As discussed in my last post, the SEC is saying that the availability of cooperation credit for individuals will pose serious potential conflicts between the interests of persons with knowledge about the events under investigation such that separate counsel might be required under the applicable ethical rules. SEC Staff will scrutinize such potential conflicts in a way that was not customary in SEC investigations before the new policy was announced. However, neither Mr. Khuzami nor Mr. Reisner have indicated whether the same will be true regarding potential conflicts in corporate representations.
If the law firm represents the company and individual officers and directors, the clients' interests can and often do diverge at some point. Traditionally, many firms have chosen the point at which the SEC Staff provides a Wells notice to notify individuals that the Staff intends to recommend an enforcement action against them as the time at which there is a divergence of interests between the company and its employees. This has been called into question by Messrs. Khuzami's and Reisner's recent comments and other comments by Enforcement Staff. Companies will need to provide separate counsel for employees at an earlier stage under the new regime. What about other conflict issues involving the corporate entity?
In 2001, the SEC issued a report of investigation known as the "Seaboard Report," named after a parent company against which the SEC did not take any action following an investigation into misstated financial statements at one of the company's subsidiaries. (See http://www.sec.gov/litigation/investreport/34-44969.htm). The SEC explained the reasons for its decision not to punish the company and laid out criteria for similar "cooperation credit" or "Seaboard credit" to be extended to other companies in future investigations. Among other things, Seaboard voluntarily self-reported its financial misstatements, gave complete cooperation to the SEC Staff, provided detailed reports of its internal investigation, and waived the attorney-client privilege and work product protection with respect to facts uncovered in the investigation.
In evaluating whether and how to provide Seaboard credit to a company, the Commission noted that one question it would examine would be whether the internal investigation was conducted by outside counsel (rather than internal personnel), whether such counsel had represented the company previously (implying that new counsel would be preferable), and whether and, if so, what scope limitations were placed on the review. This analysis in essence questions whether there is a basis for the SEC to believe that the internal investigation was not properly conducted due to a pre-existing relationship between the law firm doing the work and the company's senior management or because there was a limitation placed on what the law firm could consider in forming its conclusions.
Although the SEC Staff has, in a number of investigations, considered the independence of a law firm in evaluating what weight to give to a report, the SEC has to date never given this element the sort of prominence that is now being given to the potential conflicts issue in the context of individual cooperation. This begs the question: will potential conflicts issues become more important in the corporate context as well?
Several potential conflicts exist when a firm undertakes an investigation that will be shared with the SEC in order to obtain Seaboard credit.
If the law firm that conducts the investigation also currently represents the external audit firm (in unrelated litigation), for example, there is a potential conflict between two current clients. In a financial misstatement investigation where the facts indicate that the company's accounting treatment did not comply with GAAP, a conclusion that the auditor was aware of the underlying facts could be detrimental to the audit firm but favorable to the company and its management. The company's interests would be served by including this fact in the investigation report that is shared with the government, but this is likely to run counter to the interests of the audit firm.
Other potential conflicts exist in the corporate context. What will be interesting to follow is whether the SEC applies a similar parsing of the attorney-client relationship in these circumstances.
Friday, February 26, 2010
Tuesday, February 23, 2010
The SEC's New Cooperation Policy Explained
Today I attended a joint DC/NYC Bar Association session to hear Lorin Reisner, Deputy Director of the SEC's Division of Enforcement, address the SEC's new cooperation policy with regard to individuals in SEC enforcement investigations. Mr. Reisner spoke live in DC and by video in New York to an audience of SEC practitioners gathered in both locations. Panel members, including Steve Crimmins in DC and Walter Ricciardi, Mark Schonfeld, and Richard Marshall in NY, and attendees at both locations asked questions in a program that lasted a little over an hour.
The SEC issued the second version of its Enforcement Manual (available at http://www.sec.gov/divisions/enforce/enforcementmanual.pdf) on January 13, 2010. The updated manual contains new provisions designed, Mr. Reisner said, to enhance the ability of SEC Enforcement Staff to gain the assistance of persons with knowledge of securities laws violations early in an investigation. He noted that one of the factors to be considered in weighing the value of an individual's cooperation would be how early in the investigation the individual comes forward with an offer to cooperate. As he noted, "the earlier, the better" in this regard.
Mr. Reisner also noted that, in light of the fact that an individual may obtain lenient treatment through cooperation, counsel representing clients in Enforcement investigations will need to carefully consider whether they can represent more than one client simultaneously in the same investigation. He stated that he could think of a number of situations where it would be in one of the client's interests to cooperate and provide information to the detriment of other clients, presenting strong potential for conflicts of interest.
Mr. Reisner's remarks amplified upon earlier remarks by Robert Khuzami, the Director of Enforcement. In December, Mr. Khuzami, addressing the AICPA National Conference, noted:
Mr. Reisner made clear that Enforcement's leadership intends to allow considerable discretion in the area of cooperation to line Staff. One questioner asked Mr. Reisner whether disagreement with investigative Staff on whether to enter into a cooperation agreement, deferred prosecution, or other cooperation credit could, or should, be escalated to more senior Enforcement Staff. Mr. Reisner noted that such an escalation would probably be to no avail, absent exceptional circumstances.
