The Securities and Exchange Commission (“SEC”) recently announced its first deferred prosecution agreement (“DPA”) with an individual.1 Such agreements are one of many initiatives by the SEC to induce knowledgeable companies and individuals (including culpable ones) to come forward with information to help the agency detect and punish securities law violations.
This Alert reviews the range of those initiatives, summarizes the DPAs the SEC has entered into to date, and discusses the implications of the SEC’s cooperation program generally.
The SEC has long emphasized the benefits of cooperation for both companies and individuals. In 2001, it issued guidance explaining its decision not to take enforcement action against a public company it had investigated for financial statement irregularities and outlining the “criteria [the SEC] will consider in determining whether, and how much, to credit self-policing, self-reporting, remediation and cooperation . . . .”2 In this report, commonly known as the “Seaboard Report,” the SEC articulated four broad measures of a company’s cooperation: (i) self-policing prior to the discovery of the misconduct, including establishing effective compliance procedures and an appropriate tone at the top; (ii) self-reporting when misconduct is discovered, including conducting a thorough review of the nature, extent, origins and consequences of the misconduct, and promptly, completely and effectively disclosing the misconduct to the public, to regulatory agencies, and to self-regulatory organizations; (iii) remediation, including dismissing or appropriately disciplining wrongdoers, modifying or improving internal controls and procedures to prevent recurrence of the misconduct, and appropriately compensating those adversely affected; and (iv) cooperation with law enforcement agencies, including providing the SEC staff with all information relevant to the underlying violations and the company’s remedial efforts.3 In 2010, the SEC issued its “Policy Statement Concerning Cooperation by Individuals in [SEC] Investigations and Related Enforcement Actions” (“Policy Statement on Cooperation”)4 outlining four factors relevant to cooperation credit for individuals: (i) the assistance provided by the individual; (ii) the importance of the underlying matter; (iii) the interest in holding the individual accountable; and (iv) the profile of the individual.5
Within the general criteria set forth in this guidance, the SEC now uses a variety of tools to reward cooperation:6
• Whistleblower Program: Receiving the most attention of late is the SEC’s well-publicized whistleblower program, implemented pursuant to Section 922 of The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”).7 The program awards whistleblowers who present high-quality, “original information” that results in an SEC enforcement action in which sanctions exceed $1 million anywhere from 10 percent to 30 percent of the total money collected.8 Additionally, the rules include express provisions designed to encourage culpable individuals to come forward, providing that while there is no amnesty for a whistleblower, the SEC will take a whistleblower’s cooperation into consideration in accordance with its Policy Statement on Cooperation.9 The program appears to be working, with the SEC reporting an increase in the quality of the tips it has received since Section 922 of Dodd-Frank became law.11 Additionally, in its recent annual report to Congress, the SEC reported that, from the establishment of the program in August 2011 until the end of fiscal year 2013, the SEC has received 6,573 tips and complaints from whistleblowers. Of these, four have resulted in awards to whistleblowers so far (including one award that was shared amongst three whistleblowers), with the SEC’s third award, announced in October 2013, making headlines at $14 million.12
• Cooperation agreement: In January 2010, the SEC announced its adoption of three new incentives for cooperation, long-used by U.S. Attorneys in criminal investigations: cooperation agreements, non-prosecution agreements, and DPAs.13 Of these, the SEC has used cooperation agreements the most, with thirteen such agreements since the inception of that incentive, including agreements with companies and agreements with individuals.14 Under a cooperation agreement, the Division of Enforcement agrees to recommend to the SEC that a cooperating party receive cooperation credit and, under certain circumstances, agrees to make specific enforcement recommendations.15 A cooperation agreement is non-binding on the SEC, and the Division of Enforcement makes no promises about whether or how the SEC may act on its recommendations.16
• Non-prosecution agreement: Under a non-prosecution agreement, the SEC agrees not to pursue an enforcement action against a cooperating company or individual if the cooperating party agrees to cooperate in the SEC’s investigation and related enforcement actions and, under certain circumstances, comply with express undertakings.17 To date, the SEC has entered into four non-prosecution agreements, all with companies.18
• Deferred prosecution agreement: Under a DPA, the SEC agrees to forego an enforcement action against a cooperating party if the cooperating party agrees to cooperate in the SEC’s investigation and related enforcement actions, enter into a long-term tolling agreement, comply with express prohibitions and/or undertakings during the period of deferred prosecution, and, under certain circumstances (and distinct from non-prosecution agreements), agree either to admit or not to contest underlying facts that the SEC could assert to establish a violation of the federal securities laws.19 If the cooperating party then violates the agreement, the SEC can bring an enforcement action using those admissions (or the agreement not to contest) against the cooperating party. To date, the SEC has entered into three DPAs − two with entities and the recently announced DPA with an individual20 − each of which is summarized in the next section.
