August 08, 2016 Articles

Cooperation Credit in Enforcement Proceedings: The Importance of Independence

Use of an outside investigator may curry greater credit from regulators

by Jonathan C. Schwartz and David G. Buffa

Securities regulators and enforcement agencies, including the Securities and Exchange Commission (SEC) and U.S. Department of Justice (DOJ), have programs in place to encourage greater cooperation from individuals and companies that uncover reportable conduct. These programs encourage individuals and companies to voluntarily provide information and assistance to regulators by providing them with “cooperation credit,” which typically consists of reduced fines in civil or administrative cases or potential shorter sentences in a criminal case. For many small and mid-sized firms, cooperation credit can mean the difference between surviving an investigation or a penalty that closes its doors. 

Traditionally, regulators have valued cooperation based on a firm’s timeliness, thoroughness, diligence, and proactive nature. In addition, it has long been understood that firms must provide “extraordinary” assistance to a regulator’s investigation in order to receive cooperation credit. Because regulators do not, however, explicitly define “extraordinary” assistance or—as a matter of policy—delineate the potential quid pro quo in enforcement documents, it can be difficult to ascertain the value that can flow from the often cumbersome tasks associated with uncovering and self-reporting misconduct. Nevertheless, an article that examined the monetary benefits of firm cooperation with regulators revealed that cooperation really does count, and recent comments from regulators suggest that those seeking credit for their cooperation should strongly consider using an independent third party to conduct their internal investigations. 

The importance of using an outside party for an internal investigation may be connected to the recent focus on individual accountability. Since failing to meaningfully hold individuals accountable for the 2008 financial crisis, enforcement agencies have announced a priority to assess individual employee culpability for a firm’s misdeeds. Most recently, DOJ Deputy Attorney General Sally Quillian Yates expressed this view in a memorandum, Individual Accountability for Corporate Wrongdoing (Sept. 9, 2015). In the context of cooperation credit, Yates’s memorandum described a new, binary “all or nothing” assessment whereby “to be eligible for any credit for cooperation, the company must identify all individuals involved in or responsible for the misconduct at issue, regardless of their position, status or seniority.” Only after making this “threshold” disclosure will the DOJ consider whether a company’s actions were thorough, timely, diligent, and proactive enough to merit credit. Recent comments by DOJ officials echo the Yates memo’s spotlight on individual culpability, noting that “prosecuting individuals, including corporate executives, for their criminal wrongdoing is a top priority for the criminal division. Corporations seeking cooperation credit should conduct their internal investigations with those principles in mind.” U.S. Assistant Attorney General Leslie R. Caldwell, Remarks at New York University Law School’s Program on Corporate Compliance and Enforcement (Apr. 17, 2015). 

The DOJ’s cautionary warning reflects that, with executive accountability becoming a center of attention, the credibility of internal investigations is also being called into question. The pressure to identify all employees involved in a potential violation can lead to numerous conflicts of interest between in-house investigators and their colleagues. In particular, the effectiveness of an investigation to root out misconduct “regardless of position, status or seniority” may lack credibility when that investigation was carried out by employees of the executives who may have been involved in the conduct at issue. For those reasons, the DOJ has commented that internal investigations “must also be independent” and not merely a process of accumulating and presenting the facts so as to “whitewash the truth.” See Caldwell, supra

As internal investigations have become commonplace, firms that fail to consider the importance of an independent investigation risk losing out on credit for their cooperation. The SEC’s Seaboard Report, which long ago provided the framework for cooperation credit in actions involving corporations, explicitly directs examiners to question whether a firm’s review was performed by “outside persons.” Comments by senior SEC personnel have suggested that independence is one of the factors that has the potential to have a significant impact how regulators will view the results of an investigation. Andrew Ceresney, the SEC’s director of enforcement, has cautioned that firms that expect credit for their assistance need to provide the regulator with “all relevant facts, including facts implicating senior officials and other individuals.” Andrew Ceresney, Speech at University of Texas School of Law: The SEC’s Cooperation Program:  Reflections on Five Years of Experience (May 13, 2015). Similarly, SEC Chair Mary Jo White has stressed that firms need to conduct internal investigations in a manner that can “search for misconduct wherever and however high up it occurred.” Mary Jo White, Speech at Stanford University Rock Center for Corporate Governance: A Few Things Directors Should Know about the SEC (June 23, 2014). If an investigator cannot do these things, or if the investigation was not truly independent, the investigation is not likely to be viewed as “extraordinary” and worthy of much cooperation credit, if any at all. 

Independent reports are therefore viewed as lending credibility to an investigation and may demonstrate to a regulator that a firm is serious about disclosing the true scope of its misconduct. Accordingly, before launching an investigation, a firm should consider whether the misconduct involves far-reaching activity that potentially implicates “higher level” employees and different support functions or business groups within the firm. If the potential for individual liability exists, using an outside party to conduct the investigation will put the firm in the best position to present its case to the regulators if it chooses to cooperate. Recent SEC enforcement actions have explicitly stated that a firm’s use of outside counsel in an investigation was a factor in assessing the value of a firm’s cooperation. See e.g., In re Las Vegas Sands Corp., Exchange Act Release No. 77555, 2016 LEXIS 1399 (Apr. 7, 2016); In re Nordion, (Canada) Inc., Exchange Act Release No. 77290, 2016 SEC LEXIS 939 (Mar. 3, 2016); In re BHP Billiton Ltd. et al., Exchange Act Release No. 74998, 2015 SEC LEXIS 2061 (May 20, 2015); In re FLIR Systems, Inc., Exchange Act Release No. 74673, 2015 SEC LEXIS 1378 (Apr. 8, 2015). 

Although the use of outside counsel is generally favored, particularly for cooperation credit considerations, it should be noted that not all factors weigh in favor of using outside investigators for every instance of potential misconduct. In some cases, the in-house counsel may be better equipped to address issues about internal policies and procedures with which they are more familiar. In addition, some regulators will question the independence of an outside investigator that has a preexisting relationship with a firm or has been previously engaged by management. 

The use of an outside investigator may be only one of the factors considered by regulators when assessing cooperation credit, but it appears to be one of the most significant factors—if not the most significant factor—on which regulators focus when determining the quality of a firm’s cooperation.  

Keywords: commercial and business, cooperation credit, Department of Justice, DOJ, enforcement, internal investigation, litigation, Seaboard Report, Securities and Exchange Commission, SEC 

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