Reforming the SEC: Witness Cooperation

The Division reforms designed to increase agency expertise through the creation of speciality units and eliminating branch chiefs have become widely known.  Less discussed perhaps but far more significant have been the proposed reforms designed to increase the effectiveness of investigations by enhancing cooperation and encouraging informants. 

One of the changes would be the straightforward authority of investigating attorneys to orally tell someone that they are not targets.  Officials who know how things work and can provide considerable assistance rightfully might refuse to talk until visiting with counsel or receiving a subpoena.  The Enforcement Manual allows attorneys to obtain "assurance letters" that assure witnesses that they are not targets.  The process, however, is almost useless.  It must be in writing, approved by the Commission and, as the Manual notes, will only be granted in "narrow circumstances."  See Enforcement Manual, 3.3.5.3.1 Witness Assurance Letters  at 80.  Now they will be able to provide assurances quickly, which should accelerate the pace of some investigations.

In addition, the proposals call for techniques that will be most useful in connection with the culpable.  Khuzami has called for deferred prosecution agreements and to quicken the pace of obtaining immunity for witnesses, something that requires approval by the US Attorneys Office and the Commission.  See Enforcement Manual 3.3.5.3.2 Immunity Orders, at 83.

But most profound is likely to be the development of Seaboard standards for individuals.  The standards were set out in 2001 in a Section 21(a) report.  See 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 (Oct. 23, 2001).  They provided a series of actions that could be taken by companies that would result in credit ranging from a reduced penalty to no charges filed at all.  Indeed, Seaboard, the company, wasn't sued by the Commission in that case.

Seaboard applied to companies.  In the early days following promulgation, the Commission sometimes gave Seaboard credit to individuals.  See, e.g. In the Matter of F.X.C. INVESTORS CORP. and FRANCIS X. CURZIO, INITIAL DECISIONS RELEASE NO. 218 (admin proc Dec. 9, 2002)("[[Curzio] testified that he brought the violation to the attention of Connecticut officials and then promptly corrected it. Under current Commission policy, Curzio is entitled to some consideration for the self-policing and self-corrective actions he took in 1995.").   Nonetheless, as a practical matter, those culpable in the offense could try for some type of reduction (maybe a 17(a) instead of a 10b-5 or a lower penalty) but would rarely if ever get a complete free pass.

Applying Seaboard to individuals presumably will result in credit for cooperation and self reporting.  Once the defense bar has absorbed the new standards, it is likely that more participants in frauds under investigation will come forward and assist SEC investigators.  In some instances, it will effectively allow the Commission staff to bargain up.

The plan, apparently, is to allow cooperation agreements at the staff level, binding on the Division but not on the Commission.  (Canellos indicated this at the BNA conference referenced above).  The Commission could, presumably, reject the agreements.  But doing so would deprive all all staff engineered agreements of any credibility so as a practical matter, this is unlikely to occur. 

Seaboard cooperation only applies to the SEC.  It does not relieve the culpable of risk for criminal liability.  There will be instances where witnesses who would like to cooperate will not out of fear of criminal exposure.  This will be particularly true in connection with high profile and insider trading cases, the types of cases likely to attract the attention of the US Attorneys Office. 

This won't solve all of the Commission's problems but it will facilitate the investigative process, assuming the standards are clear enough and used effectively.  These reforms are likely to last long into the future and continue to be a benefit even after the present administration shifts.