What Are They Thinking? The SEC Enforcement Manual And How it Can Help You in an Investigation
By: DULCE J. FOSTER
March 4, 2009
As our economy has tumbled in the shadow of the Madoff scandal, so has our confidence in the Securities Exchange Commission and other agencies tasked with the job of finding and weeding out business corruption wherever it may lie. Just recently, a new scandal came to light with the filing of fraud charges against billionaire R. Allen Stanford. In the wake of these scandals, the Obama Administration has pledged to overhaul the nation’s financial regulatory scheme, and an increase in SEC enforcement efforts seems imminent.
With increased enforcement comes the likelihood of increased scrutiny of anyone doing business in today’s economy. It is in the best interests of public companies and their officers to understand how the SEC enforcement process really works. Fortunately, there is a new tool available to help them. In October 2008, the SEC quietly released its Enforcement Manual to the public for the first time, giving securities lawyers and the companies they serve a roadmap to the Enforcement Division’s decision-making process and procedures.
The Enforcement Manual is hardly a crystal ball. It won’t answer the most pressing questions companies have when they find themselves under investigation by the SEC: How serious is this and could it lead to a criminal investigation? To answer those questions you will need a savvy white collar attorney, reliable information about your case, and a bit of luck. But the Manual does provide guidance about how the Enforcement Division conducts its investigations, handles subpoenas and document production, and interacts with other agencies.
In large part the Manual simply outlines the investigation practices the SEC has been using for a long time, but it documents those practices for the public, and it does so in manner that calls for the consistent application of policies across the SEC’s many offices. The Manual includes information about:
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The factors considered by the Enforcement Division in ranking the importance of investigations;
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The stages of investigation;
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The SEC’s internal communication processes in deciding to launch an enforcement action based on a preliminary investigation;
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The processes used by the SEC to gather documents and information from witnesses;
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The handling of privileges and protections;
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The factors considered by the Enforcement Division in deciding whether to give credit for cooperation; and
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SEC communications and cooperation with other public and private oversight agencies.
The 122-page manual provides detailed information on each of these topics. A few of the most salient points companies and respondents under investigation might consider include the following:
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The SEC ranks the importance of an investigation based on: the necessity and availability of resources; whether the investigation is an SEC priority or addresses a widespread industry practice; the egregiousness and magnitude of the offense; whether the conduct poses a potential threat to the markets; whether the respondent has engaged in the conduct before; and whether the conduct involves company management or professionals in the industry who are regulatory “gatekeepers” (such as lawyers, accountants, and securities industry professionals). Assessing these factors, to the extent it is able to do so, can help a company evaluate the seriousness of the investigation.
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The SEC divides cases into five basic stages: 1.) “Matters Under Inquiry” or “MUIs” (the preliminary first look at new cases); 2.) Informal Investigations (MUIs are automatically converted into Informal Investigations after 60 days); 3.) Formal Investigations (which may be launched only after the SEC issues a Formal Order of Investigation); 4.) Enforcement Actions (which typically must be authorized by the entire Commission); and 5.) Termination.
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The Enforcement Division can require regulated entities in the securities industry to produce certain information without a subpoena (e.g., trading data, customer account statements, and transfer records). It can also ask any respondent to provide information before the Formal Investigation stage by sending out a voluntary document or interview request. But the Enforcement Division cannot compel respondents to produce documents or testimony under subpoena unless the Commission has issued a Formal Order of Investigation. Anyone who receives a subpoena from the SEC has a right to review this Order on making a written request, and should make a point of doing so.
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Unlike the DOJ, the SEC does not designate individuals as “witnesses,” “subjects,” or “targets.” The SEC may, however, issue a letter called a “Wells Notice,” advising a person that he or she is under investigation, and providing the respondent with an opportunity to produce information for the SEC to consider in deciding whether to initiate an enforcement action. Wells Notices are not mandatory, however, and the SEC may launch an enforcement action without giving a respondent any prior notice.
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The Manual gives Enforcement Division staff the authority to adopt an “open-file” policy (giving persons under investigation the right to review all non-privileged materials in the investigative file). Whether to provide such broad access is entirely at the discretion of the investigating staff members.
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The Manual provides that it is standard SEC policy to notify individuals and entities under investigation when it has made the decision not to recommend an enforcement action and to terminate the investigation. Uniform implementation of this policy should provide respondents with more clarity when the cloud of an investigation has lifted.
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The Manual instructs SEC staff not to ask respondents for waivers of the attorney-client privilege unless: the respondent has already waived the privilege by communicating the information to a third party; the respondent asserts a defense that it was acting on the advice of counsel; or unless the communication at issue was made to further a crime or fraud (called the “crime/fraud exception” to the attorney-client privilege). SEC staff must evaluate whether a respondent is entitled to credit for cooperation without considering whether the respondent has agreed to produce privileged materials.
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The SEC does not have the power to prosecute respondents criminally. But the SEC may share information with law enforcement officials and may refer certain matters to law enforcement for potential prosecution. The Manual instructs that in deciding whether to make such a referral, SEC staff should consider: the egregiousness of the conduct, whether the respondent is a recidivist, and whether the involvement of criminal authorities will provide additional, meaningful protection to investors.
It is too soon to tell whether the SEC’s decision to publish its Enforcement Manual will actually have any impact on the way it does business. But what it will do is help companies respond to SEC inquiries with better information about how the investigation might proceed.