White Collar Defense and Compliance : New Jersey White Collar Defense Lawyer & Attorney : Fox Rothschild Law Firm : Criminal Defense, Insider Trading, RICO, Consumer Fraud : New Jersey, New York City

In an earlier post we explored the relatively new SEC policy encouraging cooperation. An individual facing an SEC inquiry and his/her counsel must, of course, consider all of their available options, which in certain circumstances sensibly include not cooperating and not responding to the SEC’s questions at all.

The Fifth Amendment privilege against self-incrimination, which enables a refusal to provide testimony and records to any governmental authority, is naturally available to an individual subject to a civil investigation by the SEC, where the alleged conduct may also drive a parallel or subsequent criminal proceeding. The ways in which the same conduct can readily support both civil and criminal charges was explored in an earlier post on Raj Rajaratnam of Galleon.  See Marchetti v. United States, 390 U.S. 39, 53 (1968) (privilege available when invoker “is confronted by substantial and ‘real’ . . . hazards of incriminating); Hoffman v. United States, 341 U.S. 479, 486-87 (1951) (privilege applies where a response constitutes a “link in the chain” of evidence of criminal conduct).

Invoking the privilege carries its own set of issues. See, e.g., SEC Division of Enforcement, Enforcement Manual § 4.1.3 (2011). These include the public perception and reputational consequences of “taking the Fifth,” especially for high profile targets. See Ullmann v. United States, 350 U.S. 422, 426 (1956) (“Too many, even those who should be better advised, view this privilege as a shelter for wrongdoers. They too readily assume that those who invoke it are either guilty of crime or commit perjury in claiming the privilege”). Asserting the privilege may preclude an opportunity to provide mitigating evidence of the kind which could affect the outcome of the SEC proceeding. See, e.g., SEC v. Grossman, 887 F. Supp. 649 (S.D.N.Y. 1995) (precluding evidence about matters as to which the defendant refused to testify, including exculpatory evidence in opposition to summary judgment). Invoking the right to remain silent in a civil deposition may also subject the deponent to a devastating adverse inference or assumption by the fact-finder that the testimony or information withheld would have been unfavorable. Baxter v. Palmigiano, 425 U.S. 308, 316-20 (1976).

One way to avoid the dilemma posed by the Fifth Amendment issue is to seek a stay of the civil proceeding. However, this relief may be unavailable if the criminal prosecution is merely inchoate. A federal court in New York recently refused to stay an SEC proceeding in the face of claimed criminal jeopardy because no indictment had yet been returned, leaving the individual to the Hobson’s choice between invoking or waiving the Fifth Amendment privilege before the government’s criminal investigation was complete and thereby risking prejudice to his defenses in both matters. SEC v. Wheeler, No. 11-cv-6169-CJS (W.D.N.Y. Oct. 7, 2011).  Following the decision, the defendant in Wheeler was reported by the Rochester Business Journal to have invoked his Fifth Amendment right and declined to answer the SEC civil suit, preferring, it seems, to face the civil penalties able to be summoned by the SEC, rather than put his head in the criminal noose and risk losing his liberty.
 

(Edward J. Mullins III, Esq., the author of this entry, is an associate with Fox Rothschild LLP, based in our Roseland, NJ office. His practice concerns litigation in the areas of financial services and corporate governance, including white collar defense and securities)

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For years, the Securities and Exchange Commission has settled cases using a standard disclaimer stating that the defendant neither admits nor denies wrongdoing. This standard disclaimer allowed the SEC to claim victory and the defendant to avoid the type of public admission of wrongdoing that could be used against the defendant by shareholders or other injured parties in subsequent private lawsuits seeking damages. Thus, under this policy, the defendant could admit certain criminal conduct when criminally prosecuted by the Department of Justice or could be criminally convicted of that conduct, but the defendant could simultaneously settle civil charges with the SEC without admitting or denying nearly identical allegations in the SEC’s complaint.

