CORPORATE LAW AND PRACTICECourse Handbook Series

Number B-1987

44th Annual Institute on

Securities Regulation

Volume Two

Co-ChairsAlan L. BellerStanley Keller

Colleen P. Mahoney

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56

RECENT DEVELOPMENTS IN THE SEC COOPERATION INITIATIVE

Dixie L. Johnson Carmen J. Lawrence Jonathan A. Forman Jessica P. Neiterman Brenna C. Terry Sonya Tien

Fried, Frank, Harris, Shriver & Jacobson LLP

If you find this article helpful, you can learn more about the subject by going to www.pli.edu to view the on demand program or segment for which it was written.

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BIOGRAPHICAL INFORMATION

Dixie L. Johnson and Carmen J. Lawrence are partners and co-heads of the White Collar Criminal Defense and Securities Enforcement prac-tice at Fried, Frank, Harris, Shriver & Jacobson LLP, and Jonathan A. Forman, Jessica P. Neiterman, Brenna C. Terry, and Sonya Tien are associates with the Firm.

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When faced with the decision of whether to cooperate with the United States Securities and Exchange Commission (“SEC”), individuals and companies may be motivated by a variety of objectives. “Doing the right thing” inspires many. Rousing a government investigation into an employer’s activities may inspire others. But most who evaluate whether to cooperate inevitably wonder, “What’s in it for me?”1 As the past two years under the SEC’s Cooperation Initiative have shown, the benefits of cooperating with the SEC may be substantial, depending on a company’s or individual’s facts and circumstances, particularly with respect to the SEC’s cooperation credit factors of self-policing, self-reporting, remedia-tion, and cooperation. For example, we previously discussed how Carter’s Inc. entered into a non-prosecution agreement (“NPA”) with the SEC in December 20102 as well as how Zale Corp. received a “full pass” from the SEC in April 2011 and Tenaris S.A. entered into a deferred prosecution agreement (“DPA”) with the SEC in May 2011.3 In all three situations,

1. Although this article does not discuss the SEC’s whistleblower program, which

allows culpable whistleblowers to receive an award, this program certainly provides significant financial incentives to individuals considering whether to cooperate with the SEC. Indeed, the Director of the SEC’s Division of Enforcement, Robert Khuzami, recognized that the final whistleblower rules allowing “certain less-culpable whistleblowers to receive awards, assuming they otherwise satisfy the requirements set forth in the rule. . . . simply recognize[] the established reality in law enforcement that often only those who are part of the fraud can provide evi-dence of unlawful conduct, and equally importantly can make the case against the biggest threats to investors – the organizers and leaders of a scheme who, if not pursued, will resurface in the future to commit new frauds.” See Robert Khuzami, Director, Division of Enforcement, Speech by SEC Staff: Remarks at Open Meeting – Whistleblower Program (May 25, 2011).

The SEC, on August 21, 2012, made its first payout pursuant to the program. The whistleblower received approximately $45,000—or 30% of the $150,000 collected to date on the more than $1 million in court-ordered sanctions—for cooperating and providing documents and “other significant information,” which not only accelerated the SEC’s investigation into a multi-million dollar fraud but also prevented the fraud from “ensnaring other victims.” SEC Issues First Whistleblower Program Award, SEC Immediate Release No. 2012-162 (Aug. 21, 2012). The release is silent, however, as to whether the whistleblower was involved in the underlying conduct.

2. Dixie L. Johnson & Carmen J. Lawrence, The First SEC Non-Prosecution Agree-ment: Another Arrow in the Quiver, Fried Frank Client Memo (Dec. 28, 2010).

3. Dixie L. Johnson & Carmen J. Lawrence, Cooperating and Getting a ‘Full Pass’ from the SEC: Is ‘Seaboard’ Still Alive? (BNA Corporate Accountability Report July 29, 2011). We define a “full pass” as the circumstance where the SEC closes its investigation without bringing any enforcement action against the entity or individual despite reaching the conclusion that a violation of the federal securities laws has occurred.

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each company’s cooperation resulted in the SEC’s decision not to bring an enforcement action against the company.

This past year has shown, in particular, that the benefits of cooperation are enjoyed not only by entities but also by individuals. During this past year, the SEC:

• Entered into an entity DPA with the Amish Helping Fund;

• Entered into two entity NPAs with the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”);

• Provided two entity “full passes” to Credit Suisse Group and Morgan Stanley & Co., Inc.; and

• Issued a release describing its decision to provide a “full pass” to a former AXA Rosenberg senior executive.

