A Strategic Approach to SEC Investigations (Portfolio 5504)

Bloomberg BNA Tax and Accounting Portfolio 5504-2nd, A Strategic Approach to SEC Investigations (Accounting Policy and Practice Series), discusses strategic considerations for a company under investigation by the SEC for financial reporting problems. To access this Portfolio, visit Bloomberg Tax Financial Accounting Resource Center for a free trial. 

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Bloomberg BNA Tax and Accounting Portfolio 5504-2nd, A Strategic Approach to SEC Investigations (Accounting Policy and Practice Series), discusses strategic considerations for a company under investigation by the SEC for financial reporting problems. The Portfolio focuses on evaluating the company's risks and developing a strategy to preserve the value of the company's corporate franchise to the fullest extent possible for the benefit of shareholders and other investors. The dangers of defending the company without fully understanding its legal exposure are described. The importance of self-evaluation, particularly by means of a properly conducted internal investigation, is emphasized.

The Portfolio discusses the SEC's policy of rewarding cooperation by companies under investigation, and its policy of penalizing lack of cooperation. It also explains the sanctions available to the SEC and the process for settling with the SEC. Finally, the Portfolio presents a paradigm for determining the appropriate strategy for defending the company. The Portfolio is organized according to the timeline of major steps in a typical SEC investigation. Thus, after an introductory section, Section II details the beginning of the investigation, Section III its middle stages, and Section IV the final stages of the investigation, including possible sanctions and their collateral consequences. Section IV also discusses the Wells process, settlements of investigations, and important strategic considerations. For the reader's convenience, the worksheets reproduce pertinent documents from the SEC and the U.S. Department of Justice. These documents include reports of investigations, settlement agreements with companies, and press releases.

This Portfolio emphasizes strategic considerations for a company under SEC investigation. The Portfolio is not intended to address comprehensively the many technical issues and nuances with which defense counsel must concern themselves during SEC investigations and litigation.

Securities law attorneys will appreciate that this Portfolio covers an enormous range of topics within the body of the federal securities laws and should understand that the citation of cases and other authorities herein is illustrative, not comprehensive. This Portfolio is intended first and foremost to be a practical aide to the management and directors of public companies, and not a traditional legal treatise. In the interest of making the issues discussed herein accessible to nonlawyers, this Portfolio is written in the vernacular, and gives preference to comprehensibility for the layperson over technical legal precision. A reader seeking a more detailed and technical discussion of relevant issues should refer to Bloomberg BNA –Tax and Accounting Portfolios concerning particular bodies of law or accounting rules.

This Portfolio may be cited as Bloomberg BNA Tax and Accounting Portfolio 5504-2nd, Wang, A Strategic Approach to SEC Investigations (Accounting Policy and Practice Series).


Leonard W. Wang, Esq.

Leonard W. Wang, B.A. (Economics and Political Science) and J.D., University of Wisconsin-Madison, elected to Phi Beta Kappa, Phi Kappa Phi, the Order of the Coif, and the editorial board of the Wisconsin Law Review; member, the District of Columbia Bar and the State Bar of Wisconsin.

Mr. Wang formerly served as Assistant Director, Division of Enforcement, U.S. Securities and Exchange Commission. During a 22-year career with the SEC, Mr. Wang received the Chairman's Award for Excellence, the Stanley Sporkin Award, the Capital Markets Award, and the Division of Enforcement Director's Award. Mr. Wang may be contacted at wangleonardw@yahoo.com.

