In The Dog Days Of Summer, Its Time To Begin Reforming Enforcement Policies

Its late August when many are on vacation and watching the last days of summer disappear before school starts and the fall rush begins. It’s easy to tell this in Washington because the commuting is easy.

Another sure sign is the SEC enforcement docket – seen any cases lately? The flow of cases out of the enforcement division has trickled down to virtually none. No enforcement actions filed since last Friday.

This lull of late summer provides an excellent opportunity for the enforcement division to begin reviewing its policies and procedures to increase transparency and fairness. A good place to start is with an open jacket Wells process, brought up months ago by then Commissioner Atkins (discussed here). The Wells process is suppose to be an opportunity for the possibly to be accused to provide their views to the staff and the Commission about a potential enforcement action. A full and fair opportunity to do so can only aid the prosecutorial decision making of the staff and the Commission.

Yet, at the present time, this process is impeded because the person receiving the Wells call frequently only knows a fraction of the facts which are available to the staff and the Commission. While traditionally Wells submissions have focused on the staff providing the Commission with the facts and the about-to-be-accused arguing legal issues, it seems clear that allowing the person preparing the Wells submission access to the facts should enhance the process, providing other views about not just the legal questions, but also the factual issues involved in the potential action.

Most enforcement cases and many legal issues turn on the facts. Indeed, the Commission has made it clear that prosecutorial decision making is a question of judgment and a function of the facts. Consider for example, the Commission’s Seaboard Release on cooperation (discussed here). The Release makes it clear that cooperation by an issuer with the Commission begins with a full and complete report of the facts. Conversely, prosecutorial decision making is clearly hindered by an inability to determine the facts. It is in this context that the much-discussed issue of privilege waivers typically arises – if privilege is asserted the staff and Commission may not have access to all the facts (discussed here).

Likewise, any person facing a prospective enforcement action needs to be aware of all the facts and circumstances before determining how to proceed. Before arguing in a Wells submission that the action should not be brought or that an alternative should be considered, all of the facts must be known. Before any settlement can be negotiated, the person entering into the settlement should know the facts. An open jacket process should provide the staff and the Commission with additional points of view about the potential action. Clearly additional points of view should aid prosecutorial decision making.

A few years back some of the Commission’s offices experimented with an open jacket Wells process. The procedure used was straight forward. As part of the Wells process the staff made available at the Commission’s office the relevant part of the investigative file for review by defense counsel. This should have produced better Wells submissions and more principled settlements. Unfortunately, the experiment was never carried forward to all of the SEC’s offices. This deprives the potential defendant of an opportunity to fully discuss the situation in a Wells and the staff and Commission of the benefit of having all sides of the possible issues fully vetted.

Now, in these dog days of summer when the case load and the traffic are slow, the staff should have the time to look into reforming enforcement policies. An open jacket Wells process should aid everyone while making the Commission’s processes more transparent and fair. And, fairness should be the key to good law enforcement.

Part II: Self-Reporting and Cooperation: Key Issues

The question of self-reporting begins with the legal obligations and compulsions, as discussed in the initial segment of this series. A key component of the decision however, is the question of cooperation and cooperation credit. The self-reporting business organization faces broad, virtually open-ended liability. Since that liability can frequently severely injure the company, the question of mitigating the impact of any charging decision becomes critical.

Both the SEC and DOJ offer business organizations the prospect of avoiding being charged or at least mitigating any sanction through cooperation. While this seems like a reasonable proposition, the difficulty is not so much with the principle as its application. Stated differently, what is cooperation, what is required and what is the “credit?”

Cooperation credit is typically discussed in terms of providing the prosecution — either the SEC or DOJ — with a full report of the facts. Again, this appears to be a sensible proposition. Any prosecutor making a charging decision needs to know the facts. In practice however, this proposition can have significant implications for both the business organization and its employees.

Furnishing all of the facts frequently begins with the question of privilege waivers. Frequently, the organization has learned the facts by conducting an internal investigation. Materials and information obtained during the inquiry are often covered, at least in part, by the attorney client privilege and/or the work product doctrine. While it is clear that waiver of those privileges may have significant implications for the business organization, it is equally apparent that waiver may be required.

The Seaboard Release (discussed here), the SEC’s seminal statement on cooperation, makes this point clear. At the beginning of the Release, the Commission gives an example of cooperation drawn from the underlying case on which the report is based. The key factors which led the SEC not to prosecute the company are:

• The conduct was a limited financial fraud discovered in a subsidiary;

• Within one week of the discovery, the internal auditors had conducted a preliminary review and advised management of their findings; management informed the audit committee;

• The board was advised and outside counsel was retained;

• Eleven days after discovery, the person deemed responsible was dismissed, along with two other employees who had not adequately supervised the responsible person;

• Twelve days after discovery, the company self-reported to the SEC and issued a press release noting that a restatement would be necessary; the share price did not decline;

• The company pledged, and gave cooperation to, the staff;

• The company furnished the staff with all information relevant to the violations including details from its investigation, such as notes and transcripts of interviews of the responsible person and others;

• The company did not invoke the attorney-client privilege, work product protection or other privileges or protections with respect to any facts uncovered in the investigation; and

• The company strengthened its financial reporting process to address the specific conduct involved.

Later in the Release, the Commission returned to the question of cooperation in two passages. In the first, the SEC discussed what it called “complete” cooperation, an undefined term. The second focuses on whether the company gave the staff information it “might not have uncovered,” a comment followed by a footnote which discusses non-waiver agreements which the SEC argues can be used to produce privileged material without waiving those privileges as to third parties.

The message of Seaboard is reinforced by a speech given by the Director of the Division of Enforcement. In that speech the Director gave two examples of cooperation. In the first privilege was waived; in the second it was not. Both companies got cooperation credit. Only the first was not prosecuted.

Next: DOJ, waivers and their impact on the organization.