The SEC continued its efforts to rejuvenate the Enforcement program yesterday, taking two important steps yesterday. Once concerns the reorganization of the Division of Enforcement to increase its expertise and efficiency, while the other focuses on securing cooperation to facilitate investigations by adopting techniques used by the Department of Justice.

At a news conference on Tuesday, Enforcement Director Robert Khuzami named the unit chiefs for the five specialized units that are being created within the Enforcement Division, as well as the head of the new Office of Market Intelligence. Those units focus on asset management, market abuse, structured and new products, the FCPA and municipal securities and public pensions. The unit chiefs were drawn from the staff as was the head of the new Office of Market Intelligence, essentially an intake unit for tips received by the Division.

The specialty groups should help focus the expertise of the Division and thus speed investigations. Calling this step, along with the others being made, the “most significant reorganization” since the Division was established in 1972, as the press release states, may, perhaps, overstate the case. In fact, the creation of specialized units within Enforcement returns the Division to its past when it was considered one of the premier investigative units in government. Until the early 1980s, the Enforcement Division had units which specialized in various matters. A reorganization under then Chairman Shad eliminated those groups. Regardless, this return to the past should facilitate the work of the Division.

The new cooperation standards, added as a new chapter to the Enforcement Manual, should also aid the work of the division. The standards have two main features. One focuses for the first time on incentives for individuals to cooperate with the SEC. The other concerns the use of deferred and non-prosecution agreements for individuals and business organizations.

Section 6.1.1 of the Manual, which is also being published in CFR, details principles regarding cooperation by individuals. After noting that “there exists some tension between the objectives of holding individuals fully accountable for their misconduct and providing incentives for individuals to cooperate with law enforcement authorities,” the Manual outlines four basic considerations amplified by various sub-points that will be used in evaluating the question of cooperation credit for individuals. As under Seaboard, none of the factors are binding and the list is non-exclusive. The factors are:

1) Assistance provided by the individual: This point focuses on the value of the assistance to the investigation, the nature of the cooperation, whether others were encouraged to assist and any unique circumstances in which cooperation was provided.

2) Importance of the underlying matter: This factor is a function of the nature of the investigation and the danger to investors and others presented by the underlying violations.

3) Interest in holding the individual accountable: Here, the nature of the misconduct by the individual will be assessed, along with culpability, any efforts to remediate the harm caused and any sanctions imposed by other authorities.

4) Profile of the individual: This factor considers whether, and by how much, it is in the public interest to award cooperation credit based on the history of the person, the degree to which responsibility has been accepted and opportunities for future violations.

For business organizations Seaboard, discussed here, is still the standard and is incorporated into the Manual in Section 6.1.2.

The key new provision for both business organizations and individuals is the prospect for avoiding prosecution through the use of either a deferred prosecution or non-prosecution agreement. Both types of agreement are commonly used by the Department of Justice.

A deferred prosecution agreement, which must be approved by the Commission, is a written agreement which contains the following elements, according to the Manual: a) an agreement to cooperate; b) a long term tolling agreement which presumably would not be more than five years since that is typically the outside length of the agreement; c) an undertaking to comply with express prohibitions and/or undertakings during a period of deferred prosecution; and d) a promise “under certain circumstance, [to] agree either to admit or not to contest underlying facts that the Commission could assert to establish a violation of the federal securities laws.” This latter provision would not apply to individuals who are not: professionals, employees of a regulated entity, officers or directors of a public company or persons who are not recidivists. The agreement would also contain any prohibitions or undertakings deemed necessary to protect the investing public.

A non-prosecution agreement, which also must be approved by the Commission, is defined as a written agreement which provides that the SEC will not pursue an enforcement action against the person if that person cooperates and complies under certain circumstances with express undertaking. There is no reference in the discussion of non-prosecution agreements of making admissions of, or not contesting, the facts. Such an agreement may however require the payment of disgorgement and/or a penalty, a point not mentioned in the discussion of deferred prosecution agreements. The agreement may also contain any other prohibitions or undertakings deemed necessary to protect the investing public.

The prospect of entering into a deferred or non-prosecution agreement should help encourage cooperation and thus be beneficial to Enforcement. For individuals, the prospect that they may not be prosecuted should offer an inducement to cooperation. Business organization may also be induced to cooperate by the prospect of entering into a deferred or non-prosecution agreement, particularly if it avoids the filing of the typical SEC speaking complaint detailing pages of misconduct. Presumably if a non-prosecution agreement is reached this would be the case. The precise procedure under the Manual for a deferred prosecution agreement, however, is not specified.

It remains to be seen, however, whether in practice the prospect of cooperation credit for individuals and business organizations will have the desired impact. Under Seaboard, it is typically difficult for a person considering cooperation to evaluate its potential impact on any potential charging decision in view of the opaque process used to award cooperation credit. If no action is filed there is no press release. Even when the Commission credits cooperation, the typical Litigation Release rarely specifies the nature of the cooperation or its impact. Since the Manual does not specify that this practice will be altered, presumably it will continue to be difficult to assess the impact of cooperation.