Late last year, federal judge Jed Rakoff, sitting in the Southern District of New York, refused to approve a nearly $300 million settlement in an SEC action brought against Citigroup because the bank -- which had not been charged criminally -- had not been obliged under the terms of the settlement to acknowledge any wrongdoing. Chastened, the SEC on January 9th announced that it would be modifying the long-standing policy criticized by Judge Rakoff. The SEC will no longer allow defendants to settle cases involving civil fraud or insider trading charges without the defendant admitting or denying wrongdoing in circumstances where the defendant has admitted such conduct in its resolution with the DOJ or another government agency. Now, any civil settlement that the defendant enters into with the SEC will cite the admission of conduct or the conviction in the corresponding criminal case.

However, the SEC will continue to use the “neither admits nor denies” language in the large majority of SEC settlements, since most settlements are accomplished with defendants who have neither been prosecuted nor admitted wrongdoing to another government agency. Since Citigroup was not criminally prosecuted, the new policy would have left intact the formulation of that much-criticized settlement. It remains to be seen, therefore, whether the policy change implemented by the SEC will stem the judicial criticism so pointedly directed to the agency.
 

(Jana Volante, Esq., the author of this entry, is an associate with Fox Rothschild LLP, based in our Pittsburgh, PA office. Her practice concerns white collar criminal defense and commercial litigation)

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The same willful conduct which violates civil and regulatory provisions, including securities laws, often also constitutes a crime, and ignites separate civil and criminal proceedings against a defendant. The government has a greater likelihood of success in a civil or administrative proceeding where it must prove its case only by a preponderance of the evidence, or something less than beyond a reasonable doubt. So, a defendant who overcomes a criminal investigation may still face harsh civil penalties for the same or related conduct. But why would the government continue to pursue a parallel civil proceeding after obtaining a criminal conviction and an order for enormous fines, forfeitures, and restitution? Why, for example, did the SEC pursue summary judgment in its parallel civil lawsuit against former Galleon Group (“Galleon”) founder and hedge fund manager, Raj Rajaratnam, after his conviction for insider trading? What then is left for the government to gain and for the defendant to lose?

Last week’s unprecedented civil penalty levied against Mr. Rajaratnam instructs that the answer may be “a lot.” Mr. Rajaratnam must pay a $92.8 million fine, less than a month after being sentenced to 11 years in prison and pay a $63.8 million criminal fine and forfeiture. While the scale and notoriety of Mr. Rajaratnam’s case have produced the longest prison sentence and largest civil penalty of any insider trading case (and may be an example of insider trading enforcement pushed to its limit), he also provides an object lesson that convicted defendants may not in parallel civil proceedings rest comfortably on the argument that additional civil penalties may be avoided as superfluous. The federal judge overseeing this civil case rejected this very argument and sternly explained that “SEC civil penalties, most especially in a case involving such lucrative misconduct as insider trading, are designed, most importantly, to make such unlawful trading a money-losing proposition not just for this defendant, but for all who would consider it, by showing that if you get caught . . . you are going to pay severely in monetary terms.” Criminal fines, on the other hand, reflect related, but different, values of blameworthiness, and criminal restitution.

Of further note, the SEC’s motion for summary judgment following Mr. Rajaratnam’s conviction also sought civil penalties against Galleon, which settled before prior to the decision. A parallel civil proceeding exposes to monetary liability co-defendants who lack, or at least cannot be convicted of having had, criminal intent. The targets of civil investigations should not underestimate the consequences that may befall them following a related criminal conviction, particularly when the government need only prove a civil and regulatory violation by a mere preponderance.
 

(Edward J. Mullins III, Esq., the author of this entry, is an associate with Fox Rothschild LLP, based in our Roseland, NJ office. His practice concerns litigation in the areas of financial services and corporate governance, including white collar defense and securities.)

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The Securities and Exchange Commission recently released the final versions of the Dodd-Frank whistleblower regulations, to become effective on August 12th. A previous post addressed the statutory whistleblower scheme, which these final rules implement fully.