Table of Contents

Detailed Analysis
I. Introduction, Scope, and Purposes of Portfolio
A. Potential Significance and Consequences of an SEC Investigation
B. Focus of Portfolio
II. The Beginning of the Investigation
Introductory Material
A. How Investigations Begin
1. Informal Inquiries
2. Formal Investigations
3. Scope of Investigations
4. Investigations Leading to Enforcement Actions
B. First, Establish Internal Control
1. Necessity of Safeguarding Records
2. Potential for Obstruction of Justice Charges
a. Instruct Personnel to Freeze Relevant Records
b. Instruct Personnel to Speak Only With Counsel
c. Be Alert to Regulatory Inquiries
3. SEC Recordkeeping Requirements
4. Notify the Audit Committee and the Board of Directors
5. Governance Considerations for the Investigation
6. Stop Ongoing Misconduct
7. Disclose the Misconduct and Correct Filings
C. Disclosing the Investigation
1. Antifraud Rules
2. Periodic Reports and Registered Sales of Securities
3. Regulation FD
4. Market Rules
5. Summary of Disclosure of an Investigation
III. The Middle Stages of the Investigation
Introductory Material
A. Evaluate the Company's Potential Exposure
1. The Drexel Case
2. Seaboard Corporation
3. Summary of the Need for Self-Evaluation
B. Considerations for Internal Investigations
1. Delay Can Mean Lost Opportunity
2. Do Not Presume to Know the Facts
3. Assume the SEC Could Receive the Fruits of the Internal Investigation
a. Ensure the Bona Fides of the Internal Investigation
(1) The Investigators Should Be Disinterested
(2) Endeavor to Be Thorough
(a) Gather Evidence From Multiple Sources
(b) Follow the Evidence
(c) Provide Full Informational Access
(d) Instruct Employees to Cooperate With the Internal Investigation
(e) Be Careful With Employees Who Testify Adversely
(f) Provide Substantial Funding for the Internal Investigation
b. Protect the Integrity of the Internal Investigation
(1) Investigate Confidentially
(2) Protect Against Retaliation in the Internal Investigation
(3) Encourage Employees to Speak Up in Good Faith
(4) Sanction Bad Faith Accusations
(5) Punish Liars
(6) Protect the Documentary Trail
c. Advise Employees That This Is Serious
(1) Allow Employees to Retain Their Own Counsel
(2) Caution Witnesses About the Consequences of Untruthfulness
d. Do Not Let the SEC Influence or Direct the Internal Investigation
e. Summary for Internal Investigations
f. Take Prompt Remedial Action
C. Multiple Investigations
D. Other Regulators May Monitor the SEC Investigation
E. General Considerations for Investigations
1. Providing the SEC With Information
a. General Authority
b. How Not to Handle Document Production
(1) E-mails
(2) Compliance Reviews
(3) Compliance and Supervision Documents
c. How the SEC Staff Deals With Failure to Comply With Subpoenas
(1) Subpoena Enforcement in Federal Court
(2) Penalties for Lack of Cooperation
(3) Outflanking Recalcitrant Parties
(4) Civil Protective Orders
(5) Summary of Subpoena Compliance
d. Third Party Access to Documents Provided to the SEC
(1) Third Party Access Through the SEC
(2) Third Party Access From the Company Itself
e. Summation: Providing the SEC With Information
2. Keep the Tone Professional
3. Avoid an Adversarial Tone
4. Be Careful With Internal Lobbying
a. Contacts With High Level Enforcement Officials
b. Contacts With Divisions and Offices Other Than Enforcement
5. Do Not Lobby the Commissioners
6. Do Not Lobby the White House or Congress
a. The Administration
b. Congress
c. Summary Regarding Outside Lobbying
F. Cooperation
1. Negotiating Immunity in Exchange for Cooperation
2. Cooperating Unilaterally for Leniency
3. The Nature of Cooperation With the SEC
4. Cooperation Tools
a. The Proffer
b. The Cooperation Agreement
c. The Deferred Prosecution Agreement
d. The Non-Prosecution Agreement
e. Oral Assurances and Termination Notices
f. Publicizing Benefits of Cooperation
5. Can a Company Benefit From Relying on the Seaboard 21(a) Report?
a. Avoiding Charges by Cooperating
b. Obtaining Reduced Sanctions Through Cooperation
6. Impact of 2006 Policy Statement on Penalties
7. Considerations Relating to Cooperation
a. Waiver of Privileges
(1) Revealing a Roadmap of the Violations
(2) Confidentiality Agreements
(3) Bear in Mind the Scope of the Waiver
b. Indemnification for Employees
(1) Requirements and Policies
(2) Review D&O and Other Liability Coverage
8. Impact of Cooperation on Criminal Exposure
9. The Importance of an Internal Investigation
G. The Potential Price of Being Uncooperative
1. Penalties for Lack of Cooperation
a. Early Development of the Policy
b. The AIG Case: An Illuminating Comparison
c. The Lucent and Symbol Cases: Illustrations of the Concerns
d. The Gemstar Case: A Black Sheep in the Flock?
e. Other Cases of Lack of Cooperation in the Investigation
2. Overcoming an Early Lack of Cooperation
3. Summary Regarding Lack of Cooperation
IV. The End Game
Introductory Material
A. The Wells Process
1. The Basic Process
2. Should the Company Disclose the Wells Notice?
3. A Wells Submission Can Make a Difference
a. Try to Obtain All the Material Facts
b. Address the Staff's Proposed Case
c. Keep It Short
d. Make It Readable
e. Remember That You're Not in Litigation, Yet
4. Risks of a Wells Submission
a. A Wells Submission Is Not Confidential
b. Assume That a Wells Submission Can Be Used Against the Company
c. The Commission May Read the Wells Submission Even if the Company Wishes to Settle
5. Filing Decision Deadline Triggered by Wells Notice
6. Summary of Wells Submissions
7. Efforts to Preempt the Wells Process
B. Sanctions
1. The Choice of Forum
2. Sanctions in Federal Court
a. The Injunction
(1) Statutory Injunctions
(2) Additional Injunctive Relief
(3) Violation of an Injunction
b. Disgorgement
c. Civil Monetary Penalties
(1) General Civil Penalties
(a) How Are Penalties Determined?
(b) To Whom Are Penalties Paid?
(2) Civil Penalties for Insider Trading
(3) Civil Penalties for Anti-Bribery Violations
(4) Time Limitation on Penalties
d. Ancillary Relief
e. The Officer and Director Bar
f. Temporary Freeze Authority for Extraordinary Payments
3. Administrative Sanctions
a. Cease-and-Desist Orders
b. Accounting and Disgorgement
c. Civil Monetary Penalties
d. Stop Order
(1) Statutory Authorization
(2) Take No Comfort From the Absence of a Stop Order
e. De-Registration of the Company's Securities
f. Trading Suspension
g. Administrative Officer and Director Bar
h. Sanctioning Professionals
4. Collateral Consequences of Sanctions
a. Safe Harbor for Forward Looking Statements
b. Availability of Certain Private Placement Regulations
c. Shelf Offerings, Quiet Period Exemption and Free Writing Prospectuses
d. Investment Advisers
e. Small Business Investment Companies
f. Disclosure of Sanctions
5. Settling Without Formal Sanctions
6. An Alternative to Sanctions: The 21(a) Report
C. Settlement
1. When to Start Discussing Settlement
2. Focus of Settlement Discussions
a. Look for Evidentiary Weaknesses
b. Analyze the Basis for the Proposed Sanctions
(1) The SEC has the Burden of Proof
(2) Do Not Rely on Supposed Benchmarks
(3) The SEC Takes a Regulatory Perspective on Sanctions
c. Legal Arguments
d. Policy Arguments
3. Settlements Must Be Approved by the Commission
4. Settlement Without Admitting or Denying
a. The Policy
b. Use of an SEC Settlement as Evidence
c. Avoid Making Public Statements Denying Liability
5. Remedial Undertakings
6. Corporate Settlements With the U.S. DOJ
a. The Deferred Prosecution Agreement
b. Avoiding Prosecution
7. Cooperation With Continuing Government Investigations
8. Additional Settlement Steps
a. Certification of Completion of Document Production
b. Placing Payments in Escrow
c. The SEC Expects Penalties to Penalize in Full
d. Review of Charging Documents and Publicity
(1) Review the Charging Documents
(2) Review the SEC's Publicity
(3) Let the SEC Review the Company's Publicity
e. Control the Company's Publicity
f. Press Conferences for Major Cases
9. Coordinate Settlements, if Possible
10. And What of the Officers, Directors, and Employees?
11. Judicial Approval of Settlements in Federal Court
12. Avoiding the Need for Judicial Approval Through a Cease-and-Desist Proceeding
D. Comments: Strategic Considerations
1. The Internal Investigation Shows No Liability
2. The Internal Investigation Uncovers Substantial Wrongdoing
a. Consider a Cooperative Approach
b. The Risks of Not Cooperating
c. Taking the Seaboard Approach
d. Consider Negotiating an Agreement for Cooperation
3. Navigating the Gray Area
E. Maintain Vigilance After the Settlement
1. Fulfill the Undertakings
2. Fix the Problem(s) the SEC Did Not Discover
3. Fix Newly Discovered Problems