Given the relatively sparse information available regarding the SEC’s Cooperation Initiative,4 these recent developments provide invaluable guidance on (i) what facts and circumstances the SEC considers when determining whether an entity or individual qualifies for cooperation credit, as well as (ii) the type of cooperation credit the SEC ultimately provides under particular facts and circumstances.

ENTITY COOPERATION

As we previously discussed, the SEC’s first few entity cooperation cases revealed that the factors set forth in the Seaboard Report5 guide its coop-eration analysis. The SEC’s most recent entity cooperation cases—the Amish Helping Fund DPA, the Fannie Mae and Freddie Mac NPAs, and the Credit Suisse and Morgan Stanley “full passes”—further corroborate

4. The SEC maintains a page on its website for publicly released cooperation agree-

ments. See http://www.sec.gov/litigation/cooperation.shtml. Other agreements are available through the SEC’s press releases as indicated in the citations herein.

5. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Exchange Act Release No. 44,969 (Oct. 23, 2001) (setting forth the factors that the SEC “will consider in determining whether, and how much, to credit self-policing, self-reporting, remediation and cooperation—from the extra-ordinary step of taking no enforcement action to bringing reduced charges, seeking lighter sanctions, or including mitigating language in documents we use to announce and resolve enforcement actions”).

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that the SEC still relies on these factors when determining whether, and to what extent, it should credit an entity’s cooperation.

Amish Helping Fund DPA

Just over one year after entering into its first entity DPA with Tenaris,6 the SEC announced that it had entered into a DPA with the Amish Helping Fund (“AHF”), a non-profit corporation that offers securities to fund mortgage and construction loans to young Amish families in Ohio.7 According to the SEC’s release, AHF’s offering memorandum contained material misrepresentations about the fund and the securities that it offered because the memorandum had not been updated for 15 years.8

With limited exceptions,9 the AHF DPA is very similar to the Tenaris DPA. Pursuant to both DPAs, each company accepted respon-sibility for its conduct10 and agreed “to cooperate fully and truthfully” with the SEC’s investigation, to toll the statute of limitations for two years, and not to contest or contradict the detailed factual statements regarding its misconduct contained in the DPA (including through public statements made after the Deferred Period). In kind, the SEC agreed that it would not file an enforcement action against either com-pany so long as they each adhered to the terms of its DPA. The SEC further agreed that, if it determines that either company has failed to comply with its DPA, the SEC will notify that company to provide it with the opportunity to make a Wells submission. Both DPAs also only bind each company and the SEC—all other federal, state, or self-regulatory organizations are expressly excluded.

6. Deferred Prosecution Agreement between Tenaris, S.A. and the Securities and

Exchange Commission (May 17, 2011), http://www.sec.gov/news/press/2011/ 2011-112-dpa.pdf.

7. Deferred Prosecution Agreement between Amish Helping Fund and the Securities and Exchange Commission (July 18, 2012), http://www.sec.gov/news/press/2012/ 2012-138-dpa.pdf.

8. SEC Announces Deferred Prosecution Agreement with Amish Fund, SEC Imme-diate Release No. 2012-138 (July 18, 2012).

9. For example, Tenaris was required to pay approximately $5.5 million in disgorge-ment and prejudgment interest for alleged illegal bribes, whereas AHF was not required to pay any disgorgement or civil penalty and its DPA noted that “[t]o date, the investors have suffered no realized losses,” “there have been no foreclosures,” and “[a]lmost no investors accepted the Fund’s offer of the right of rescission.”

10. Tenaris accepted responsibility without admitting or denying the allegations, whereas AHF accepted responsibility unconditionally.

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Moreover, both DPAs contain prohibitions against further viola-tions of federal and state securities laws by each company and require them each to perform certain undertakings. In particular, each company is required (i) to provide written notification to the SEC if it is charged or convicted of any federal, state, or local offense or if a formal or informal complaint has been made against it,11 (ii) to adopt and imple-ment policies and procedures to protect against future violations of the laws each company violated, and (iii) to provide the SEC with “a written certification of compliance with the prohibitions and undertakings in [the DPA] between forty-five and sixty days before the end of the Deferred Period.”

The SEC’s release states that the Commission entered into a DPA with AHF as a result of AHF’s immediate cooperation and significant remedial measures it undertook, including updating its offering memo-randum, after it became aware of its misconduct.12 In particular, the release noted that AHF “immediately cooperated, updated its offering memorandum, and took other significant remedial steps in an expedited manner,” such as “provid[ing] existing investors with a corrected [offering memorandum],” “offer[ing] existing investors the right of rescission,” “retain[ing] an independent certified public accountant to perform ongoing audits,” and “register[ing] its securities offerings with the Ohio Division of Securities and consent[ing] to a cease-and-desist order with the agency.”