The final form of the rules was accompanied by a release containing the SEC’s analysis of the comments received as to its proposed rules, and the reason for the resulting changes made in the final version. (The analysis, entitled “Implementation of the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934,” is available as a .pdf file on the Commission’s website) (hereafter, “Release, at ____”). The SEC has estimated that the financial rewards awaiting whistleblowers whose disclosures meet the eligibility criteria will result in as much as 30,000 tips per year. (Release, at 209).

The final rules merit more extended analysis than is possible in this limited space. But one of the hot-button corporate compliance issues raised by the rules when first proposed was the effect on corporate compliance programs of a bounty system which, it was feared, would incentivize employees to avoid their company’s internal procedures in favor of direct report to the SEC. The corollary fear was that corporate management, and outside counsel, would not have an ability to determine when negative information about the company was reaching the SEC.

Sensitive to comments that the proposed rules insufficiently buttressed the role of internal compliance, the final rules seek to give compliance a boost without requiring first resort to internal mechanisms. Rule 21F-6 (17 C.F.R. § 240.21F-6), for example, lists a series of factors to be considered by the SEC in setting the amount of reward, and “participation in internal compliance systems” is a criterion which may increase a reward, while “interference with internal compliance and reporting systems” may cause a decrease (Release, at 118-126).

Of particular interest to those who conduct internal investigations as outside counsel, the final rules include the following points: (a) Rule 21F-4 (17 C.F.R. § 240.21F-4) requires that any qualifying disclosure be “voluntary,” which excludes information provided to the SEC pursuant to a duty to a contractual duty to the SEC. The SEC’s commentary makes clear that the Rule would not consider “voluntary” a statement made to the SEC pursuant to a cooperation or similar agreement with the Department of Justice obligating the individual to provide information to government agencies in general (Release, at 38); and (b) for the disclosure to qualify as “original information” it cannot, under the terms of the same Rule, derive from knowledge obtained by the individual as the result of what a United States court determines was a violation of criminal law, state or federal (Release, at 80).
 

(Alain Leibman, Esq., the author of this entry and a co-author of this blog, is a partner with Fox Rothschild LLP, based in our Princeton, NJ office. A former decorated federal prosecutor, he practices both criminal defense and commercial litigation in federal and state courts)

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Earlier posts, here, here and here, discussed the announced intention of the Securities and Exchange Commission to newly employ prosecutorial-type devices in an effort to bring a greater number of enforcement actions. One such tool, the deferred prosecution agreement, or DPA, has long been used by U.S. Attorney’s Offices to bring corporate targets into compliance with law and emplace a system within the corporation to ensure continued compliance.

On May 17th, the SEC announced that it had executed its very first DPA, with Tenaris S.A. Tenaris, a manufacturer of piping used in the energy industry, had apparently paid off Uzbekistani officials in order to win multiple government contracts to supply oilfield equipment. Although the DPA was entered into as part of a no-admission settlement, in which Tenaris disgorged nearly $5 million in profits on the contracts obtained through bribery, the DPA contained a length factual statement by the SEC of the offense and the corrupted contract bidding process. In nearly thirty paragraphs, the DPA set forth in indictment-like terms the series of communications, secret arrangements, and illegal payments by which Tenaris obtained information about others’ supposedly secret bids and its own resulting lowest bids, enabling the company to secure a series of lucrative contracts.

Tenaris agreed in the DPA not to publicly dispute the accuracy of those facts; to cooperate with the SEC and encourage current and former officers and employees to also cooperate; and to enforce newly-strengthened internal codes of conduct. Interestingly, the SEC did not require -- as many prosecutors’ offices have required -- the corporation to have segments of its activities overseen by a third-party monitor. This omission may have been due to the relatively isolated nature of the misconduct within this global entity and the self-reporting of that activity by Tenaris to the SEC and Department of Justice.
 

(Alain Leibman, Esq., the author of this entry and a co-author of this blog, is a partner with Fox Rothschild LLP, based in our Princeton, NJ office. A former decorated federal prosecutor, he practices both criminal defense and commercial litigation in federal and state courts)

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A recent entry here discussed the adoption by the Securities and Exchange Commission of a set of enforcement tools new to the agency, but hardly new in the law enforcement world. We described the SEC’s adoption last year of a formal cooperation policy, designed to garner usable leads and evidence for the agency while assuring cooperating individuals that they would not be sued, or limiting their exposure to suit, based on the nature and quality of their cooperation.

