Risk & Compliance

Truth and No Consequences

The SEC hopes new cooperation agreements will entice fraud witnesses to come forward.
Sarah JohnsonJanuary 14, 2010

Witnesses to securities fraud have had little incentive to tattle on their errant co-workers — or accomplices, as the case may be. Coming forward, after all, can put one’s career, reputation, and wallet at risk. “In terms of your legal exposure, there [has been] little or no incentive to step forward and report a violation [to the Securities and Exchange Commission],” says Russell Ryan, a partner at King & Spalding who spent a decade in SEC enforcement.

But Ryan says reluctant fraud witnesses now have more reason to tell the authorities what they know, thanks to the SEC’s new set of internal guidelines for pursuing civil actions. Announced Wednesday, the guidelines were basically borrowed from the Department of Justice’s playbook for reaching agreements with companies that are cooperative in criminal cases.

The guidelines set out new “cooperation tools” — formal written agreements between the SEC and cooperating companies and individuals that could result in lesser penalties or no enforcement action whatsoever. The agreements are called cooperation agreements, deferred prosecution agreements, and nonprosecution agreements, the same terms the DoJ uses to pry information from witnesses of misdeeds in criminal cases.

Securities lawyers predict that if these tools are fully used by the SEC, they will lead to a higher number of enforcement actions but lower penalties. They believe the agency will accept a trade-off between collecting more information about wrongdoing and granting more-lenient settlement terms.

To be sure, the agency needs individuals’ cooperation to unravel securities-law violations that occur behind closed office doors, SEC officials said during a press conference on Wednesday. “Cooperating witnesses can be an enforcement lawyer’s most valuable weapon in the fight against securities fraud,” said Robert Khuzami, director of the commission’s Enforcement Division.

As a former federal prosecutor, Khuzami has experience with cooperation agreements. Still, it may take a while for SEC staffers to get used to the new policies, says Patrick Hunnius, a partner at White & Case and a former SEC enforcement attorney. While the staffers will have more flexibility in their negotiations with companies, some of them have less experience with the strategies of deferred prosecution and nonprosecution agreements. “It will be a brand-new experience for them, in how they determine how they use these new tools,” says Hunnius.

Of course, one of the strongest incentives for fraud witnesses to come forward is still missing: cash. While whistle-blowers are offered protections under the Sarbanes-Oxley Act, the 2002 law has a very high burden of proof, and its only reward is the right to keep your job. SEC chairman Mary Schapiro has frequently asked Congress to give the SEC the authority to provide monetary awards to people who reveal securities-law violations. She repeated that call during a hearing of the Financial Crisis Inquiry Commission on Thursday.

In the meantime, the SEC may have trouble demonstrating the success of its new cooperation program. The DoJ began tracking its own deferred prosecution and nonprosecution agreements only last year. Earlier this week, a report from the U.S. Government Accountability Office criticized the department for not finding a way to measure the agreements’ effectiveness. According to the GAO report, Justice does not follow up on closed cases to see whether any of the cooperative companies later committed similar crimes, or actually implemented the changes they had promised to make as part of the terms of the agreements.