Robert Khuzami, Director of the SEC’s Division of Enforcement, emphasized in the AHF release that its DPA is a prime example of how “[c]ooperation provides real and substantial benefits for compa-nies that respond appropriately to the discovery of wrongdoing in their ranks.”

Fannie Mae & Freddie Mac NPAs

Nearly one year after issuing its first NPA with Carter’s, the SEC announced two additional NPAs with Fannie Mae and Freddie Mac

11. While AHF is required to notify the SEC within five days, Tenaris is required to

notify the SEC within fourteen days. AHF is also required to notify the SEC if it is “questioned . . . by any federal, state, or local law enforcement organization or regulatory agency,” whereas the Tenaris DPA contains no similar requirement.

12. See SEC Announces Deferred Prosecution Agreement with Amish Fund, SEC Immediate Release No. 2012-138 (July 18, 2012). Unlike Tenaris, which con-ducted an internal investigation after learning of the FCPA violations and self-reported its misconduct to the SEC, AHF was “informed of its alleged violations by the SEC.”

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in connection with its investigations of both companies’ disclosures regarding their exposure to higher-risk mortgage loans, including subprime loans.13 Unsurprisingly, the Fannie Mae/Freddie Mac NPAs share some similarities with the Carter’s NPA.14 In particular, each of the three companies agreed not to take any action or make any state-ment that denies, directly or indirectly, the factual basis of the NPA. Also, only the SEC is bound to the NPAs—other federal, state, or self-regulatory organizations are expressly excluded. The NPAs, moreover, were all announced at the same time that the SEC brought unsettled civil charges against former executives of the companies for related conduct, and pursuant to the NPAs, each of the three companies agreed “to cooperate fully and truthfully” with the SEC in connection with its litigation with those former executives. In this sense, all three NPAs appear to be tools used by the SEC to secure continuing cooper-ation from a company while the SEC pursues enforcement actions against the company’s employees.

Notwithstanding these similarities, some material differences between the Fannie Mae/Freddie Mac NPAs and the Carter’s NPA exist. For example, unlike the Carter’s NPA, the Fannie Mae and Freddie Mac NPAs (similar to the Tenaris and AHF DPAs) contain an undertakings section in which both companies agree (i) to provide the SEC with written notification within five days of being investigated, charged, or convicted of a securities law offense, and (ii) to submit a report to the SEC “detailing its efforts to identify and implement improved disclosure procedures since being placed into conservator-ship on September 6, 2008.” And the Fannie Mae and Freddie Mac NPAs contain a detailed statement of facts (also similar to the Tenaris and AHF DPAs) in which both companies agreed not to “dispute, contest, or contradict,” whereas the Carter’s NPA contained no state-ment of facts whatsoever.15

13. SEC Charges Former Fannie Mae and Freddie Mac Executives with Securities

Fraud, SEC Immediate Release No. 2011-267 (Dec. 16, 2011). 14. Compare Non-Prosecution Agreement between Carter’s Inc. and the Securities and

Exchange Commission (Dec. 17, 2010), http://www.sec.gov/litigation/cooperation/ 2010/carters1210.pdf, with Non-Prosecution Agreement between Fannie Mae and the Securities and Exchange Commission (Dec. 16, 2011), http://www.sec.gov/ news/press/2011/npa-pr2011-267-fanniemae.pdf, and Non-Prosecution Agree-ment between Freddie Mac and the Securities and Exchange Commission (Dec. 16, 2011), http://www.sec.gov/news/press/2011/npa-pr2011-267-freddiemac.pdf.

15. Also, while the Carter’s NPA appears to toll the statute of limitations indefinitely, the Fannie Mae and Freddie Mac NPAs toll their respective statutes of limitation for a limited period of time. See Non-Prosecution Agreement between Fannie Mae

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These differences may stem from the SEC’s rationale behind entering into each of the NPAs. Specifically, in entering into the Fannie Mae and Freddie Mac NPAs, the SEC noted that it was swayed by the “unique circumstances presented by the companies’ current status, including the financial support provided to the companies by the U.S. Treasury, the role of the Federal Housing Finance Agency as con-servator of each company, and the costs that may be imposed on U.S. taxpayers.” Absent these “unique circumstances,” the SEC may have pursued enforcement actions or DPAs against Fannie Mae and Freddie Mac. Indeed, it appears from the language in the NPAs that, despite these “unique circumstances,” the SEC had intended to bring an enforcement action against both companies until they agreed “to accept responsibility” for their conduct.16

