Enforcement Chief Linda Thomsen, in an April address before the Mutual fund Directors Forum, called for a spirit of cooperation between independent directors at mutual funds and the SEC, citing a speech by the First Chairman of the SEC, Joseph Kennedy.  Specifically, Ms. Thomsen noted that, in her view, good corporate citizenship should be viewed from a cooperative prospective.  To amplify her thoughts she revisited the SEC’s 2001 Seaboard Report, which discusses cooperation standards.  Under that Report, according to Ms. Thomsen, the four key points considered in determining whether a sanction should be imposed on a company and if so to what extent are:  1) self-policing, 2) self-reporting, 3) remediation, and 4) cooperation with law enforcement.  Ms. Thomsen chose two specific examples to illustrate her point.  The first was an action involving Putnam Fiduciary Trust Co., where the SEC elected not to bring an enforcement action against the company, but only against the individuals.  The Commission’s decision was based on Putnam’s conduct, including that it self-reported, conducted an independent internal investigation, shared the results of that inquiry with the government, terminated and otherwise disciplined those employees involved, made full restitution and implemented new controls.  An enforcement action was brought, however, against the individuals involved.  SEC v. Karnig H. Durgarian, Jr. et al, Litigation Release No. 19517 (Jan. 3, 2006), http://www.sec.gov/litigation/litreleases/lr19517.htm.    

In her second example, the SEC decided that the facts and circumstances warranted bringing an action against the firm.  In that case, however, the SEC elected not to seek disgorgement against OppenheimerFunds, Inc., prejudgment interest or a penalty in view of the company’s cooperation.  There the cooperation included an independent investigation of the company’s revenue sharing practices, reporting on those practices to the fund boards, and the company determining that payment should be made to the funds, and voluntary reimbursement to the funds in an amount that exceeded the actual benefit the company received from the fraudulent practices.  Yet, unlike the first example, the cooperation did not include sharing privilege information with the Commission.  In re OppenheimerFunds, Inc and OppenheimerFunds Distributor, Inc., Investment Company Act Release No. 27065 (Sept. 14, 2005.), http://www.sec.gov/litigation/admin/34-52420.pdf 

Ms. Thomsen’s call for cooperation between the SEC and the companies it regulates is reminiscent of the tone evoked in the McNulty Memo, which is DOJ’s revision of the highly criticized cooperation standards in the predecessor Thompson Memo.   Unfortunately Ms. Thomsen did not offer any specific clarification of the Seaboard Report and its factors, which suffers from many of the same flaws as the Thompson Memo.  

At the same time however, careful analysis of  Ms. Thomsen’s remarks in the context of the cases she cited are a cause for real concern by any issuer considering cooperating with the SEC.  Previously, the Seaboard Report has been heavily criticized for contributing to the so-called “culture of waiver,” referring to the fact that under DOJ and SEC cooperation standards most companies and their counsel concluded that they must waive fundamental rights in order to have any opportunity to be viewed as cooperative.   Ms. Thomsen and the SEC staff have repeatedly denied that waiver is a requirement of cooperation.   

In a January 2007 letter to the SEC, however, the ABA requested reform of the Seaboard Report.  The SEC has been silent on the ABA’s request and others to reform Seaboard – seemingly until Ms. Thomsen’s speech.  Analysis of the examples cited by Ms. Thomsen in her speech suggests that the critics are correct – cooperation equals waiver, at least if the company is seeking non-prosecution.  In the Putnam case, one of the cooperation factors cited by the SEC in its Litigation Release is the waiver of privilege.  SEC v. Karnig H. Durgarian, Jr. et al, Litigation Release No. 19517 (Jan. 3, 2006), http://www.sec.gov/litigation/litreleases/lr19517.htm.  In contrast, in the Oppenhemier case there is no reference to waiver.  In the Putnam case, the company was not prosecuted, according to Ms. Thomsen, because of its cooperation, although she failed to mention the privilege waiver.  In the Oppenheimer case, the company did not waive privilege, a fact also not mentioned by Ms. Thomsen.   

The Seaboard Report is consistent with the examples cited by Ms. Thomsen.  At the beginning of the Seaboard Report the SEC gives an example of cooperation from the underlying case.  In the example, the company, like Putnam, was not prosecuted and waived privilege.  In contrast Oppenheimer’s cooperation saved the company from having to pay a penalty (likely because it already paid restitution, disgorgement by the SEC would seem inappropriate) but without the privilege waivers the company was not spared prosecution.  While the Commission refuses to properly define what each of the Seaboard factors requires, after considering Ms. Thomsen’s speech the true price of cooperation could not be clearer:  Cooperation may not, as the staff frequently says, require waiver – unless the company is seeking non-prosecution.  