• Proffer agreement: Under a so-called “queen for a day” letter, any statements made by a cooperating individual during a proffer session on a specific date may not be used against that individual in subsequent proceedings, although the SEC may use such statements as a source of leads to discover additional evidence, for impeachment or rebuttal, and to aid in a prosecution for perjury, making a false statement or obstruction of justice.21 Although the Department of Enforcement casts the use of proffer agreements in its publicly available Enforcement Manual as one of its “Cooperation Tools,” a “proffer is generally required in order to evaluate whether to recommend that a cooperation agreement be entered by the Division.”22
• Statutory or letter immunity: Statutory immunity permits the SEC, pursuant to 18 U.S.C. Sections 6001-6004, to seek a court order compelling a witness who has asserted its Fifth Amendment privilege to give testimony or provide other information that may be necessary to the public interest, if the request is approved by the U.S. Attorney General.23 Letter immunity is conferred by agreement between an individual and a component of the U.S. Department of Justice.24 Both types of immunity prevent the use of statements or other information provided by the individual, directly or indirectly, against the individual in a criminal case, except to aid in a prosecution for perjury, giving a false statement, or obstruction of justice.25 However, neither prevents the SEC from using the testimony or other information in its enforcement actions, including actions against the individual.26
The SEC has discretion to evaluate whether a given cooperating party is to receive one of these incentives, and gives more credit for cooperation in matters involving “priority matters or serious, ongoing, or widespread violations.”27
While there are limitations, as outlined above, on how the SEC may use the information a cooperating party provides to it, the SEC often makes its files available to other government agencies, particularly U.S. Attorneys and state prosecutors, that are not bound by the SEC’s agreements.28
The SEC’s Deferred Prosecution Agreements
The circumstances leading to each of the three DPAs the SEC has entered into to date share little in common, making it difficult to surmise the specific circumstances in which a DPA may be available to a culpable party rather than some other reward for cooperation:
The SEC’s first DPA was with a cooperating company that discovered Foreign Corrupt Practices Act violations in its foreign offices, notified authorities, and agreed to cooperate with the SEC, the U.S. Department of Justice, and any other law enforcement agency, and to pay $5.4 million in disgorgement and prejudgment interest.29
The SEC’s second DPA stemmed from its investigation of a non-profit corporation, which led to findings that the non-profit used an offering memorandum that was not updated for fifteen years and that therefore contained material misrepresentations about the relevant fund and securities being offered (although with no identifiable harm to investors).30 When informed of the alleged violation, the non-profit immediately cooperated and took remedial steps, including updating and correcting its offering memorandum and providing existing investors with a corrected copy, offering all existing investors the right of rescission, retaining an independent certified public accountant to perform ongoing audits, registering its securities offerings with the applicable state securities regulator, and consenting to a cease-and-desist order with that regulator.31
The SEC’s most recent DPA was with a former hedge fund administrator, Scott Herckis, who helped the agency take action against a hedge fund manager who stole investor assets.32 After resigning from the hedge fund, Herckis contacted government authorities with his concerns about the hedge fund manager’s conduct and certain discrepancies in the hedge fund’s accounting records. He voluntarily produced “voluminous documents” and described to the SEC how the hedge fund manager was able to perpetrate his fraud.33 With this “voluntary and significant cooperation,” the SEC filed an emergency enforcement action against the hedge fund manager for misappropriating more than $1.5 million from the hedge fund and overstating its performance to investors.34 Under the terms of the DPA, which states that Herckis aided and abetted the manager’s securities law violations, Herckis cannot serve as a fund administrator or otherwise provide any services to any hedge fund for a period of five years, and cannot associate with any broker, dealer, investment adviser, or registered investment company.35 The DPA also requires Herckis to disgorge approximately $50,000 in fees he received for serving as the fund administrator, which will be added to the Fair Fund that has been created for the hedge fund’s investors.36 In the SEC’s press release, an associate director in the Division of Enforcement commented:
We’re committed to rewarding proactive cooperation that helps us protect investors, however the most useful cooperators often aren’t innocent bystanders. To balance these competing considerations, the DPA holds Herckis accountable for his misconduct but gives him significant credit for reporting the fraud and providing full cooperation without any assurances of leniency.37
ConclusionWhile the SEC’s cooperation program and its various tools are promising mechanisms for uncovering and prosecuting securities law violations, the SEC has used three of its newest tools — cooperation agreements, non-prosecution and DPAs — only sparingly. Granted, it may be that with time, more opportunities for their use will arise and the SEC will in fact use them more. But the statistics imply that these cooperation initiatives have not yet marked a watershed, for cooperators to come forth, or at least for the SEC to reward them. With a new SEC Chair who is familiar with the use of inducements and rewards and non-prosecution agreements and DPAs in particular, that may change.