A formalized system of assuring non-prosecution in exchange for information and testimony has, of course, been a staple of U.S. Attorney’s Offices for many years, and the SEC has been slow to embrace its utility in the civil context. So, one year into the brave new world of soliciting cooperators, how is the SEC doing?

According to recent comments from Bob Khuzami, head of SEC Enforcement, just so-so. As reported in The Blog of Legal Times, Mr. Khuzami spoke on May 6th to a securities law conference in Colorado about the state of the new venture. He is reported to have said that only about 25 individuals to date have signed agreements with the SEC for reduced or no sanctions in exchange for their assistance.

Predictably, the blame for the very modest numbers to date is placed by Mr. Khuzami on the uncertainty of lawyers for individuals regarding the effect of their cooperation and admissions on potential and related DOJ criminal proceedings. While that hesitation is entirely appropriate, a fuller explanation for the fitful start to the program would likely also include an acknowledgment that the SEC’s attorneys have not yet become adept at making the early, and sometimes case-dispositive, judgments needed to identify and distinguish eligible cooperators from investigation targets.

Presumably, the SEC’s attorneys will over time gain a facility in making quick determinations, as individuals’ attorneys also achieve greater confidence in predicting the consequences of cooperating with a civil agency. As those respective learning curves flatten and become stable, one would expect to see an ever-increasing use of the cooperation vehicle in SEC investigations.

(Alain Leibman, Esq., the author of this entry and a co-author of this blog, is a partner with Fox Rothschild LLP, based in our Princeton, NJ office. A former decorated federal prosecutor, he practices both criminal defense and commercial litigation in federal and state courts)

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Earlier this month, I had the privilege of participating as a panelist the ABA Business Law Section’s spring meeting concerning the Dodd-Frank Act’s whistleblower provisions. Those statutory provisions, together with follow-on regulations, are intended to better equip the Securities and Exchange Commission to perform its enforcement function by incentivizing corporate insiders to provide information about corporate wrongdoing, such as insider trading, reporting violations, or Foreign Corrupt Practice Act violations.

The new SEC whistleblowing regime borrows from existing, and successful, protocols long-established by the Internal Revenue Code and the False Claims Act. The IRS rewards tipsters with a percentage of eventual tax recoveries, while typically allowing the sources of the information to remain anonymous. See 26 U.S.C. § 7623. The FCA in contrast requires the filing of a qui tam complaint which is sealed for a period of time while the Department of Justice evaluates the matter and determines whether or not to take over the civil, treble-damages litigation and, commonly, to initiate a criminal investigation of the underlying misconduct; successful civil lawsuits yield percentage recoveries for the initial qui tam complainant. See 31 U.S.C. § 3729 et seq. The SEC model does not involve the filing of a complaint, even under seal, but the submission of a claim form, and the anonymity of the informant is not assured. An excellent discussion of these different, but related, approaches is found in co-panelist Michael E. Clark’s The Dodd-Frank Act’s Bounty Hunter Provisions, 44 Rev. of Sec. Comm. Reg., No. 3, Feb. 9, 2011.

As part of a tactical modernization, the SEC last year finally adopted a formal cooperation policy, allowing the Enforcement Division to assure cooperating individuals that they would not be sued, or limiting their exposure to suit, all tied to the nature and quality of their cooperation. The adoption of both a whistleblowing reward system and a formalized methodology for recognizing and developing cooperation may seem to be radical changes for the SEC, but attorneys with experience in white-collar defense are intimately familiar with both models, since they have for years been staples of the Department of Justice.

The adoption by the SEC of these new/old weapons raises a number of interesting questions, including: (i) do internal corporate governance mechanisms need to be modified to capture reports of wrongdoing before the reporters go to the SEC and to incentivize officers and employees to first exhaust their internal reporting approaches; (ii) are these SEC regulations broadly destructive of internal corporate cultures and concepts of attorney-client privilege and fiduciary duties owed to the company and shareholders; and (iii) does the new whistleblowing culture make it even more imperative that in-house counsel act quickly to enlist outside counsel, with experience in these new/old issues, and that outside counsel move more quickly to conduct investigations of activities which are feared to be the subject of a whistleblower report?

