The SEC Defines Cooperation to Obtain Non-Prosecution: In a Word, Waiver.

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),    

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.), 

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),  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.