Last Friday, the Washington Post ran a story by Carrie Johnson outlining a new SEC settlement policy for cases involving a corporate penalty.  Under the proposed policy the Enforcement Division staff would have to obtain Commission approval before negotiating a settlement in a case involving a corporate financial penalty.  The staff will then be given a range for any penalty.  This blog noted that a key issue with financial penalties is the difficulty of determining how the SEC applies the principles outlined in its Statement of Financial Penalties issued in January 2006.  (see post 3/13/07) 

Following the Washington Post article, SEC Chairman Cox addressed the Mutual Fund Directors Forum and, in part, outlined the significant change in policy.  Traditionally, the staff negotiated a tentative settlement with defense counsel, which was then submitted to the Commission for approval.  Presumably the staff was aware of the views of the Commission on various issues, such as corporate penalties, and negotiated the tentative settlement in accord with its understanding.  The staff then submitted the settlement to the Commission with a memorandum detailing the rationale for the proposed terms.  The Commission could approve or disapprove the proposal.  

Chairman Cox said in his address that the reason for the change is because Commission review should provide for “a guarantee of fairness and of horizontal equity in a nationwide program.”  The Chairman also pointed out that it will strengthen the staff’s ability in negotiating a settlement because the staff will know precisely what the Commission will authorize.  All of this will also speed the settlement process, the Chairman said, because if the proposed settlement is within the authorized range, it will be approved seriatim – a procedure where the staff memo detailing the settlement is sent to the office of each Commissioner for approval rather than calendared for a hearing at a closed Commission Enforcement meeting.  

The new procedure should accomplish what the Chairman outlined – in some cases.  It will of course dictate to the staff precisely what the Commission wants, as opposed to the prior system where the staff relied on its experience and understanding.  But why this is necessary is unclear because there is no indication that the staff is out of sync with the Commissioners.  The new policy may in some cases strengthen the staff’s position because it can simply say “this is it.”  The reason the staff needs a stronger position, however, is far from clear.  Indeed, given the fact that most companies can ill afford to litigate with the SEC because of the significant adverse consequences increased leverage for the staff seems unnecessary.  Similarly, the reason the new policy will promote more uniformity than the old policy is far from clear.   

One benefit of the new policy might be that it may promote uniformity among the Commissioners.  Reportedly, there are disparate views among the Commissioners concerning corporate penalties.  Requiring the Commissioners to conclude whether and, if so, how much of a penalty should be sought prior to settlement negotiations will force a consensus – or at least a prevailing majority view – among the Commissioners before discussions with defense counsel.  In this sense the new policy should promote uniformity.  

The new procedure also raises a significant question however:  Will the SEC listen to defense counsel if it has already made a decision on whether to impose a penalty and the approximate amount as evidenced by a range?  Presumably the point of negotiating a settlement is for the staff and defense lawyers to discuss the case, exchange information, exchange views and come to a principled resolution of what many times is a complex case.  Under the new procedure, however, the staff will already have been told if a penalty is to be imposed and the approximate amount in a forum where defense counsel views and those of the proposed corporate defendant were not represented.  Yet presumably defense counsel and the defendant would contribute to the debate, which could impact the views of the staff and Commission.  

For example, under the SEC’s Statement on Financial Penalties key considerations in determining whether a penalty should be imposed are whether the company profited from the wrongful conduct and whether imposing a penalty would harm the shareholders.   Under the new procedure, the Commissioners will have resolved these issues prior to settlement negotiations.  If they have decided a penalty is not appropriate the issue is resolved.  If on the other hand they have concluded that a penalty should be imposed they will have also determined the approximate amount evidenced by the range.  The staff will then begin negotiations with defense counsel armed with its settlement directive from the Commission based on its unilateral determinations.  What happens, however, if defense counsel offers new arguments the Commissioners did not consider or perhaps an expert economist who demonstrates that the company did not benefit or received only a marginal benefit from the alleged fraud and that, in reality, the fired employees were the beneficiaries of the wrongful acts.  The now several things can happen: 

1) The staff does not listen because it is bound by the settlement range and the company settles because it can ill afford to litigate.  Here the company pays an inappropriate fine harming the shareholders.

2) The staff does not listen because it is bound by the settlement range and the company refuses to settle.  The case continues to litigation for the wrong reasons; again, needlessly harming the shareholders and wasting SEC resources. 

3) The staff goes back to the Commission and requests a revision of its authority.  This results in an extended delay in an already far to long settlement process; again, injuring the shareholders.

The only real “win” scenario for the SEC and the shareholders is if the unilateral decision by the SEC is correct and a quicker settlement is achieved.  

Under the new policy the SEC and the shareholders seem to have a one in four chance of benefiting.  This seems inconsistent with the SEC’s shareholder protection mission.  If the SEC is truly concerned about the imposition of penalties on corporations rather than gambling on new rules promoting Commissioner unity, it would seem far better for the agency to amplify its Statement on Financial Penalties and add some true transparency to the process.