The Manual does, however, suggest that deferred and non-prosecution agreements will only be used in limited circumstances. Any requirement that there be an admission of facts before entering into a deferred prosecution agreement may also cause many to have second thoughts about cooperation on this basis. This may be particularly true for business organizations facing parallel civil damage and derivative actions or for any person where there is the prospect of criminal liability. At the same time, the Manual makes it clear that non-prosecution agreements will only be used in very limited circumstances. Thus, the impact of these new provisions is difficult to assess.

Overall, however, the two announcements represent a good step in the direction of rejuvenating the enforcement program. The return to the use of specialty groups within the Division of Enforcement should have a beneficial impact on the program. Likewise the new cooperation provisions may well have a positive impact on the program.

Cooperation is often critical to effective law enforcement. SEC enforcement director Robert Khuzami has acknowledged this point in recent public remarks, noting that he would like to develop incentives to encourage more cooperation by individuals.

For corporations, the SEC, like the Department of Justice and other federal law enforcement agencies, has long held out the prospect of credit in the charging process in exchange for cooperation. While there is no talismanic test which will guarantee a company that it can secure enough credit to avoid being charged, the SEC’s Seaboard Release, discussed here, contains an example of a company that did in fact earn sufficient credits and discusses general principles regarding cooperation.

Typically, when acknowledging that a company has cooperated, the Commission does not enumerate what specific acts were done or how they benefited the company. One notable exception last year occurred in In the Matter of Black, Adm. Proc. File No. 3-13625 (Sept. 24, 2009) and SEC v. Black, Case No. 09-cv-0128 (S.D. Ind. Sept. 24, 2009). These are the Reg. FD actions brought against Christopher Black discussed here. There, the Commission discussed the reasons an action was not brought against the company.

The Commission’s discussion of the cooperation of NATCO Group Inc. in resolving an FCPA case this week provides an additional window into the otherwise opaque world of cooperation credit. In the Matter of NATCO Group Inc., Adm. Proc. File No. 3-13742 (Filed Jan. 11, 2010); SEC v. NATCO Group, Inc., Civil Action No. 4:10-CV-98 (S.D. Tex. Filed Jan. 11, 2010). See also Litig. Rel. 21374 (Jan. 11, 2010). These FCPA cases were settled with a consent by the company to a cease and desist order based on the FCPA books and records and internal control provisions and the payment of a $65,000 penalty.

Houston-based NATCO manufacturers and markets oil and gas production equipment and systems that are used worldwide. TEST Automation & Controls is a wholly owned subsidiary with an office in Kazakhstan. The subsidiary fabricates and sells control panels and packaged automation systems and furnishes related field services.

According to the Order, TEST won a contract to provide certain instrumentation and electrical services in Kazakhstan. The subsidiary hired local Kazakh workers and expatriates to perform the work. During an audit of TEST in 2007, Kazakh immigration prosecutors claimed that the expatriate workers did not have the proper documentation and threatened to impose fines and to either jail or deport the workers if the company did not pay the fines. TEST senior management approved the payments based on the belief that the workers would be jailed. A February 2007 $25,000 wire transfer made to an affected employee was inaccurately described as a salary advance. A subsequent $20,000 wire transfer to reimburse other payments advanced by the individuals was booked as “visa fines.”

TEST used consultants to assist in obtaining immigration documentation for the expatriate employees. One consultant who did not have the proper license, but had close ties to the Ministry of Labor requested cash in two instances to facilitate obtaining the visas. To secure the payments, the consultant provided TEST with bogus invoices totaling $80,000 for the funds. The invoices, which were necessary under local law to withdraw the money from the bank, were later submitted to TEST and reimbursed despite knowledge of the true purpose.

The cooperation of the company was critical to the settlement. The Order for Proceedings details eleven specific steps taken by the company which the Commission considered in evaluating credit which do not reference the waiver of privilege:

1) NATCO discovered the TEST payments during a routine internal audit review in 2007;

2) The company conducted an internal investigation and self-reported to the SEC;

3) It undertook what were described as “numerous remedial measures” including “employee termination and disciplinary actions;”

4) It revised the form of documentation for agent agreements;

5) New due diligence procedures for the vetting and the retention of third party intermediaries were created;

6) Staffing in the global compliance department was bolstered including the retention of a full time Chief Compliance Officer;

7) The company joined a non-profit association which specializes in anti-bribery due diligence and screens potential partners and other third parties that work with multinational corporations;

8) Improved FCPA compliance training was implemented;

9) The company invested heavily in software to assist in enhancing internal controls and compliance;

10) It restructured its internal audit function and enhanced its monitoring and audit process for the compliance programs; and

11) In view of its initial findings, the company expanded its review into other high risk areas and did not find any malfeasance.

To foster cooperation in the future it would be beneficial if the Commission continues to provide such guidance.