Notably, other than an acknowledgment that the companies’ ongoing cooperation was an “important and material factor” underlying the SEC’s decision to enter into the NPAs, neither the Fannie Mae/ Freddie Mac NPAs nor their accompanying release contains any details of the companies’ cooperation or to what extent cooperation played a role in the SEC’s decision to enter into the NPAs. In contrast, the release accompanying the Carter’s NPA commended Carter’s for “extensive and substantial remedial actions,” which are laid out in more detail in the company’s filings and included personnel, corporate governance, and internal controls changes. The release also noted that Carter’s identified the former executive’s violative conduct, reported

and the Securities and Exchange Commission (Dec. 16, 2011), http://www.sec. gov/news/press/2011/npa-pr2011-267-fanniemae.pdf (“The Respondent agrees that the running of any statute of limitations applicable to any action or proceeding against it authorized, instituted, or brought by or on behalf of the Commission arising out of the Investigation . . . , including any sanctions or relief that may be imposed therein, is tolled and suspended during the Cooperation Period.”); Non-Prosecution Agreement between Freddie Mac and the Securities and Exchange Commission (Dec. 16, 2011), http://www.sec.gov/news/press/2011/npa-pr2011-267-freddiemac.pdf (same).

16. See Non-Prosecution Agreement between Fannie Mae and the Securities and Exchange Commission ¶ 1 (Dec. 16, 2011), http://www.sec.gov/news/press/2011/ npa-pr2011-267-fanniemae.pdf (“Prior to a public enforcement action being brought by the Commission against Fannie Mae, without admitting or denying liability, Respondent has offered to accept responsibility for its conduct and to not dispute, contest, or contradict the factual statements set forth in Exhibit A, as specifically provided herein. Accordingly, the Commission and the Respondent enter into this Non-Prosecution Agreement.”); Non-Prosecution Agreement between Freddie Mac and the Securities and Exchange Commission ¶ 1 (Dec. 16, 2011), http:// www.sec.gov/news/press/2011/npa-pr2011-267-freddiemac.pdf (same).

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the circumstances to the SEC, conducted an internal investigation using outside counsel supervised by the Audit Committee, and restated its earnings for the affected periods. The release further noted that the misconduct was “relatively isolated” and that it occurred through the circumvention of the company’s internal controls.

The Fannie Mae and Freddie Mac NPAs’ silence on cooperation suggests that the SEC’s decision was based largely on the unique cir-cumstances noted above. As a result, although the Fannie Mae and Freddie Mac NPAs illustrate the SEC’s continued willingness to enter into an NPA under certain circumstances, the facts and circumstances leading to these NPAs are fairly exceptional and may not provide much guidance for other companies considering whether cooperation would be beneficial.

Credit Suisse & Morgan Stanley “Full Passes”

In February 2012, the SEC announced that it would not bring an enforcement action against Credit Suisse for the alleged overstatement of prices of $3 billion in subprime bonds during the height of the finan-cial crisis.17 This release was the first public statement by the SEC of a decision to provide an entity or an individual with a “full pass” under its Cooperation Initiative.18 That same day, the SEC announced that it was bringing an enforcement action against four former employees of Credit Suisse for alleged violations of the federal securities laws, including securities fraud.19

Invoking the Seaboard Report and the Cooperation Initiative, the SEC stated in the release that “entities can benefit from acting swiftly to detect, report, and remediate misconduct and cooperate robustly with the SEC’s investigation.”20 The SEC explained that its decision not to bring an enforcement action against Credit Suisse was based on several factors, including Credit Suisse’s: (i) “immediate self-reporting to the SEC and other law enforcement agencies as well as prompt

17. SEC Charges Former Credit Suisse Investment Bankers in Subprime Bond Pricing

Scheme During Credit Crisis, SEC Immediate Release No. 2012-23 (Feb. 1, 2012). 18. Although we previously reported that the SEC provided Zale with a “full pass” in

2011, the SEC did not make any public statements regarding that decision. See supra n.3.

19. Three of these enforcement actions were settled as a result of the defendants’ cooperation, whereas the fourth action against the non-cooperating defendant is still pending. See infra section on Individual Cooperation.

20. The release also mentions cooperation by individuals, Faisal Siddiqui, David Higgs, and Salmaan Siddiqui. See infra section A Mosaic of Individual Cooperation.

