recommendations. A pattern of rejection would undermine the Enforcement Division's initiative and, with it, the Commission's “Policy Statement Concerning Cooperation by Individuals in Its Investigations and Related Enforcement Actions.“

At the end of the day, the bigger problem for counsel representing an individual in an SEC investigation and analyzing the benefits and risks of cooperation is the classic dilemma: although failure to cooperate and “taking the Fifth“ can lead to an adverse inference in the civil matter, providing information ' absent negotiated protections ' can have negative consequences on a parallel criminal investigation.

Deferred-Prosecution Agreements

Deferred-prosecution agreements are written agreements pursuant to which the SEC agrees to forgo an enforcement action if a party agrees to: 1) cooperate fully and truthfully; 2) enter into a long-term tolling agreement; 3) comply with express prohibitions and undertakings during a period of deferred prosecution; and 4) under certain circumstances, agree either to admit or not contest underlying facts that the Commission could assert to establish a violation of the federal securities laws in the event the agreement is violated. If the agreement is violated, the Division can recommend enforcement action, and any statements made to the SEC during the investigation can be used in any enforcement proceeding. The Enforcement Manual provides that the term of a deferred-prosecution agreement should not exceed five years. It also provides: “Unless the Commission directs otherwise, deferred prosecution agreements will be made available to the public upon request.“

Deferred-prosecution agreements have long been an available tool for resolving criminal investigations, first historically as to individuals and more recently as to corporations. One frequently used provision in such corporate agreements is the hiring of a corporate compliance monitor. Such monitors have also been a feature of SEC settlements. Controversy surrounding the use of monitors by the DOJ has led to the establishment in the so-called “Morford Memo“ of nine guidelines for the use and selection of compliance monitors. The extent to which monitors become a staple of SEC deferred-prosecution agreements remains to be seen, as does the extent of the monitor's duties and any attendant oversight by the Commission.

Non-Prosecution Agreements

Non-prosecution agreements are written agreements, made in limited circumstances, pursuant to which the SEC will agree not to pursue an enforcement action in exchange for full cooperation with the Commission's investigation, and compliance with express undertakings by a cooperating party. As is the case with deferred-prosecution agreements, the Commission itself must approve such an agreement.

The Enforcement Manual generically sets forth terms that the Enforcement Division should generally include in non-prosecution agreements. Not surprisingly, the terms include complete cooperation, disgorgement or penalty payments, “additional undertakings designed to protect the investing public,“ and provisions that, if an individual violates the agreement, the Commission can use all the provided information in a subsequent enforcement action. Furthermore, if an agreement is violated, the Commission may pursue an action against an individual without limitation and “not subject to the applicable statute of limitations.”

Both with respect to cooperation agreements and non-prosecution agreements, the Enforcement Manual recognizes that, in many cases, the Commission may not need to use these tools to “buy“ cooperation given the practical dynamic of a parallel investigation with the DOJ. The Manual provides that the staff, when attempting to determine whether to recommend that the Commission enter into either type of agreement, “should consider whether the individual or company has entered into or is likely to enter into a plea agreement with criminal prosecutors that will require them to cooperate in the Commission's investigation and related enforcement actions ' “

Advising Your Clients

If your clients are considering cooperating with the SEC under the Cooperation Initiative, keep these tips in mind when formulating your advice:

• Assume that criminal authorities can obtain access ' by subpoena if necessary ' to any information disclosed to the SEC.
• Be timely in any effort to reach a cooperation agreement with either the SEC or DOJ. Both authorities put a premium on a party stepping forward early as a factor in deciding whether to enter into a cooperation agreement.
• Do not rely on any oral representations. Get it in writing and clearly define with specificity the obligations your client is undertaking.
• Assume that any agreement with the SEC will be on the first page of The Wall Street Journal and that the text will be publicly available.
• In determining whether you can represent multiple parties, you must always analyze the possibility that one prospective client has information adverse to another client or prospective client, so one client might some day be be compelled to give testimony adverse to the other. This analysis is now complicated by the fact that the opportunity to obtain a cooperation, deferred-prosecution, or non-prosecution agreement can create an incentive to provide such adverse evidence about others.

Conclusion

Although the SEC's Cooperation Initiative Program aims to enhance the Commission's ability to detect violations by providing incentives to cooperating parties, potential cooperators should proceed with caution. The SEC's Policy Statement notes the “tension between the objectives of holding individuals fully accountable for their misconduct and providing incentives for individuals to cooperate with law enforcement authorities.” It remains to be seen whether the SEC's cooperation tools, as presented in the Enforcement Manual, will be sufficiently beneficial to parties to induce their cooperation and thus “change the game.”

Howard W. Goldstein ([email protected]), a member of this newsletter's Board of Editors, is a partner at Fried, Frank, Harris, Shriver & Jacobson LLP in New York and a former federal prosecutor. Sujata Jhaveri, an associate at the firm, assisted in the preparation of this article.