With much fanfare three years ago, the Securities and Exchange
Commission ("SEC") announced a Cooperation Initiative as
part of an overall effort to strengthen its enforcement program.
Modeled on the 2001 "Seaboard Report," the Cooperation
Initiative sought to encourage potentially culpable individuals to
cooperate in SEC investigations in exchange for more lenient
treatment by the agency. While offering cooperation agreements to a
number of individuals, the agency only recently entered its first
individual deferred prosecution agreement ("DPA"). The
advantage of a DPA is the prospect of avoiding a formal SEC
enforcement action altogether, rather than simply mitigating the
charges and penalties in return for cooperation. Under the terms of
the DPA, hedge fund manager Scott Herckis agreed to make certain
admissions, including admitting to transferring money from a hedge
fund to accounts owned and controlled by the general partner of the
fund, and materially overstating the fund's monthly account
statements and rates of returns.1
When the SEC first announced its individual Cooperation
Initiative, it touted the initiative as a "game-changer"
for its enforcement efforts, capitalizing on the
"insiders' view into fraud and
misconduct."2 The initiative offers an incentive to
those with unclean hands to be proactive, report violations, and
offer assistance to the SEC as it pursues those violations. In
determining whether and to what extent it should credit an
individual's cooperation, the SEC will consider: (i) the
assistance provided by the individual; (ii) the importance of the
underlying matter; (iii) society's interest in ensuring the
cooperating individual is held accountable for misconduct; and (iv)
whether cooperation credit is appropriate based on the
individual's risk profile (for example, whether he or she is a
first-time offender).3
While the Herckis DPA is the first between the SEC and an
individual, the SEC reached DPAs in two prior instances with
corporate entities that were also required to admit to wrongdoing.
In 2011, global manufacturer Tenaris admitted to bribing Uzbekistan
officials for government contracts.4 After an internal
investigation, Tenaris reported its violations to the SEC, and it
agreed to cooperate with both the SEC and the Department of Justice
in further investigations or proceedings. Tenaris also paid civil
and criminal penalties and enhanced its internal compliance
controls and policies. The SEC entered its second DPA in 2012 with
Amish Helping Fund ("AHF"), a nonprofit organization that
offers securities to fund home loans to Amish families.5
AHF admitted that its offering memorandum was not kept up to date
and contained material misrepresentations about both AHF and the
securities it offered. Unlike Tenaris, AHF did not self-report,
though it immediately cooperated with the SEC and took certain
remedial steps.
Although DPAs are legally different from a traditional SEC
enforcement action, which typically culminates in a court
injunction or administrative cease-and-desist order against future
violations, the Herckis DPA suggests there can be little if any
practical difference in terms of sanctions and the burden on the
respondent. In addition to offering full cooperation with any
investigation or other proceeding initiated by the SEC and paying
more than $50,000, Herckis agreed, by contract rather than by order
of the SEC or a district court, to refrain from certain activities
for five years, including: (i) associating with any broker, dealer,
investment advisor, municipal securities dealer, municipal advisor,
transfer agent, or nationally recognized statistical rating
organization; (ii) serving or acting as an employee, officer,
director, member of an advisory board, investment adviser, or
depositor of, or principal underwriter for, a registered investment
company or affiliated person of such investment adviser, depositor,
or principal underwriter; and (iii) serving or acting as, or
providing services to, any hedge fund or registered investment
company.
Although Herckis was able to avoid the collateral consequences
that can be triggered by an injunction or administrative order, it
is otherwise difficult to discern how this DPA is substantively
different from a traditional SEC enforcement action. As described
above, in terms of sanctions and remedies, this may be a
distinction without a substantial difference. In addition, like
Tenaris and AHF, Herckis was obliged to admit the SEC's
"findings" outlined in his DPA—including those
detailing his involvement in fraudulent activity. These admissions
can possibly be used against him by other governmental law
enforcement agencies and private litigants. The SEC has indicated
that, in contrast to its prior "no admit/no deny" policy,
it will continue to seek these types of admissions—which have
been required in all DPAs to date—in appropriate
cases as it pursues its enforcement agenda.6
Another remaining question is what DPA-mandated cooperation will
mean for individuals like Herckis. The Herckis DPA suggests that he
is required to respond "fully and truthfully" to any
inquiry—including those conducted by other law enforcement
agencies—at the SEC's instruction. He must testify at
trials or other judicial proceedings if so directed by the SEC. In
short, it appears that Herckis may be deemed to have forfeited his
Fifth Amendment privilege against self-incrimination regarding any
ongoing or subsequent criminal investigation related to the subject
of the DPA.
Notwithstanding the uncertainties raised by the SEC's limited
use of DPAs to date and its overly general guidance on this
subject, certain individuals and entities may find DPAs and other
cooperation-oriented enforcement tools to be their best option. For
example, individuals and entities in certain regulated industries,
or those who engage in significant government procurement work, may
find DPAs—even with their flaws and
ambiguities—preferable to traditional SEC enforcement actions
that can trigger detrimental collateral consequences, such as
government contractor debarment proceedings. It is critical that
any individual or entity considering cooperation weigh both the
benefits and risks of cooperation before deciding how to
proceed.
Jones Day will continue to monitor developments regarding the
SEC's implementation of its Cooperation Initiative.
Lynsey Barron, an associate in the Atlanta Office, assisted in the preparation of this Commentary.
Footnotes
1.Press Release, Securities and Exchange Commission, "SEC Announces First Deferred Prosecution Agreement With Individual" (Nov. 12, 2013).
2.Press Release, Securities and Exchange Commission, "SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations" (Jan. 13, 2010).
3.Id.
4.Press Release, Securities and Exchange Commission, "Tenaris to Pay $5.4 Million in SEC's First-Ever Deferred Prosecution Agreement" (May 17, 2011).
5.Press Release, Securities and Exchange Commission, "SEC Announces Deferred Prosecution Agreement with Amish Fund" (July 18, 2012).
6.See, e.g., Mary Jo White, Chair, Securities and Exchange Commission, 5th Annual Judge Thomas A. Flannery Lecture, "The Importance of Trials to the Law and Public Accountability" (Nov. 14, 2013) (explaining why the SEC revisited its "no admit/no deny" policy, and noting her belief that "a public acknowledgment of the unlawful conduct" is "necessary to ... ensure greater public accountability"); see also Alison Frankel, "SEC Enforcement co-director: We're bringing 'swagger' back" (Oct. 1, 2013), http://blogs.reuters.com/alison-frankel/2013/10/01/sec-enforcement-co-director-were-bringingswagger-back/ (citing SEC Co-Director of Enforcement Andrew Ceresney's comments on the agency's use of deferred prosecution agreements to require admissions when "'public airing of unambiguous facts serves an important public interest'").
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