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public disclosure of corrected financial results,” (ii) “voluntary termi-nat[ion of] the four investment bankers and implement[ation of] enhanced internal controls to prevent a recurrence of the misconduct,” and (iii) vigorous cooperation with the SEC investigation in which Credit Suisse “provid[ed] SEC enforcement officials with timely access to evidence and witnesses.” It is evident from this explanation that Credit Suisse satisfied three of the four “broad measures” of a com-pany’s cooperation identified in the SEC’s Enforcement Manual, namely: self-reporting, remediation, and cooperation.21 As a result, Credit Suisse’s “full pass” (like Zale’s “full pass” and the Tenaris and AHF DPAs) shows that it is possible for a company to avoid an enforcement action based primarily on actions the company takes after it becomes aware of misconduct.

In contrast, the Morgan Stanley “full pass” shows how a company’s actions before it becomes aware of misconduct can help it avoid an enforcement action. In April 2012, the SEC announced that it was bringing a settled enforcement action against a Morgan Stanley “rogue employee” who allegedly violated the anti-bribery, books and records, and internal controls provisions of the FCPA as well as aided and abetted violations of the anti-fraud provisions of the Investment Advisers Act of 1940 by “secretly acquir[ing] millions of dollars of real estate investments for himself and an influential Chinese official who in turn steered business to Morgan Stanley’s funds.”22

The release indicated that the SEC would not charge Morgan Stanley because it “cooperated with the SEC’s inquiry and conducted a thorough internal investigation to determine the scope of the improper payments and other misconduct involved.” The release also intimated that Morgan Stanley’s compliance program and internal controls fac-tored into the company receiving a “full pass.”23 In particular, the

21. Enforcement Manual, SEC Division of Enforcement (Mar. 9, 2012) (“Enforcement

Manual”) at Section 6.1.2, http://www.sec.gov/divisions/enforce/enforcementmanual. pdf (identifying self-policing, self-reporting, remediation, and cooperation as the “four broad measures of a company’s cooperation” set forth in the Seaboard Report).

22. SEC Charges Former Morgan Stanley Executive with FCPA Violations and Investment Adviser Fraud, SEC Immediate Release No. 2012-78 (Apr. 25, 2012).

23. The release simultaneously issued by the Department of Justice (“DOJ”) provides additional information of the underlying facts. For example, the DOJ release noted that Morgan Stanley “voluntarily disclosed this matter and has cooperated through-out the department’s investigation.” Former Morgan Stanley Managing Director Pleads Guilty for Role in Evading Internal Controls Required by FCPA, DOJ Immediate Release No. 12-534 (Apr. 25, 2012).

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release stated that the SEC’s complaint against the former executive alleged that “a Morgan Stanley compliance officer specifically informed [the former executive] in 2004 that employees of Yongye, a Chinese state-owned entity, were government officials for purposes of the FCPA” and that the former executive “received at least 35 FCPA compliance reminders from Morgan Stanley, but nonetheless com-mitted the FCPA violations.”

A closer look at the complaint reveals that Morgan Stanley’s compliance program and internal controls were robust.24 In addition to the measures discussed in the release, the complaint noted that:

• “Morgan Stanley trained [the former executive] on anti-corruption policies and the FCPA at least seven times between 2002 and 2008. In addition to other live and web-based training, [the former executive] participated in a teleconference training conducted by Morgan Stanley’s Head of Litigation and Global Head of Morgan Stanley’s Anti-Corruption Group in June 2006.”

• “Morgan Stanley distributed to [the former executive] written training materials specifically addressing the FCPA, which [the former executive] maintained in his office.”

• The compliance reminders that the former executive received from Morgan Stanley covered the FCPA, its Code of Conduct (which addressed the FCPA), its policies on gift-giving and entertainment, its Global Anti-Bribery Policy, and policies on the engagement of consultants as well as specific high-risk events, including the Beijing Olympics.

• “Morgan Stanley required [the former executive] on multiple occa-sions to certify his compliance with the FCPA. These written

24. Similarly, the DOJ release stated that it would not bring any charges against

Morgan Stanley because Morgan Stanley “constructed and maintained a system of internal controls, which provided reasonable assurances that its employees were not bribing government officials . . . .” The DOJ’s release noted that Morgan Stanley’s internal controls were designed “to ensure accountability for its assets and to prevent employees from offering, promising or paying anything of value to foreign government officials” and were “updated regularly to reflect regulatory developments and specific risks.” The DOJ’s release also noted that Morgan Stanley “conducted extensive due diligence on all new business partners and imposed stringent controls on payments made to business partners,” and that its “compliance personnel regularly monitored transactions, randomly audited par-ticular employees, transactions and business units, and tested to identify illicit payments.”