These and other Dodd-Frank whistleblower issues will be developed through further entries on this blog.

(Alain Leibman, Esq., the author of this entry and a co-author of this blog, is a partner with Fox Rothschild LLP, based in our Princeton, NJ office. A former decorated federal prosecutor, he practices both criminal defense and commercial litigation in federal and state courts)
 

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This is the thirty-fourth in a series of Installments on this blog that discusses issues that arose in the aftermath of the Bernard L. Madoff (“Madoff”) scandal.  Various Installments of this series  have discussed the impact of the Madoff scheme on public charities in the context of new disclosure requirements for Form 990 adopted by the Internal Revenue Service in 2008.  Installment 29 of this series featured the limited public disclosures made available by Howard Hughes Medical Institute (“HHMI”) regarding its reported investments with Madoff.

In light of the relative paucity of public information regarding the investments by HHMI with Madoff, a study of public filings of its stated investment adviser might be helpful. As reported in Installment 29 , on February 5, 2009, in the early aftermath of the arrest of Madoff in December 2008, HHMI was on a 163-page list of “victims” produced by the Madoff Bankruptcy Court and re-published by Data360.org.

According to that list, HHMI was an investor with Madoff through “RELATIVE VALUE STRATEGIES LLC C/O IVY ASSET MANAGEMENT CORP.” Just as one may learn significant information about charities from the publicly available Forms 990, one may acquire considerable information from Form ADV, the Uniform Application for Investment Adviser Registration, that is required to be filed with the Securities and Exchange Commission (“SEC”) and updated by all investment advisers registered with the SEC. The current form of a filed Form ADV may be obtained universally through the SEC Website.  Forms ADV of earlier years may be obtained by making a request to the SEC under the federal Freedom of Information Act (“FOIA”).

My search on the Internet for “Relative Value Strategies LLC” yielded only that it is a limited liability company formed in Delaware in 1997. There was no record of its being an investment adviser registered with the SEC.  Rather, “relative value strategies” may be found on the Internet primarily as a generic term for an investment strategy of hedge funds that seek profit by exploiting irregularities or discrepancies in the pricing of stocks, bonds or derivatives.  Such hedge funds, which take a position on forward interest rates, the spread between different yields and the price differences between related securities, are also called “market neutral” or “arbitrage” funds.

Therefore, it appears that Relative Value Strategies, LLC was used by Ivy Asset Management Corp., now known as Ivy Asset Management LLC (collectively, “Ivy”), primarily as a fictitious name under which it operated.  However, there is much information available about Ivy on the Internet and as a registered investment adviser on the SEC Website.  An example is an April 1, 2010 article in The Wall Street Journal, which reports Ivy’s extensive executive restructuring, staff layoffs, acquisition by BNY Mellon and investigation by the New York Attorney General.

The most recent information on Ivy of note is the disclosure in Schedule D to the Ivy Form ADV on the SEC Website (the “Current Ivy ADV”) that the New York Attorney General filed a complaint on May 11, 2010 and a summons on July 22, 2010, against Ivy and two of its officers, alleging violations of New York law by Ivy in “concealing material information concerning Bernard L. Madoff from certain clients, allegedly contributing to losses by individuals or entities for whom those clients provided investment-related services.”

What is equally interesting, however, from the perspective of one who is analyzing HHMI and its investment with Madoff is a consistent response in the Current Ivy ADV and Forms ADV filed by Ivy during early 2008 and 2009 that were obtained under a FOIA request. Item 5.C. requires an investment adviser to identify each type of client that it advises and the approximate percentage that such type of client constitutes in number. One possible response is “None” with the next higher category being “Up to 10%.”

