The SEC Enforcement Manual—An Aid to Combat SEC Investigations
The public’s trust in securities markets has diminished to historic lows as fraudulent investment schemes are exposed with rising frequency. President Obama will face mounting pressure to respond with increased regulation. As strong Democratic majorities in both houses of Congress are likely to support these policies, it is no longer a question of if but when. Such a climate is likely to spawn an increase in the number of investigations conducted by the Securities and Exchange Commission (the commission).
Fortunately, securities lawyers are now better equipped to represent clients subject to such investigations. For the first time, the commission has released its enforcement manual. ( See SECURITIES AND EXCHANGE COMMISSION DIVISION OF ENFORCEMENT, ENFORCEMENT MANUAL (2008), www.sec.gov/divisions/enforce/enforcementmanual.pdf.) Previously unavailable to the public, the manual lays out various policies and procedures that must be followed by the commission’s Enforcement Division when conducting an investigation.
Historically, commission staff enforcement policies varied among regional offices. There was little or no transparency with respect to applicable procedures. As a result, no uniform standard was applied.
The publication of the enforcement manual changed all that. Transparency has now been provided with respect to each stage of an investigation. Concurrently, by publishing the standards the commission staff must follow in reaching various decisions during the course of an investigation, the manual provides defense counsel with an outline of arguments to make in order to prevent an “informal” investigation from becoming “formal,” or charges from being brought or sustained.
First, the manual sets forth an analytical framework that the staff must follow before commencing an informal investigation. The staff must now first determine “whether the known facts show that an enforcement investigation would have the potential to address conduct that violates the federal securities laws,” and the manual sets forth various matters that must be considered in reaching this decision. Although this threshold is low (because the purpose of commencing an informal investigation is to gather facts to determine whether a violation may have occurred), by specifying the analytical framework that must be followed before an investigation is commenced, the manual may somewhat limit the number of new informal inquiries.
Second, multiple provisions within the manual provide parties subject to investigation with protection and predictability they could not previously rely upon. The manual, for example, creates stricter requirements for the approval to issue a “Wells notice.” (A Wells notice advises the subject of an investigation that the staff is considering recommending that charges be brought against him or her, and affords the subject an opportunity to make a submission arguing that charges should not be brought.) Among other things, a deputy director is required to approve the issuance.
Historically, the Wells process was unpredictable in another way. The discretion to allow a Wells notice recipient to examine “non-privileged portions of the investigative file” was applied inconsistently among commission offices. Section 2.4 of the manual now sets standards upon which staff in every office must base this decision. Together, these provisions take large strides toward greater consistency in the Wells process. These standards also provide a platform from which a skilled practitioner can argue for disclosure.
Third, the manual’s procedures with respect to various privileges and immunities provide protection for parties under investigation. The manual states that the staff “must respect legitimate assertions of the attorney-client privilege and attorney work product protection. . . . As a matter of public policy, the SEC wants to encourage individuals, corporate officers and employees to consult counsel about potential violations of the securities laws.” It further provides that the staff “should not ask a party to waive the attorney-client or work product privileges and is directed not to do so.” In recent years, as a result of statements made by various government officials, a request for waiver of the privilege became pro forma. A subject of an investigation who declined to waive the privilege was deemed “not cooperative,” which often led to charges being brought and other negative consequences. As a result, subjects of investigations came to view waiver of the privilege as not only desirable, but necessary. The manual completely eviscerates that practice, dictating instead that there is no requirement to waive the privilege and waiver will not be requested. This represents a sea change in practices and parallels similar policy changes that have been implemented by the U.S. Department of Justice with respect to criminal investigations.
At the same time, if a party decides that it would be advantageous to disclose privileged communications or documents—for example, in a situation in which an employee engaged in insider trading—it remains free to do so. In that case, the staff is permitted to enter into a “confidentiality agreement” with the party where the staff “agrees not to assert that the entity has waived any privileges or attorney-work product protection by producing the documents.” This is important to companies that face the prospect of civil litigation, either concurrently with or subsequent to a commission investigation. Although there is a question as to the extent to which a nonwaiver agreement will be respected by the courts, their availability creates some comfort for the practitioner and his or her clients.
Additionally, the manual states that an investigation is to be closed “as soon as it becomes apparent that no enforcement action will be recommended.” This provision applies even if “every investigative step has not been completed.” In determining whether to close an investigation, the manual provides standards for the staff to consider. By making these standards publicly available, the manual provides defense counsel with tools that may be used in order to effectively argue that a given investigation should be closed and no charges brought.
Finally, the procedures set forth in the manual centralize key decision making in Washington at the deputy director level. This is done in two ways. First, staff must now obtain the approval of one of two deputy directors of the Enforcement Division before opening an investigation. Second, the manual requires deputy director approval for the issuance of a Wells notice. Placing these important decisions at the level just below the director will increase consistency.
The importance of the manual to a skilled practitioner cannot be overstated, particularly in light of the likelihood of increased commission activity under the Obama administration. It not only places another arrow in the defense lawyer’s quiver, it also provides defense counsel an entirely new quiver from which to draw arrows.
James V. Masella III is a partner and Ryan Cronin is an associate in the New York City office of Blank Rome LLP. Their respective email addresses are firstname.lastname@example.org and email@example.com.
This article is a reprint of “ Keeping Current: Securities - The SEC Enforcement Manual - An Aid to Combat SEC Investigations,” by James V. Masella III and Ryan Cronin, 2009, Business Law Today Magazine, 18:4, pp. 32–33. Copyright 2009 © by the American Bar Association. Reprinted with permission.
© Copyright 2009, American Bar Association.