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certifications were maintained in [his] permanent employment record.” In contrast with the “full passes” received by Credit Suisse and

Zale (where their self-policing did not appear to be a factor in the SEC’s charging decision), it is evident from the SEC’s complaint that the strength of Morgan Stanley’s compliance program and internal controls played a significant role in its avoiding an enforcement action. Thus, the development and maintenance of robust compliance programs and internal controls will protect not only against potential misconduct but also, as evidenced by the Morgan Stanley “full pass,” against an enforcement action in the event that misconduct occurs despite a company’s best efforts.

INDIVIDUAL COOPERATION

Over the past two years, the SEC has entered into approximately 40 cooperation agreements with individuals under its Cooperation Initiative.25 None of these cooperation agreements, however, is currently in the public record. And while the SEC occasionally notes the cooperation of individ-uals in its releases and settlements, it has disclosed very little information regarding why those individuals received cooperation credit or the details of what benefit those individuals received for their cooperation. As a result, until the recent AXA Rosenberg release (discussed infra), practi-tioners have been left to piece together the SEC’s disparate public statements to evaluate whether, and to what extent, individuals receive credit under the Cooperation Initiative.

A Mosaic of Individual Cooperation

According to a review of public materials, the most common cooperation credit the SEC provides an individual appears to be the waiver or reduction of a civil penalty. In many instances, the SEC rewards cooperation by refraining from seeking a civil penalty.26 This

25. Susan Beck, Where Does the SEC’s Cooperation Initiative Stand, Law.com (July 19,

2012), http://www.law.com/jsp/cc/PubArticleCC.jsp?id=1202563477584&Where_ Does_the_SECs_Cooperation_Initiative_Stand (quoting SEC spokesman, John Nester).

26. See, e.g., SEC v. Mark Anthony Longoria, No. 11-CV-0753 (JSR) (S.D.N.Y.) (no civil penalty imposed on cooperating defendants Bob Nguyen, Daniel L. Devore, Jason Pflaum, Mark Anthony Longoria, Noah Freeman, Samir Barai, and Walter Shimoon); SEC v. Kareem Serageldin et al., No. 12-CV-0796 (LTS) (S.D.N.Y.)

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provides a particularly significant incentive to cooperate because civil penalties can be steep. For example, Kenneth T. Robinson, Matthew H. Kluger, and Garrett D. Bauer were all allegedly involved in the same insider trading scheme, but the SEC did not impose a civil penalty on Robinson to credit him “for his substantial assistance and cooperation in the investigation.”27 The SEC, however, initially sought a civil penalty against Kluger and Bauer of up to three times the illegal profits, totaling approximately $96 million.28 In other instances, the SEC’s decision not to seek a civil penalty is based in part on the individual’s cooperation and in part on other facts or circumstances, such as sanc-tions imposed against the individual in a parallel proceeding.29 The SEC has also sought reduced civil penalties based on an individual’s cooperation.30 Similarly, in at least one case, the SEC did not seek disgorgement and prejudgment interest based on the individuals’ cooperation.31

(no civil penalty imposed on cooperating defendants Faisal Siddiqui, David Higgs, and Salmaan Siddiqui); SEC v. David P. Turner, No. 10-CV-01309 (D.D.C. Aug. 10, 2010) (no civil penalty on cooperating defendant); SEC v. Adam Smith, 11-CV-0535 (JSR) (S.D.N.Y. May 31, 2011) (same).

27. SEC v. Matthew H. Kluger & Garrett D. Bauer, Litig. Release No. 22345 (Apr. 25, 2012); see also SEC v. Kenneth T. Robinson, No. 12-CV-02438 (May 2, 2012) (final judgment).

28. SEC v. Matthew H. Kluger & Garrett D. Bauer, No. 11-CV-01936 (D.N.J. Apr. 6, 2011) (complaint).

However, the SEC ultimately declined to seek the imposition of civil penalties against Kluger and Bauer based on the criminal sanctions imposed on them. See SEC v. Matthew H. Kluger & Garrett D. Bauer, No. 11-CV-01936 (D.N.J. May 2, 2012) (final judgments of Bauer and Kluger); United States v. Bauer, No. 11-CR-00842 (D.N.J. June 6, 2012); United States v. Kluger, No. 11-CR-00858 (D.N.J. Dec. 15, 2011)

29. See, e.g., SEC v. Mark Anthony Longoria, No. 11-CV-0753 (JSR) (S.D.N.Y.) (for cooperating defendant Donald Longueuil, the SEC did not seek a civil penalty based in part on his agreement to cooperate in an SEC investigation or enforce-ment action and in part on a prison sentence and criminal forfeiture imposed).