In each of Ivy’s Form ADV filings during 2008, 2009 and 2010, for the category “(7) Charitable organizations,” Ivy responded “None.” This is clearly and totally inconsistent with the type of client that HHMI was as an investor. On HHMI’s Internet page “About HHMI,” HHMI prominently has the following excerpt from its Code of Conduct: “As a non-profit charitable organization, HHMI is committed to conducting its activities in accordance with the highest standards of integrity and ethics.”

If HHMI had examined the Form ADV filed in 2008 by Ivy, it could have seen a red flag. Ivy has consistently reported that it did not advise clients that were charitable organizations. Either Ivy failed to carry out the requirement as to HHMI of “knowing its customer,” or Ivy simply inaccurately reported its composition of clients. By referring to the Forms ADV, HHMI could have become alerted earlier as to a potential problem in utilizing the services of Ivy. Clearly by Ivy’s own disclosures to the SEC, it lacked sufficient experience to provide advice on investment strategies for an organization of the stature of HHMI in the context of HHMI’s overall charitable mission.

In any event, a message is clear. Every investor, whether or not a charitable organization, should consider obtaining current and past Forms ADV filed by their investment advisers with the SEC as part of due diligence to consider whether the stated purposes, classes of clients and scope of operations are compatible with the needs of such investor.

[To be continued in Installment 35]
 

(With appreciation to Michael J. Kline, Esq., the author of this entry and author of an on-going analysis of the concerns of Madoff stakeholders. Mr. Kline is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm's Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics)

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In a series of insider trading cases, the Second Circuit has appeared to hike the government’s burden of proof in showing the “willfulness” of conduct needed for conviction by requiring evidence that a defendant acted with the knowledge that he was violating the securities laws. This additional layer of proof, common to prosecutions of many regulatory offenses, helpfully requires a jury to find more than the usual mens rea standard of “knowing and intentional” conduct. Recently, a defendant sought to have the enhanced level of proof applied in a conventional securities fraud case, but the court declined to do so.

Mark Kaiser was a corporate officer of U.S. Food Service, a distributor of food products to restaurants, and he supervised the company’s purchasing department. He had received bonuses based on the amount of promotional allowances paid to USF by its vendors; those allowances increased as USF’s purchases from the vendors increased. Apparently not content with the ordinary course amount of the payments, Kaiser, according to the government, inflated the amount of payments USF appeared to receive, and his resulting bonuses, by having vendors pre-pay large bonuses based on purchasing targets not yet achieved. Kaiser then allegedly hid the scheme by causing false bookkeeping entries and by personally lying to outside auditors about the nature of various payments received by his company. He was convicted in the Southern District of New York of securities fraud and causing false filings to be made to the SEC.

Kaiser appealed on several grounds, including the claim that the jury instruction on the “willfulness” element under 15 U.S.C. § 78ff(a) (penalizing "[a]ny person who willfully violates any provision of this chapter ....") was erroneous because the trial judge failed to instruct that a defendant could only act “willfully” if he had knowledge that his actions were illegal. He succeeded in vacating his conviction and winning a new trial, but on other issues, including a flawed “conscious avoidance” charge; the Second Circuit flatly rejected his argument that “willfulness” in this context requires knowledge of illegality. United States v. Kaiser, 609 F.3d 556 (2nd Cir. 2010).

While noting recent its own precedent that endorsed a higher standard for willfulness in insider trading cases, the appeals court distinguished insider trading, which does not necessarily involve deception and, therefore, where an insider may be unaware that his conduct was illegal and therefore wrongful. The court explained that the same cannot be said of one who deliberately misleads investors about a security.

Although the appeals court held the district court erred in instructing the jury on “conscious avoidance”, the court upheld the district court’s instruction on willfulness. The Second Circuit disagreed with Kaiser’s argument that “willfulness” requires knowledge of illegality and held that Section 32(a) of the Exchange Act does not require proof that the defendant knew he was violating the law, only that which was charged in this case: knowingly false statements made with an intent to deceive, with an absence of good faith on the defendant’s part. Those requirements, the court noted, necessarily suffice to prove that Kaiser knew he was committing a wrongful act.
 