1 Press Release, U.S. Securities and Exchange Commission, SEC Announces First Deferred Prosecution Agreement With Individual (Nov. 12, 2013) (“Herckis Press Release”), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540345373; Deferred Prosecution Agreement Between The Division of Enforcement of the United States Securities and Exchange Commission and Scott Jonathan Herckis (Nov. 8, 2013), available at http://www.knowledgemosaic.com/gateway/sec/press-release/2013_2013-241-dpa.pdf.
2 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Exchange Act Release No. 44969, at 2 (Oct. 23, 2001), available at https://www.sec.gov/litigation/investreport/34-44969.htm.
3 Id.; see Office of Chief Counsel, Securities and Exchange Commission Division of Enforcement, ENFORCEMENT MANUAL, 134 (Oct. 9, 2013) (“Enforcement Manual”), at 121-122 (summarizing the four broad measures of a company’s cooperation as set forth in the Seaboard Report).
4 Policy Statement Concerning Cooperation by Individuals in its Investigations and Related Enforcement Actions, Exchange Act Release No. 34-61340 (Jan. 19, 2010), available at http://www.sec.gov/rules/policy/2010/34-61340.pdf (codified at 17 CFR § 202.12).
5 Id. at 3-7.
6 The SEC also actively publicizes circumstances in which it has rewarded cooperation. For instance, the SEC routinely features language highlighting cooperation in offers, consents or other dispositions. Enforcement Manual, supra note 3 at 134-35 (directing same). Additionally, the SEC has organized past cooperation agreements, non-prosecution agreements and DPAs on an “Enforcement Cooperation Program” page on its website, at http://www.sec.gov/spotlight/enfcoopinitiative.shtml.
7 The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.L. 111-203, H.R. 4173 at Title 9, § 922 (2010), available at http://www.sec.gov/about/offices/owb/dodd-frank-sec-922.pdf.
8 17 C.F.R. § 240.21F-2(a)(2), available at www.sec.gov/about/offices/owb/reg-21f.pdf.
9 17 C.F.R. § 240.21F-15, available at www.sec.gov/about/offices/owb/reg-21f.pdf. As the SEC explained in its release for the final rules, it tried to balance the principle “that one effective way to bring about justice is to use a rogue to catch a rogue,” with preventing the creation of incentives to whistleblowers that are contrary to public policy. See Securities Whistleblower Incentives and Protections, 76 Fed. Reg. 34300, 34350 (June 13, 2011) (“Whistleblower Release”), available at www.knowledgemosaic.com/gateway/fedreg/2011-13382.pdf. Accordingly, the rules provide that, in determining whether the required $1 million threshold for a whistleblower award has been met, the SEC will not take into account any monetary sanctions that the whistleblower is ordered to pay, or that are ordered against any entity whose liability is based substantially on conduct that the whistleblower directed, planned, or initiated. For a whistleblower eligible for payment, any amounts that the whistleblower or such an entity pay in sanctions will not be included for purposes of calculating the whistleblower award. 17 C.F.R. § 240.21F-16, available at www.sec.gov/about/offices/owb/reg-21f.pdf. The SEC also has explained that, “as part of a negotiated settlement agreement, deferred prosecution agreement, non-prosecution agreement, immunity agreement, cooperation agreement, or other similar agreement with a highly culpable whistleblower, we have the ability to obtain the whistleblower’s agreement to accept less than the statutory minimum or to forgo seeking a whistleblower award.” Whistleblower Release at 34350, n. 390.
