Series: SEC Enforcement Program 2007, Projecting Trends and Key Issues (Part III)
Key Issues in InvestigationsTwo key issues that may have a significant impact on SEC investigations in 2007 and beyond are: 1) parallel proceedings, and 2) cooperation. While these issues are not new, cases in 2006 and expected rulings and developments in 2007 may reshape how these important issues impact SEC investigations.
First, a review of recent SEC cases suggests that parallel government investigations are on the rise. Typically, while the SEC is conducting an investigation to determine whether there has been a violation of the federal securities laws, DOJ or the local U.S. Attorney’s Office will conduct a parallel investigation into the same matters. During the investigations, the SEC typically makes its files available to DOJ or the USAO and, on occasion, will detail one of its staff members to assist with the criminal inquiry. Parallel investigations offer efficiencies for both government and potential defendants. For this reason former SEC Chairman Harvey Pit noted that the SEC will continue to have a close relationship with other law enforcement agencies and use parallel proceedings. See Remarks at DOJ Corporate Fraud Conference (Sept. 26, 2002). For potential defendants parallel proceedings offer economies and the potential for a coordinated resolution. Courts have held repeatedly that parallel proceedings are proper and appropriate.
Problems can arise, however, when SEC and DOJ investigations are not parallel but merge in a manner that prejudices a defendant. Two recent cases illustrate the point and may potentially reshape the manner in which the government conducts parallel inquiries. Last January in U.S. v. Stringer, 408 F. Supp. 2d 1083 (D. Ore. 2006) the court dismissed a criminal indictment for government misconduct where the USAO concealed its investigation behind the SEC’s investigation and, according to findings by the court, mislead the defendants about the existence of the criminal inquiry. On appeal the SEC has argued in an amicus brief that its standard warnings in Form 1662 are standard practice and sufficient warning of the possibility of a criminal inquiry. Form 1662 is a standard set of warnings the SEC provides to every witness. In part, the Form notes that information may be shared with other law enforcement agencies. The SEC’s claims the Form is sufficient and that even where it knows there is a criminal inquiry it can rely on the Form warnings and not tell witnesses who ask about the existence of a DOJ or USAO inquiry. This case will be decided by the Ninth Circuit later this year.
Another parallel proceedings issue recently arose in SEC v. Reyes, (N.D. Cal. July 19, 2006). Mr. Reyes, the former CEO of Brocade, and others are accused of securities fraud based on a stock option backdating scheme. Similar charges are pending against Mr. Reyes in a criminal case brought by the USAO in San Francisco. After the USAO and SEC filed their cases, the USAO moved to stay the SEC action to prevent the defendants from using the civil discovery rules to develop evidence for use in the criminal case. The court denied the motion noting that it would be unfair to prevent the defendants from defending against the government accusations – particularly because the government brought its cases with significant fanfare, which included a press conference. Subsequently, the defendants in the SEC case asked the court to compel the deposition testimony of several key witnesses who refused to testify and invoked their Fifth Amendment rights. In their motion the defendants essentially argued that it was unfair for the USAO and the SEC to interview each of these witnesses in “proffer sessions” and then use that evidence when the same evidence is not available to the defendants. Criminal prosecutors typically ask witnesses to give them a proffer or a statement of what they know when they are considering offering the witness immunity. In this case, the USAO let the SEC join the proffer sessions so that the agency had the benefit of the evidence. The court denied the motion as premature, noting that it did not have authority to immunize witnesses. In ruling on the motion, however, the court cautioned the government about the unfairness of the situation and noted that if it continued as the case approaches trial, a remedy would be fashioned for the defendants.
Stringer and Reyes may reshape the way the SEC and the DOJ interact and conduct parallel investigations. If upheld, Stringer could require the SEC to inform witnesses when it is aware of a parallel criminal investigation. This contrasts sharply with current practice where SEC staff may know that there is a criminal inquiry but can refuse to share that information with witnesses whose rights may be impacted significantly. Rather the SEC enforcement staff under current practice simply point of Form 1662 or give a stock answer of “assume the worst.” Neither response is helpful and can be misleading. Reyes may also significantly impact SEC and DOJ investigations. The court’s ruling makes it clear that the playing filed will be leveled prior to trial.
Reyes is not the first case in which the SEC has had access to information developed by criminal prosecutors that is not available to the defendants in an SEC enforcement action. A ruling in Reyes, coupled with the ruling in Stringer, may go far to level the playing filed for defendants. Second, there may be significant developments on the question of cooperation that will impact SEC investigations. Cooperation is a key topic because it can shape the prosecution or mitigate a penalty for a company facing a potential securities law action by the SEC or the DOJ. The SEC’s standards in its Seaboard Release, No. 34-44969, 2001 WL 1301408 (Oct. 23, 2001) have been heavily criticized along with those of the DOJ by the ABA, in testimony before congress, by business groups and even by former high ranking justice department officials as causing a “culture of waiver,” which requires companies to waive their attorney-client privilege, work product protections and often the rights of its employees in the hope of being viewed as cooperative. While the SEC staff and the DOJ prosecutors disclaim responsibility for creating the so-called “culture of waiver” there is no doubt that many companies strip themselves of key rights and even perhaps impede their ability to obtain legal advice important to conforming their conduct to legal requirements in an effort to be viewed as cooperative. Indeed, Senator Specter has even offered legislation, tiled the Attorney Client Protection Act of 2007, to attempt to remedy the situation. While DOJ has taken some steps to amend its policies, the SEC has yet to respond to its critics, other than in sporadic denials. In February, however, SEC Commissioner Atkins noted that Seaboard should be reviewed – a reiteration of comments he made last year. Similarly, last month the ABA sent SEC Chairman Cox a letter requesting that Seaboard be revised. In view of the continued pressure on the SEC to revise its cooperation policies, there may be movement on this issue later this year. A revision of Seaboard to eliminate the “culture of waiver” by, for example, providing a bright-line test for cooperation or adopting the suggestion of Commissioner Atkins that waivers not be counted toward cooperation credit, would be a key step in reforming cooperation standards. Reforms in this area, coupled with the pending ruling in Stringer and potential developments in Reyes, may have a significant impact on how the SEC conducts its investigations in the future. Next, significant case trends.