(With appreciation to Christine Soares, Esq., for contributing this entry)

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There are a variety of circumstances under which investors may provide sensitive tax-related information to the Securities and Exchange Commission; they may be victims of securities fraud eager to assist the SEC in recovering lost monies or, under the SEC's newly-developed policy of encouraging and rewarding cooperation -- previously reported here -- they may be low-level participants in the fraud anxious to prove their bona fides.  No matter the scenario, the disclosing parties will desire protection against the further disclosure of their tax-related information to other arms of the government, such as the IRS.  The SEC may even, in the right circumstance, consent to a protective order to facilitate the disclosure.

But what assurance does the disclosing party have, even with a protective order in place, that the SEC will not turn around and re-disclose their information to a United States Attorney's Office or to the IRS for criminal prosecution?  Under a recent Tenth Circuit case, the answer is: "some."

In SEC v. Merrill Scott & Assocs., Ltd., 2010 WL 1039796 (10th Cir., Mar. 23, 2010), a victim-investor in the defendant entity turned over to the SEC confidential information pertaining to his income, and did so pursuant to two protective orders, the first for his deposition testimony, the second for his documents.  Both protective orders were explicit in regards to the subsequent use of the information -- the information could only be used for purposes of the SEC litigation and no other, and could only be disclosed to the United States Attorney's Office for the District of Utah as necessary to the SEC action.  Imagine the investor's surprise when, shortly after his disclosures to the SEC, agents of the IRS initiated a criminal investigation of him by dropping summonses at his banks, law firms, and brokerages.  The investor moved for an order directing the return of his information; the United States intervened to seek a modification of the protective orders to permit broad disclosure.  The district court not only refused to order the return of the investor's materials, but it modified the protective orders nunc pro tunc to support the broader disclosure sought by prosecutors.

The Court of Appeals reversed, directing the return of the information and negating the modification.  It held that the prosecutors were barred under the terms of the original orders from further disclosing the information received from the SEC or from using the information other than in the SEC action.  The court said that "[a]llowing the government to breach the promises made in the protective orders would encourage similar improper conduct in the future and would discourage future civil litigants from relying on the government's promises."  Id. at *6.  While there are sections within Title 15 which generally allow the SEC to disclose information to the Attorney General, they are permissive, not mandatory, and so did not override the protective orders.  Id. at *8.

There is precedent holding that grand jury subpoenas, at least rebuttably, overcome any civil protective orders. E.g.,, In re Grand Jury, 286 F.3d 153 (3d Cir. 2002).  The Tenth Circuit noted one such case from the Fourth Circuit, but distinguished it, since the IRS/prosecutors had in this instance been handed the protected information and had not compelled its disclosure through grand jury subpoena.  But it is clear in a number of Circuits, including the Third and Fourth, that the service by an AUSA of a grand jury subpoena upon the SEC would have compelled the production of this investor's data, protective orders or not.  In that light, the Merrill Scott case has limited utility.  Put another way, a protective order is better than nothing, but securing one for a client in jeopardy is no guarantee of a good night's sleep, for you or for the client.

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All United States Attorney's Offices have routinized the practice of cooperation and standardized their form of cooperation agreement which, following Section 5K1.1 of the Sentencing Guidelines and 18 U.S.C. § 3553(e), specifies to a degree both the benefits of cooperation and the consequences for violation of the agreement.  In contrast, the Enforcement Division of the SEC has traditionally not had in place a formal practice of cooperation, with its promised benefits, much less achieved a standard form of such agreement. The former prosecutor now heading up the SEC's Enforcement Division plans to change that.

Before the AICPA National Conference on December 8, 2009, Director Robert Khuzami discussed the SEC's new “cooperation initiative.”  Khuzami explained that the agency will now seek to encourage cooperation in SEC investigations through a variety of methods, including cooperation agreements, which for the first time will provide for the prospect of reduced sanctions based on the timeliness of the decision of a subject to cooperate and the value of the information he or she provides.

