The New Enforcement Manual: Parallel Proceedings

Prior installments of this occasional series on the SEC’s new Enforcement Manual have discussed the Wells Process and Cooperation. The segment considers parallel proceedings.

Section 5.2.1 of the Manual discusses parallel proceedings. The term, as used here, typically refers to situations in which the SEC and another agency are investigating the same or a similar matter. The Supreme Court has upheld the use of these types of inquiries. Indeed, provisions in the securities laws such as Exchange Act Section 21(d) seem to contemplate such proceedings. Parallel proceedings offer law enforcement and the potential defendant certain efficiencies. At the same time, they also present potential pitfalls for the unwary.

The Manual discusses parallel proceedings primarily in the context of Department of Justice inquiries. In contrast, other sections dealing with references by the SEC of information to other agencies cover a wide variety of government and private organizations. In essence, the Manual encourages the staff to coordinate with other agencies.

In coordinating with other agencies, the Manual directs the staff to “keep in mind” certain considerations. These include:

• The investigation must be independent;

• The staff should make its own decisions on what testimony and documents to seek; and

• The staff should not seek testimony and documents solely for DOJ.

These factors are reminiscent of those on which the district court findings were based in U.S. v. Stringer, 408 F. Supp. 2d 1093 (D. Or. 2006), where the court dismissed an indictment based on parallel proceedings violations. Those findings were later reversed by the Ninth Circuit Court of Appeals.

If counsel for the witness inquires about the existence of a parallel inquiry, the staff is to direct counsel’s attention to Form 1662. If counsel asks who to contact at the U.S. Attorney’s Office, Section 5.2.1 directs the staff not to answer unless the U.S. Attorney’s Office has specifically authorized disclosure. This is consistent with standard procedure. At the same time, the refusal of the staff to disclose which U.S. Attorney’s Office is conducting the criminal investigation, or who at that office to contact, affords counsel some insight into the parallel criminal inquiry and how it is being conducted.

Two other sections on parallel proceedings are of interest. The first concerns proceedings being conducted by the Division itself. Here, Section 3.13 of the Manual specifies that the Division may continue to investigate under a formal order while simultaneously litigating a related civil action if there is an independent, good faith basis for continuing the inquiry. Where however, there is a pending court proceeding, the Manual cautions that the staff should use “judgment” in issuing investigative subpoenas, taking into consideration:

• The degree of factual and legal overlap;

• The prior course of the litigation;

• The likely response of defense counsel; and

• The likely views of the particular judge assigned to the case.

If the staff obtains “testimony or documents in the investigation that are properly discoverable in the litigation, the SEC must produce them in the litigation in accordance with the Federal Rules of Civil Procedure.”

If there is a pending administrative proceeding, the Division is required to notify the hearing officer and each party regarding the issuance of a subpoena. The hearing officer is authorized to take whatever steps are necessary to ensure that the investigative subpoena is not issued for the purpose of obtaining evidence for the proceeding. In addition, the hearing officer can provide documents obtained through such a subpoena to each respondent in the proceeding on a “timely basis.”

Finally, Section 3.1.4 deals with parallel investigations with SROs and the state actor doctrine. Essentially, this section cautions the staff about allowing its inquiry to become intertwined with an SRO investigation. This could impact the ability of witnesses to invoke the Fifth Amendment (typically, SRO Rules require cooperation). In this regard, the staff is cautioned about either “joint actions” or situations where there is “government compulsion.” Under the former, the SEC and the SRO act in concert. Under the latter, the SRO is encouraged to take certain actions at the request of the SEC. Under either, the SRO could be viewed as a state actor, which would permit the witness to invoke a constitutional privilege in response to a request to testify.

The Market Crisis, Short Selling And The Uptick Rule

Earlier this year, the SEC lifted its ban on short selling without restoring the “uptick” rule which it abolished over a year ago. Last summer the SEC initially imposed a ban on short selling in the securities of certain financial institutions as the market crisis began to unfold as discussed here. That ban was later expanded and disclosure obligations were added, as discussed here. At the beginning of October however, the SEC lifted its short selling ban (here).

All of these actions followed the termination of the uptick rule last year. That rule essentially prevented short sellers from piling on as the price of a security tumbled down – a short sale could only be made when the price was going up or on an “uptick” in the price. The SEC concluded that the depression era rule was unnecessary.

While other market regulators, such as the UK’s Financial Services Authority joined the SEC in its market crisis short sale ban, all of those regulators did not agree with the Commission’s decision to lift the ban. The UK’s ban, and that of others, is still in place as discussed here.

Now, there are reports that financial institutions are lobbying the SEC to bring back the uptick rule. Citi, whose shares have been trading at penny stock levels, and others are apparently concerned that short sellers will push their share price even lower. According to some reports, short sellers significantly contributed to the demise of Bear Stearns. Others, such as the SEC’s inspector general (discussed here), seem to suggest different theories for the demise of the one-time Wall Street giant.

Regardless of the merits of the debate Bear Stearns, it is clear that executives on Wall Street are concerned about the impact of short selling. SEC Chairman Cox has in recent weeks called for additional regulation in view of the market crisis. To date, however the SEC has not indicated whether it will reconsider its position on the uptick rule.