SEC weighs exam cooperation

The SEC will consider how well a firm responded to its exams when weighing whether to reduce penalties for cooperation, said new Enforcement Division Director Gurbir Grewal.

“You should understand that we have a close relationship with our colleagues in exams,” Grewal said in an October 6 speech to the Practicing Law Institute. “If a party or its counsel engage[s] in dilatory or obstructive tactics in an examination that gives rise to a referral, I will take a dim view of arguments that you deserve credit for cooperation with the ensuing enforcement investigation.”

The Enforcement Division has long had policies for giving registrants credit for cooperating in an investigation. Such credit can result in lowering fines, skipping industry bars or even dropping or not bringing an enforcement action altogether. This is the first time that regulators have said they want to see cooperation at the exam level.

Something new

“I’ve not really seen that before,” said a veteran securities defense counsel in Washington, DC. The attorney, who used to work in the SEC’s Enforcement Division, asked not to be identified. Others we spoke with agreed with her interpretation.

Know that “it’s always a judgment call” by Enforcement as to when to recognize that a firm deserves credit for cooperating, said Philip Moustakis, partner at Seward & Kissel in New York. Simply not being an obstructionist “does not get you credit. It has to be more proactive than that.”

“It’s getting tougher” to get credit for cooperating under the Biden administration, said the Washington, DC attorney. “If there’s no benefit, why would you engage in cooperative behavior,” they ask.

The SEC risks losing out on a lot of extra information if it gets too stingy in granting cooperation credit, they continue.

One action that several attorneys say generally results in cooperation credit is testifying in an SEC case targeting another defendant. Yet even this doesn’t guarantee the person testifying will benefit. Michelle Jacko, CEO of the Jacko Law Group and Core Compliance & Legal Services in San Diego, tells of a client who testified on behalf of the Commission only to find the Commission’s sights then turned on to the testifier.

Three levels of cooperation

There are three tiers to the SEC’s cooperation regime, notes Brent Baker, a shareholder with Parsons Behle in Salt Lake City. Tier 1 is a formal written agreement where the investigative staff at the SEC’s Enforcement Division merely agrees to keep a specific witnesses’ cooperation “in mind” when making enforcement recommendations, Baker said.

Tier 2 involves a deferred prosecution agreement. DPAs are formal written agreements in which the Commission accedes to forego an enforcement action against a cooperator if the individual or company agrees, among other things, “to cooperate fully and truthfully and to comply with express prohibitions and undertakings during a period of deferred prosecution,” he continues.

Tier three is known as “non-prosecution” agreements. These are most difficult to obtain because they have to have the agreement of both the SEC and the Department of Justice, Baker said.

Grewal’s recent speech cited sources that outline the Commission’s rules around cooperation. Your first stop should be the Enforcement Division’s manual. It states that anyone requesting cooperation credit “must disclose all such facts within the party’s knowledge.”

In 2001, the Commission released a statement on cooperation. While it warned that “there may be circumstances where conduct is so egregious, and harm so great, that no amount of cooperation or other mitigating conduct can justify a decision not to bring any enforcement action at all,” it also provided some guidelines.

These included whether the conduct was simple negligence, what compliance procedures the firm had in place, how long the misconduct lasted and what the company did once it discovered the violations. The statement indicates that you could win points for sharing “notes and transcripts of interviews” conducted as part of the firm’s internal investigation as well as not invoking attorney-client privilege.

The third source of guidance on the SEC’s stance around cooperation can be found in a 2010 policy statement. It noted that the division evaluates requests for cooperation credit on “a case-by-case” basis. Elements that weave into the analysis include the “timeliness” of the cooperation, how much “time and resources” the agency saved thanks to the cooperation and whether the cooperation was voluntary.

Self-reporting (with a hitch)

“The best credit you could get is by self-reporting,” Moustakis said. However, the gesture doesn’t assure credit. “Cooperation also means more than ‘self-reporting’ to the SEC only when your violation is about to be publicly announced,” said Grewal, for example, in an upcoming news media story.

“It has to be voluntary,” said Baker. “You have to be early in the process and you have to offer them something that they don’t already have.”

“Cooperation is going above and beyond,” adds the Washington, DC attorney.

Here are some examples – provided by our sources – of steps firms facing enforcement action have taken that garnered credit for cooperation:

• Replaced the firms CCO.
• Hired a compliance consultant without being prodded to do so.
• Closed the firm and agreed to leave the industry.
• Made witnesses available to the SEC.
• Shared the firm’s internal investigation.
• Passed along copies of firm compliance training documents presented to staff following a securities law violation.
• Remediated the violation on their own, eg, making clients whole even before the SEC got involved or deeply involved.

Of course, the most effective strategy is to have a robust compliance program in place to prevent violations from occurring in the first place.