The publication of the SEC Enforcement Division’s Enforcement Manual, which details its internal procedures, is a milestone. Many, including former SEC Commissioner Atkins, have repeatedly called for the Division to publish such a manual in the interest of fairness and transparency. In contrast, the Department of Justice has long had such a manual.

One significant section of the Manual deals with the Wells Process. That process, which is largely governed by Release No. 5310, issued in 1972, Rule 5(c) of he SEC’s Rules on Informal and Other Procedures, and to some extent custom and practice, is critical to the enforcement process. In the narrow sense, the Wells Process refers to the Wells notice, which is an opportunity of those against whom the Enforcement staff may make a recommendation to the Commission that an action be instituted to submit a presentation advancing their point of view on the question. In a broader and more fundamental sense, the Wells Process is more than the notice. Rather, it refers to the entire process by which enforcement recommendations are formulated, discussed with potential defendants and through which cases are frequently resolved.

The procedures outlined in the Manual begin by citing back to the origins of the process, which is the recommendations made by an advisory committee chaired by then Commissioner John Wells in June 1972. That Report significantly altered the existing process. At the time, according to the Wells report, the staff was not permitted to initiate settlement discussions or negotiate the terms of an offer of settlement before the action had been authorized by the Commission. The staff at that point was also “precluded from indicating to the prospective defendant or respondent the particular recommendations that the staff intends to make to the Commission.” The Committee recommended that the process be revised, concluding that “We think that frank discussions between the staff and opposing counsel concerning the staff’s conclusions and probable recommendation to the Commission would encourage settlements.”

The policy adopted under Release 5310 and Rule 5(c) implemented the spirit of the Wells Committee report. Much of what is in the Manual reiterates standard practice regarding the staff’s discretion to give a notice and its content. The initial subsection on the process encourages a written notice which identifies the specific charges, gives the recipient an opportunity to provide a statement and sets reasonable limits on the length of the submission. The section concludes by noting that the staff may reject a submission if the person making it limits its admissibility under Federal Rule of Evidence 408 regarding settlements or in some other manner.

Perhaps the most significant subsection in this portion of the Manual is the one titled “The Post-Notice Wells Process.” Here, the staff is afforded “discretion to allow the recipient of the notice [the opportunity] to review non-privileged portions of the investigative file, including documents that the recipient likely would receive during discovery if the Commission were to file a recommended action or proceeding.” In considering this request the staff is to “keep in mind” three factors: 1) whether access would be “a productive way” for the staff and the notice recipient to assess the strength of the evidence on which the staff recommendation is based; 2) whether the notice recipient invoked the Fifth Amendment or otherwise refused to testify during the investigation; and 3) the stage of the proceeding and whether others have yet to testify.

This policy represents a significant advancement in Enforcement Division procedures. Prior to the issuance of the Manual, the Division typically did not give a potential defendant or respondent access to the factual material on which the enforcement recommendation would be based, although some offices and sections of the Division experimented with the concept.

Full use of the discretion by the staff to grant access should only serve to further implement the goals of the Wells Committee to foster settlement. If the staff has developed a sound factual record, permitting defense counsel to review it should only encourage settlement. If however, the staff has not fully or accurately assessed the evidence, it should welcome an opportunity to discover this before bringing an enforcement action which could only serve to unjustly injure the name and reputation of the defendant and embarrass the Commission with a loss in court. Not only is this consistent with the ethical obligations of a good prosecutor, but, in a pragmatic sense, it simply recognizes the inevitable – after an action is filed the evidence will have to be produced in discovery. Thus, if the staff utilizes the discretion discussed in this portion of the Manual – even if the Fifth Amendment has been invoked as discussed here – it is a win-win for everyone: The practice for the Commission will encourage a good dialogue and settlement in appropriate cases and avoid losses in court. For the defendant, it should also encourage settlement where the Commission has the facts and avoid litigating a case where it would be inappropriate.

In the future we will periodically explore other sections of the Enforcement Manual.

Parallel proceedings offer certain economies for all parties. They can also cause unfairness. This is particularly true when the government files a criminal case and the SEC files a parallel civil case generating significant publicity and then the U.S. Attorney requests a stay of the SEC case. In this context the ruling in SEC v. Cioffin and Tannin, Case No. 08-CV-2457 (E.D.N.Y. June 19, 2008) denying a stay of an SEC action sought by the USAO who was conducting a parallel criminal investigation is significant.

Both the criminal and civil case are based on allegations of securities fraud by two former Bear Stearns fund managers. The two defendants, Matthew Tannin and Ralph Cioffi, managed the Bear Stearns funds which collapsed in the summer of 2007. The SEC and the Department of Justice brought actions claiming fraudulent conduct by the two men in connection with the collapse of the funds. The two cases were filed just one day apart. U.S. v. Cioffi & Tannin, Case No. 08-CR-415 (E.D.N.Y Filed June 18, 2008).

After the two cases were filed in June, the USAO moved to intervene in the SEC’s case, requesting a stay pending the resolution of the criminal case. The government argued that while the parties in the SEC case will not be prejudiced by a stay and the court will not be inconvenienced, the government will be prejudiced absent a stay. That prejudice will result from the defendants “taking unfair advantage of broad civil discovery rules, to the detriment of the government and its witnesses,” the government argued. Defendants countered that a blanket stay is inappropriate in a case where answers have not been filed and no discovery has been sought. The SEC did not take a position.

The district court permitted the USAO to intervene, but denied its request for a stay. The key question in considering such a motion is prejudice, according to the court. At the same time “[c]ourts are justifiably skeptical of blanket claims of prejudice by the government where – as here – the government is responsible for the simultaneous proceedings in the first place.” Furthermore, while there are limits on criminal discovery, “‘to the extent that the defendants’ discovery requests simply result in the happenstance that in defending themselves against the serious civil charges that another government agency has chosen to file against them they obtain certain ordinary discovery that will also be helpful in the defense of their criminal case, there is no cognizable harm to the government in providing such discovery beyond its desire to maintain a tactical advantage,’” quoting SEC v. Oakford Corp., 181 F.R.D. 269, 272-73 (S.D.N.Y. 1998).

The court went on to hold that without specific discovery requests and specific objections, it could not evaluate the validity and strength of the government’s concerns. Those concerns should be measured in view of three factors: 1) whether broad disclosure may lead to perjury and manufactured evidence; 2) if identification of prospective witnesses may create an opportunity for intimidation; and 3) whether the criminal defendants may unfairly surprise the prosecution with evidence developed through discovery where the Fifth Amendment would effectively block any discovery attempts by the government in the criminal case.

In denying the request for a stay, the court directed that discovery proceed. The USAO will have the opportunity to object to particular discovery requests.

This ruling is similar to the one in SEC v. Reyes, No. C 06-04435 Minute Order (N.D. Ca. Oct. 4, 2006). There, the SEC and the U.S. Attorney’s Office brought high profile option backdating cases against former Brocade Communications chairman Gregory Reyes. The court denied the request of the USAO in the SEC’s civil case for a stay concluding: “it appears to me that when the SEC decides they want to charge people with a violation of securities laws, which they are entitled to do and have a right to do and duty to do, they invite, of course, the defense to respond; and the defendant has the right to respond. … I don’t understand the logic … I don’t really appreciate the fundamental fairness of …” then having the USAO request a stay and denying the defendant in the SEC case an opportunity to respond.”

If these two rulings represent a trend, the government and the SEC may begin to rethink filing simultaneous criminal and civil enforcement actions, particularly in high profile cases.