Current criminal practices followed around the nation typically reward not only the first witness in the door with a cooperation agreement, but often confer the same benefit on a number of others subsequently passing through the same portal. As a result of the proliferation of cooperation arrangements in any given investigation or prosecution, the Sentencing Commission reports, between September 2008 and October 2009 nearly 26% of all sentences were imposed below the Guidelines range as a result of government-sponsored departures.  In contrast, Khuzami's statements indicate that his agency will offer the benefits of cooperation far more parsimoniously. News reports from the AICPA conference quoted him as warning defense attorneys that "only one client can be first" in coming to the SEC with information.

Perhaps Khuzami intended only to create a rush to the SEC's door, much as federal prosecutors often attempt artificially to precipitate haste by claiming to limit the availability of cooperation deals. And perhaps the SEC will in practice relax the first-in-time requirement, much as prosecutors have relented in the interests of pragmatism. But if the Enforcement Director is taken at his word, then practitioners have cause to consider the need for speed in their clients' decision-making in civil securities fraud investigations.

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Generally, the Supreme Court has approved the Government’s use in a criminal case of evidence gathered in a related civil proceeding, often by a civil agency of the Government. The leading authority in this area is United States v. Kordel, 397 U.S. 1 (1970). The Kordel Court, addressing the criminal use of evidence garnered by the FDA, required only that the Government show an absence of bad faith on the part of the civil agency. Id. at 12-13. A civil action brought solely to advance a criminal investigation is one brought in bad faith. Id.; United States v. Rand, 308 F. Supp. 1231 (N.D. Ohio 1970).

Of course, a prosecutor violates Fed. R. Crim. P. 6(e) if evidence collected by a grand jury is turned over to civil authorities, even within the same United States Attorney’s Office, absent the applicability of an exception to that Rule. E.g., 18 U.S.C. §  3322 (disclosure permitted in connection with civil forfeiture).

Recently, the Ninth Circuit reinstated indictments which had been dismissed by a district court based on the Kordel standard and in so doing breathed new life, and breadth, into the government's ability to manipulate civil proceedings to assist criminal prosecutions. In United States v. Stringer, 521 F. 3d 1189 (9^th Cir. 2008), the SEC first began investigating Stringer, the former CEO of a defense contractor, and others for fraud, then began holding coordination meetings with the U.S. Attorney’s Office. A criminal investigation into the same activities was then initiated.

In due course, access to the SEC’s files was granted to the prosecutors. The SEC was advised that targets of the investigation included Stringer and his former CFO, although apparently a grand jury had not been formally convened at that point in time.

The prosecutors stayed hidden to the targets, but coordinated with the SEC on how the latter should conduct witness interviews, and even suggested the venue for SEC depositions to facilitate criminal prosecution of false statements made in depositions in that district. Prior to the SEC depositions of Stringer and other persons who subsequently became defendants, the witnesses were given an advice of rights and a warning text explaining only that the SEC often makes its files available to federal prosecutors. Asked directly by Stringer’s attorney whether any, and if so which, U.S. Attorney’s Office was working with the SEC, however, the SEC attorney was less than candid and made no disclosure.

Following their indictment, Stringer and the other defendants moved to dismiss the indictment alleging a due process violation in the misuse of two parallel proceedings and moved to suppress their statements to the SEC. Defendants argued that their Fifth Amendment rights were violated by the SEC’s trickery and deceit.

The Ninth Circuit rejected the argument that defendants’ Fifth Amendment rights were not undermined by the quality of the notice given to them by the SEC; even though the notice only generally warned of the possibility of criminal prosecution and did not identify the prosecutors with whom the SEC was shaping strategy, the notice was not deemed to be deceitful. The court also naively found no Kordel violation because the SEC investigation began first, which "tends to negate any likelihood that the government began the civil investigation in bad faith as, for example, in order to obtain evidence for a criminal prosecution. Id. at 1197-99.

It remains to be seen how Stringer is received by other circuit courts of appeals. Unless checked, the Stringer analysis leaves criminal prosecutors absolutely free to orchestrate SEC or other agency investigations, choreographing the content and even location of depositions, and allows the SEC or other agency to act with no meaningful disclosure to deponents of the furious behind-the-scenes activity designed solely to collect evidence against those witnesses.

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