Working Papers

Worksheet 1 Report of Investigation Pursuant to Section 21(a) of the Securities Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Securities Exchange Act Release No. 44969 (Oct. 23, 2001)
Worksheet 3 Letter Agreement Between U.S. Department of Justice and Merrill Lynch & Co., Inc., (Sept. 17, 2003)
Worksheet 4 Joint Press Release, U.S. Securities and Exchange Commission, New York Attorney General, North American Securities Administrators Association, National Association of Securities Dealers, and New York Stock Exchange, Ten of Nation's Top Investment Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking (April 28, 2003)
Worksheet 5 American International Group, Inc. Agrees to Pay $126 Million to Settle Fraud Charges Arising Out of Its Offer and Sale of an Earnings Management Product, Press Release No. 2004–163 (Nov. 30, 2004)
Worksheet 6 SEC v. Lehman Brothers Inc., 03 CV 2940 (WHP) (S.D.N.Y. April 28, 2003), Consent of Defendant Lehman Brothers Inc. at ¶ 20
Worksheet 7 SEC Charges Time Warner with Fraud, Aiding and Abetting Frauds by Others, and Violating a Prior Cease-and-Desist Order; CFO, Controller, And Deputy Controller Charged With Causing Reporting Violations, Press Release No. 2005–38 (March 21, 2005)
Worksheet 8 Lucent Settles SEC Enforcement Action Charging Company with $1.1 Billion Accounting Fraud, Press Release No. 2004–67 (May 17, 2004)
Worksheet 9 Symbol Technologies Agrees to Settle SEC Enforcement Action Charging Company with Accounting Fraud, Press Release No. 2004–74 (June 3, 2004)
Worksheet 10 SEC Charges American International Group, Inc. and Others in Brightpoint Securities Fraud, Press Release No. 2003–111 (Sept. 11, 2003)
Worksheet 11 List of Significant Accounting Pronouncements Principally Discussed
Worksheet 12 Statement of the Securities and Exchange Commission Concerning Financial Penalties