The Impact of the New Commission Cooperation Initiatives – Part I.

Cooperation was a major tenant in the retooling of the SEC’s enforcement program. Borrowing heavily from the Department of Justice, the Commission announced proposals to use non-prosecution agreements and deferred prosecution agreements to encourage cooperation in 2010. While the emphasis was on individuals, issuers were included. The idea was to encourage cooperation to speed investigations.

It has been almost two years since the first non-prosecution agreement was entered into by Atlanta based clothing manufacturer Carter’s, Inc. Since then the Commission has entered into one other non-prosecution agreement and two deferred prosecution agreements. It has also acknowledged that cooperation impacted the settlement in a number of other cases.

To assess the impact of the new cooperation proposals key, cases in which cooperation has been acknowledged by the Commission will be assessed. Those actions can be divided into three groups for discussion purposes: 1) Non-prosecution agreements; 2) deferred prosecution agreements; and 3) settled actions in which the Commission has acknowledged that cooperation impacted the resolution. The first two groups will be considered in this article while the remaining actions along with an assessment of the initiatives will be in an article published later this week.

No prosecution

Since the announcement of the proposals, the Commission has only entered into two non-prosecution agreement and two deferred prosecution agreements. The former were with Carter’s, Inc. and an executive at investment advisor AXA Rosenberg. The latter were with Tenaris S.A. and the Amish Help Fund.

The Commission’s first non-prosecution agreement arose out of the financial fraud at Carter’s, Inc. There senior executive Joseph Ellis manipulated certain industry standard rebates or discounts that were given to a large customer. Specifically, Mr. Ellis is alleged to have granted larger than appropriate rebates or discounts to induce larger sales. He concealed his actions with false documents, causing the revenue of the company to be significantly overstated for a period. When the scheme was announced the share priced dropped significantly. Mr. Ellis has been named in both civil and criminal actions. Two other executives have also been charged by the Commission.

Carter’s, Inc., was not prosecuted in view of its cooperation. Rather, the company entered into the first non-prosecution agreement with the Commission in December 2010. The agreement did not require an admission of liability although the company did agree not to deny the underlying conduct except in proceedings not involving the SEC. The company also agreed to fully cooperate with the SEC’s inquiry.

The SEC’s second non-prosecution agreement involved an executive at AXA Rosenberg, an investment adviser which settled an administrative proceeding. In the Matter of AXA Rosnberg Group, Adm. Proc. File No. 3-14224 (Feb. 3, 2011). The case there involved a computer modeling error that resulted in significant losses. In June 2009 senior management discovered the error. Shortly thereafter it was corrected for U.S. clients and later for others. The firm did not disclose the error to clients who were registering complaints. Eventually, it was disclosed to the Commission and investors. The company settled the proceeding with a cease and desist order, payments for the harm caused investors and a penalty and the implementation of certain procedures.

The executive who entered into a non-prosecution agreement had a limited role in the misconduct and had advocated internally at the company that it be disclosed earlier. He fully cooperated with the Commission from the time he was first contacts and before entering into an agreement with the agency. He was also retiring. Accordingly, there was little likelihood of a reoccurrence of the conduct by the executive and, as with the fraud at Carter’s, the wrongful conduct was limited in nature.

Deferred prosecution

The two deferred prosecution agreements reflect similar circumstances. The Commission’s first non-prosecution agreement was in an FCPA case with Tenaris S.A. There the company, a Luxembourg based international seller of steel pipe products and related services to the oil and gas industry, was alleged to have obtained confidential information through a local agent on the bidding process for certain contracts. The agent was paid a commission, portions of which went to state officials as bribes.

When Tenaris first learned of the actions by its subsidiary, the company self-reported and conducted an extensive investigation and analysis of the situation. It fully remediated the wrongful conduct.

The company resolved the possible charges with the DOJ by entering into a non-prosecution agreement and paying a $3.5 million criminal fine. It settled with the SEC by entering into a deferred prosecution agreement and agreeing to pay $5.4 million in disgorgement and prejudgment interest. Under the terms of the agreement the company will continue to cooperate with the Commission and implement certain remedial efforts.

The Commission’s second deferred prosecution agreement was with the Amish Help fund, an Ohio based non-profit corporation. The violations centered on the fact that the Fund, established to provide loans to members to further the Amish way of life, had not updated its prospectus in 15 years. The prospectus was used to sell investment contracts to fund the loans. Over its history the fund had 3,500 investors, over 1,200 borrowers and about $125 million in mortgage receivables. It had never had a default and no investor had suffered a realized loss.

When notified that it was in violation of state and federal securities laws, the Fund immediately cooperated, updated the prospectus, offered all existing investors the right of recession and took other remedial steps. Thus this action, like the one involving Tenaris, was predicated a limited situation where the wrongful conduct was fully remediated once discovered.

Each of the non-prosecution and deferred prosecution agreements entered into by the Commission to date have been consistent with the decision not to prosecute in the 2002 Seaboard Release, the Commission’s long standing initiative on cooperation. That Release centered on a limited financial fraud in a subsidiary where the company fully cooperated once the situation was identified. Similarly, the wrongful conduct in Carter’s, AXA, Tenaris and Amish Fund involved limited, contained wrongful conduct which was fully remediated. In each instance the company or the executive fully cooperated with the Commission and there were assurances that the wrongful conduct would not be replicated in the future.

Viewed in this context the new cooperation initiatives do not appear to have significantly expanded the circumstances under which the Commission will not insist on resolving the situation with a settled enforcement action. At the same time the new initiatives do give the agency additional options for resolving a case beyond simply settling an enforcement action as in the past. To fully assess the significance of the initiatives however, the other actions in which the Commission has acknowledged cooperation in settled actions must be carefully analyzed and assessed. Those cases will be analyzed in the second part of this article later this week.

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