10 E.g., Chairman Mary L. Shapiro, Speech by SEC Chairman: Opening Statement at SEC Open Meeting: Item 2 - Whistleblower Program (May 25, 2011), available at http://www.sec.gov/news/speech/2011/spch052511mls-item2.htm.
11 See 2013 Annual Report to Congress on the Dodd-Frank Whistleblower Program at 1 (Nov. 15, 2013), available at http://www.sec.gov/about/offices/owb/annual-report-2013.pdf.
12 Press Release, U.S. Securities and Exchange Commission, SEC Awards More Than $14 Million To Whistleblower (Oct. 1, 2013) (“Whistleblower Press Release”), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539854258. The specific events leading to that award are unavailable; the SEC has said only that the whistleblower’s “information led to an SEC enforcement action that recovered substantial investor funds.” Id. The SEC’s first payment to a whistleblower was made in August 2012 and totaled approximately $50,000. Id. In August and September 2013, over $25,000 was awarded to three whistleblowers who helped the SEC and the U.S. Department of Justice halt a sham hedge fund, with the SEC reporting that the ultimate total payout in that case once all sanctions are collected will likely exceed $125,000. Id. On October 30, 2013, the SEC announced its most recent whistleblower award of $150,000 to a whistleblower whose tips helped the SEC stop a scheme that was defrauding investors. Press Release, U.S. Securities and Exchange Commission, SEC Rewards Whistleblower With $150,000 Payout (Oct. 30, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540158194.
13 Press Release, U.S. Securities and Exchange Commission, SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations (Jan. 13, 2010), available at http://www.sec.gov/news/press/2010/2010-6.htm.
14 Enforcement Cooperation Program page, supra note 6.
15 Enforcement Manual, supra note 3 at 124.
16 Id. at 125.
17 Id. at 130.
18 Enforcement Cooperation Program page, supra note 6.
19 Enforcement Manual, supra note 3 at 128.
20 Enforcement Cooperation Program page, supra note 6.
21 Enforcement Manual, supra note 3 at 123.
22 Id. at 122-123.
23 Id. at 132.
27 E.g., Policy Statement on Cooperation, supra note 4, at 3 and n. 1.
28 Enforcement Manual, supra note 3 at 105. The Division of Enforcement’s Enforcement Manual explains:
It is important that the civil investigation has its own independent civil investigative purpose and not be initiated to obtain evidence for a criminal prosecution. This does not prevent the staff from taking an action if the action will provide a benefit to both the SEC’s case and the parallel criminal matter. It does mean, however, that staff should not take an SEC civil investigative action for which the sole aim is to benefit the criminal matter.
Id. (emphasis in original).
29 Press Release, U.S. Securities and Exchange Commission, Tenaris to Pay $5.4 Million in SEC’s First-Ever Deferred Prosecution Agreement (May 17, 2011) (“Tenaris Press Release”), available at http://www.sec.gov/news/press/2011/2011-112.htm; Deferred Prosecution Agreement Between The Division of Enforcement of the United States Securities and Exchange Commission and Tenaris S.A. (May 17, 2011), available at http://www.sec.gov/news/press/2011/2011-112-dpa.pdf. Tenaris also agreed to pay a $3.5 million criminal penalty in a non-prosecution agreement with the U.S. Department of Justice. See Tenaris Press Release at 1.
30 Press Release, U.S. Securities and Exchange Commission, SEC Announces Deferred Prosecution Agreement with Amish Fund (July 18, 2012) (“Amish Fund Press Release”), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171483290; Deferred Prosecution Agreement Between The Division of Enforcement of the United States Securities and Exchange Commission and the Amish Helping Fund (July 17, 2012), available at http://www.sec.gov/news/press/2012/2012-138-dpa.pdf.
31 Amish Fund Press Release, supra note 28 at 1-2.
32 Herckis Press Release, supra note 1.
37 Herckis Press Release, supra note 1.
This article was originally published by Bingham McCutchen LLP.