It remains to be seen how effective this new tool will prove to be. As one questioner commented, following the SEC's Seaboard opinion, which laid out the criteria for an entity gaining credit for cooperation with SEC investigations (see http://www.sec.gov/litigation/investreport/34-44969.htm), subsequent SEC settlements with entities yielded few clues as to how cooperation had benefited settling companies or firms. The settlements generally acknowledged cooperation but it was difficult to establish what benefits that cooperation had gained. According to a questioner, more clarity may be needed before it makes sense to recommend to individual clients that there will be a tangible benefit to cooperating with the SEC under the new policy. Mr. Reisner intimated that there are investigations currently in the works that will provide insight into how individual cooperation credit will be rewarded.
Whether or not the SEC's cooperation policy will prove effective, it is clear that Enforcement's new leadership plans to leverage all tools at its disposal to streamline and accelerate the time it takes to investigate and bring cases.
The SEC issued the second version of its Enforcement Manual (available at http://www.sec.gov/divisions/enforce/enforcementmanual.pdf) on January 13, 2010. The updated manual contains new provisions designed, Mr. Reisner said, to enhance the ability of SEC Enforcement Staff to gain the assistance of persons with knowledge of securities laws violations early in an investigation. He noted that one of the factors to be considered in weighing the value of an individual's cooperation would be how early in the investigation the individual comes forward with an offer to cooperate. As he noted, "the earlier, the better" in this regard.
Mr. Reisner also noted that, in light of the fact that an individual may obtain lenient treatment through cooperation, counsel representing clients in Enforcement investigations will need to carefully consider whether they can represent more than one client simultaneously in the same investigation. He stated that he could think of a number of situations where it would be in one of the client's interests to cooperate and provide information to the detriment of other clients, presenting strong potential for conflicts of interest.
Mr. Reisner's remarks amplified upon earlier remarks by Robert Khuzami, the Director of Enforcement. In December, Mr. Khuzami, addressing the AICPA National Conference, noted:
Cooperation will have other consequences, such as in the area of representation of multiple witnesses by a single lawyer or law firm. It is not uncommon for dorporations and audit firms to hire a single law firm to represent multiple company employees in SEC investigations. When one law firm represents more than one witness, there is a risk of a conflict of interest between the clients — and this risk generally increases exponentially as the number of witnesses represented grows. Indeed, in some cases, we have seen one law firm represent up to 20 witnesses or more. The risk of conflict of interest is further increased where the witnesses occupy different positions, responsibilities, knowledge, and involvement in the conduct being investigated. For example, an engagement partner’s potential liability for a failed audit can be very different from a staff member’s.(See Mr. Khuzami's full remarks at http://www.sec.gov/news/speech/2009/spch120809rsk.htm). It seems that the SEC will now, like the DoJ, view as problematic any situation involving counsel representing more than one client simultaneously due to the new cooperation policy. Whereas companies and firms have hitherto attempted to secure certain economies of scale by using a single firm to represent the company and its officers and employees, at least until the stage of an SEC investigation when the Staff issues a Wells notice at which point separate counsel are retained, this may no longer be advisable due to the effects of the new policy.
Now, lawyers have an ethical obligation to zealously represent the interests of their clients. And let me be clear — most lawyers take that obligation seriously and fulfill that important obligation appropriately. However, the broader availability of cooperation credit will increase the risk of conflicts of interest in situations where counsel seeks to represent multiple clients. It may be in the interest of one client to be the first to report the misconduct to the Commission or offer his or her cooperation. But, obviously, only one client can be first. Similarly, it may be in the interest of one client to provide evidence that is not helpful to another client of the same counsel. Accordingly, this new program could pose heightened ethical concerns for counsel representing more than one person who could potentially benefit from cooperating in a Commission investigation. It is something that counsel and their clients should carefully consider.
Mr. Reisner made clear that Enforcement's leadership intends to allow considerable discretion in the area of cooperation to line Staff. One questioner asked Mr. Reisner whether disagreement with investigative Staff on whether to enter into a cooperation agreement, deferred prosecution, or other cooperation credit could, or should, be escalated to more senior Enforcement Staff. Mr. Reisner noted that such an escalation would probably be to no avail, absent exceptional circumstances.
It remains to be seen how effective this new tool will prove to be. As one questioner commented, following the SEC's Seaboard opinion, which laid out the criteria for an entity gaining credit for cooperation with SEC investigations (see http://www.sec.gov/litigation/investreport/34-44969.htm), subsequent SEC settlements with entities yielded few clues as to how cooperation had benefited settling companies or firms. The settlements generally acknowledged cooperation but it was difficult to establish what benefits that cooperation had gained. According to a questioner, more clarity may be needed before it makes sense to recommend to individual clients that there will be a tangible benefit to cooperating with the SEC under the new policy. Mr. Reisner intimated that there are investigations currently in the works that will provide insight into how individual cooperation credit will be rewarded.
Whether or not the SEC's cooperation policy will prove effective, it is clear that Enforcement's new leadership plans to leverage all tools at its disposal to streamline and accelerate the time it takes to investigate and bring cases.
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