30. See, e.g., SEC v. Paul W. Jennings, Litig. Release No. 21822 (Jan. 24, 2011) (“Jennings will . . . pay a civil penalty of $100,000 that takes into consideration Jennings’ cooperation in this matter.”); SEC Charges Eight in Georgia-Based Insider Trading Ring, SEC Immediate Release No. 2012-167 (Aug. 28, 2012) (“Rooks agreed to pay disgorgement of $18,482.14, prejudgment interest of $1,432.68, and a penalty of $4,620.54. . . . The terms of Rooks’ settlement reflect credit given to him for his cooperation and substantial assistance to the investiga-tion.”).

31. SEC v. Kareem Serageldin et al., No. 12-CV-0796 (LTS) (S.D.N.Y.) (for cooperating defendants Faisal Siddiqui, David Higgs, and Salmaan Siddiqui, the SEC did not seek a civil penalty or disgorgement and prejudgment interest in light

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In some cases, it appears that an individual’s cooperation affects the charges that the SEC ultimately brings against them. For example, in March 2012, the SEC announced a settled enforcement action against a former United Commercial Bank executive, John Cinderey, who allegedly misled his bank’s independent auditors regarding risks the bank faced on certain outstanding loans by altering documents intended for the auditors and circumventing the bank’s controls.32 Without admitting or denying the allegations, Cinderey agreed to be permanently enjoined from violating provisions of the federal securi-ties laws regarding record-keeping, misleading outside auditors, and internal controls. In its release, the SEC noted that the terms of settle-ment reflected credit given to Cinderey for his “substantial assistance in the investigation and the fact that he has entered into an [sic] cooperation agreement to assist in an ongoing related enforcement action.” A civil penalty was not imposed partially because Cinderey paid a $40,000 civil penalty in an administrative proceeding brought by the Federal Deposit Insurance Corporation. Also, perhaps more significantly, the SEC did not charge Cinderey with violating the anti-fraud provisions (as the SEC did with United Commercial Bank and other senior executives at the bank), thus minimizing the settlement’s collateral consequences to Cinderey. Although the SEC did not provide any other details, its cooperation credit analysis was probably guided in part by Cinderey’s significant role in the fraud and the fact that the case, as a financial crisis case, was a priority area for the SEC.

In another example of the SEC not pursuing civil charges when arguably it could have done so, the SEC barred former J.P. Morgan Securities vice president and marketer, James L. Hertz, from associating with the investment advisor industry and from participating in penny stock offerings in an administrative proceeding based on his criminal plea, but did not pursue a civil injunction action to seek, among other things, disgorgement or penalties.33 It appears that the SEC may have

of their cooperation). The enforcement action against the non-cooperating defendant, Kareem Serageldin, is still pending.

32. SEC v. John M. Cinderey, Litig. Release No. 22309 (Mar. 27, 2012). 33. See In the Matter of James L. Hertz, Admin. Proc. File No. 3-14455 (July 7, 2011). In a parallel criminal proceeding, Hertz pleaded guilty to: (i) engaging in fraudu-

lent misconduct in connection with rigging the competitive bidding process for investment agreements and other municipal finance contracts; (ii) conspiracy to defraud the Internal Revenue Service by impeding the collection of tax revenue; and (iii) conspiracy to defraud municipal issuers by obtaining money and property from the municipal issuers by means of false and fraudulent pretenses. United States v. James L. Hertz, No. 10-CR-1178 (Nov. 30, 2010).

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forgone the civil injunctive action to credit Hertz for his cooperation with several investigations related to J.P. Morgan Securities.34

AXA Rosenberg Senior Executive “Full Pass”

In March 2012, for the first time since the implementation of the Cooperation Initiative, the SEC announced that it would not bring an enforcement action against an individual based on his “substantial cooperation” with the SEC, and issued a release “to provide guidance regarding the circumstances under which individuals may receive credit as part of the SEC’s Cooperation Initiative.”35 The individual was a former senior executive at AXA Rosenberg, an institutional money manager that concealed a material error in the computer code of the model it used to manage client assets thereby causing $217 million in losses in 600 client portfolios. With the senior executive’s coopera-tion, the SEC was able to bring settled enforcement actions against AXA Rosenberg’s co-founder and various AXA entities. In justifying its decision, the SEC explained how the senior executive’s particular facts and circumstances satisfied the four cooperation considerations outlined by Section 6.1.1 of the Enforcement Manual.

