With SEC enforcement actions on a steady rise, the new cooperation initiative will likely further increase this trend. In this changing climate, working with the SEC can have significant benefits, though must be carefully considered
Settlement is now a viable option to consider when one faces charges from the SEC. While there has been a documented increase in settlements under the new administration, the most dramatic change could come from the SEC’s recently announced cooperation initiative. This reflects a continuing and strategic shift in the SEC’s enforcement agenda to obtain earlier and increased cooperation from companies and individuals.
In announcing the initiative, Robert Khuzami, the SEC’s enforcement director, said ‘the program has the potential to be a game-changer.’ As with any other incentive the government offers, however, potential cooperators must give serious consideration to the possible risks of exercising this option.
It’s too early to tell exactly how the SEC’s new leadership will consistently approach settlements, but initial numbers show an increase in cases being resolved. According to studies from NERA Economic Consulting, the SEC entered into 205 settlements in the first quarter of its 2010 fiscal year (the last three months of 2009). This is up from 181 settlements in the previous quarter and is nearly twice as many as were seen the prior year under chairman Christopher Cox’s leadership.
NERA notes, however, that the percentage of settlements with a monetary component declined from 56 percent to 41 percent in the first quarter of 2010 when compared with the prior year. All this could mean the SEC is now bringing more cases for violations not usually charged under previous administrations, or it could signify the increased pressure the commission faces to settle in order to clear the way for new investigations.
Moreover, in its groundbreaking cooperation initiative, the SEC laid out three new tools to garner increased cooperation with its enforcement actions: written cooperation agreements, deferred prosecution agreements, and non-prosecution agreements. The first allows a cooperator to determine with some certainty what cooperation is worth. The SEC in turn benefits by being able to use the cooperator’s assistance to more quickly develop its investigations and locate assets that can be frozen. The cooperator will still likely face some enforcement action, albeit with lighter consequences. Any credit will be premised on the cooperator having rendered ‘substantial assistance’.
An even more enticing carrot is a written deferred prosecution agreement, where the SEC agrees to forego an enforcement action for a certain period. The cooperator will have to cooperate fully and truthfully with the SEC, waive any applicable statutes of limitations, comply with certain prohibitions, pay any agreed disgorgement or penalties, and admit or agree not to contest the relevant facts underlying the alleged offenses. These agreements cannot exceed a five-year period.
The ultimate prize for the cooperator is the non-prosecution agreement, where the SEC agrees not to pursue an enforcement action. These agreements will generally be used in limited circumstances and not early on in investigations or for individuals who have previously violated securities laws. Like the other cooperation agreements, non-prosecution agreements will likely be available to the public.
The SEC has also mentioned several other factors it will use in evaluating individual cooperation, including level of cooperation, importance of the underlying matter, societal interest in holding the individual accountable and appropriateness of cooperation credit based upon the individual’s risk profile.
The Gen Re settlement
While the cooperation initiative is still in its infancy, companies may gauge the SEC’s treatment of cooperators through recent settlements, including that of General Re Corporation (Gen Re). This may provide some insight into the factors the SEC considers in settling with a firm and could use again in future cases.
The commission alleged that a Gen Re foreign subsidiary entered into sham ‘reinsurance’ transactions with AIG in 2000 to allow it to manipulate and falsify its reported financial results. According to the SEC, Gen Re had also entered into a series of reinsurance contracts with Prudential from 1997 to 2002 that allowed Prudential to improperly build up assets so it could recognize more than $200 million in revenue. Gen Re agreed to pay a $12.2 million settlement.
In announcing the settlement, the SEC pointed to cooperation credit Gen Re had received: conducting a comprehensive, independent internal investigation of its operations when the government’s investigation began; sharing the findings of this investigation with the government; providing assistance to the government in civil and criminal actions it brought against the individuals involved; enacting internal corporate reforms that included dissolving the subsidiary involved with the AIG transactions; instituting legal review of contracts underlying similar transactions in the future; and strengthening its internal audit rules and underwriting functions.
Given that this settlement was likely being finalized at the same time the SEC’s cooperation initiative was formulated and made public, this could serve as a harbinger of what the commission expects companies to do to get cooperation credit.
Choosing with caution
Khuzami has said ‘every criminal law enforcement authority in the nation is armed with [cooperation tools].’ This statement may have been made to highlight the strength of an effective enforcement program, but it also illustrates a major weakness in the SEC’s new measures: the commission has only civil authority. In adopting these new cooperation procedures, has the SEC positioned itself to reap the same rewards as criminal prosecutors while failing to offer the same benefits?
The rules may have changed at the SEC, but the game remains the same: information provided by cooperators may give rise to or be used in subsequent criminal prosecutions or civil litigation. This especially pertains to the SEC now requiring a company to admit to, or agree not to contest, relevant facts before getting a non-prosecution or deferred prosecution agreement.
Perhaps in anticipation of some of these concerns, the SEC’s new cooperation program also provides for expedited immunity requests where the enforcement division director has authority to submit them to the Department of Justice. These requests are available only to individuals and, even if immunity is obtained, any admissions by cooperators could still be used in subsequent civil litigation, so cooperating with the commission where there is other litigation risk or criminal exposure is still fraught with peril.
Although there are benefits to cooperating with the SEC, including reduced litigation costs and risk, a quicker resolution and cooperation credit, one should be cautious before jumping in. Going down the cooperation path is a one-way trip – having begun, it is difficult to take back what has been disclosed. Also, given the program’s infancy, it remains to be seen exactly how the SEC will apply these tools in real-world situations.
What is likely, however, is that these cooperation policies will evolve as the SEC tries to balance restoring its credibility as a protector of the markets with continuing to work within the framework of being a civil regulator. In these uncertain times, the potential cooperator should tread carefully.