• Assistance Provided. The senior executive’s cooperation allowed the SEC “to conduct an efficient and effective investigation of a complex matter.” His assistance was timely (he was the first to offer his cooperation) and of high quality (providing truthful, com-plete, reliable, detailed, and credible information), and the senior executive provided this assistance without conditions, which raised his credibility “by showing that he had not been promised any specific outcome in exchange for truthful testimony.”

• Importance of the Underlying Matter. The AXA enforcement action was the SEC’s first action concerning the concealment of a material error within an investment adviser’s quantitative invest-ment models. AXA’s concealment and the compliance policies and procedures involved were a priority area for the Division of Enforcement. Further emphasizing the matter’s importance, the SEC returned all $217 million to the harmed clients, imposed

34. See SEC v. J.P. Morgan Sec. LLC, Litig. Release No. 22031 (July 7, 2011) (“The

Commission recognizes Hertz’s cooperation in the SEC’s investigation and investigations conducted by other law enforcement agencies.”).

35. SEC Credits Former AXA Rosenberg Executive for Substantial Cooperation During Investigation, Litig. Release No. 22298 (Mar. 19, 2012).

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additional penalties in the amount of $27.5 million, and required the AXA entities to hire an independent consultant to conduct a comprehensive study of their compliance and control procedures.

• Interest in Holding the Senior Executive Accountable. The SEC noted that (i) the senior executive “played a limited role in events surrounding concealment of the coding error,” (ii) the senior executive advocated that AXA’s CEO be informed of the error, (iii) AXA’s co-founder gave the senior executive and others instructions to conceal the error and not fix it, and (iv) the AXA entities allegedly made material misrepresentations and omissions to clients about the error. By cooperating, the senior executive facilitated a quick and successful resolution of the SEC’s enforce-ment action.

• The Senior Executive’s Profile. The SEC determined that the senior executive (i) was not an associated person of any regulated entity, (ii) was not a fiduciary for other individuals or entities, (iii) was not an officer or director of a public company, (iv) did not have any disciplinary or regulatory history, and (v) was no longer in a position to commit future violations because he resigned his positions and retired from the investment advisory industry. The AXA release is significant because it is the first case

explaining the SEC’s analysis in crediting an individual for his or her cooperation and its decision not to charge that individual. Although the release expressly limits its analysis to the “unique facts and circumstances of this case,” there are at least two takeaways.

First, an individual’s involvement in the underlying misconduct appears to be paramount to the SEC’s analysis. This factor makes sense programmatically as the SEC itself pointed out in Section 6.1.1 of its Enforcement Manual: “[T]here exists some tension between the objectives of holding individuals fully accountable for their misconduct and providing incentives for individuals to cooperate with law enforce-ment authorities.” For example, the AXA senior executive played a “limited role” in the misconduct and received a “full pass,” whereas Cinderey and Hertz participated more extensively in their companies’ misconduct and were sanctioned (albeit on a seemingly lesser level than they would have had they not cooperated).

Second, it appears that the SEC places a premium on the timing of cooperation. The AXA release, in particular, noted that the senior executive was “the first to offer his cooperation” and that his cooperation “facilitat[ed] the quick and successful resolution of its enforcement

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actions.” The SEC’s Enforcement Director Robert Khuzami explained the importance of timely cooperation in a statement he made simulta-neously with the AXA release, noting that “cooperating witnesses enable the Commission to investigate misconduct more quickly and efficiently due to the high-quality nature of their evidence; increase the likelihood of stopping ongoing misconduct, thus minimizing the amount of investor loss and number of victims; unlock the intricacies of cases involving complex markets, transactions and products; and build more and better cases against the organizers, leaders and other higher-ups who cover their tracks and operate through subordinates.”36

Clearly, the senior executive’s profile, as described by the release, enabled the SEC to avoid the issue of whether it will give a “full pass” to an individual still employed in the securities industry or serving as an officer or director of a public company.

CONCLUSION

In light of the relatively sparse information in the public domain regarding how the SEC credits cooperation, the AHF DPA, the Fannie Mae/Freddie Mac NPAs, and the Credit Suisse, Morgan Stanley, and AXA senior executive “full passes” provide invaluable guidance on whether, and to what extent, entities and individuals receive credit under the SEC’s Coop-eration Initiative. Nevertheless, given that the SEC makes these decisions on a factual and circumstances basis, entities and individuals will continue to face a fair degree of uncertainty about whether cooperation would be beneficial when deciding whether to cooperate.

36. Robert Khuzami, Director, Division of Enforcement, Commission Credits Individual

Under Cooperation Initiative (Mar. 19, 2012).

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