The News.  In November, SEC Enforcement chief Robert Khuzami told a group of lawyers that the Commission would "try to get those individuals answers whether or not there is criminal interest in the case so defense counsel can have as much information as possible."  His remark was in the context of discussing the Enforcement Division’s new policy of entering into cooperation agreements with people it is investigating in exchange for reduced penalties.

As Prof. Peter Henning writes in his White Collar column for NYT Dealbook, defense lawyers would be leery about cooperating with the SEC absent some assurance that the Justice Department is not investigating, or is at least willing to consider participating in an agreement to exchange information for a lesser punishment.  Mr. Khuzami’s statement recognizes a basic reality:  Lawyers are much more fearful of the potential criminal consequences of an investigation, so any hope for gaining cooperation with the SEC hinges on knowing the extent of the Justice Department’s interest in a case.

    Behind The News.   Senator Charles Grassley, the ranking Republican on the Senate Judiciary Committee, wants to know whether the SEC has changed its policy on disclosing criminal investigations.  Last week, he sent identical letters to Attorney General Eric Holder Jr. and SEC Chairman Mary Schapiro that ask whether the SEC has changed its longstanding policy to permit the disclosure of a criminal investigation to those it's examining for possible civil violations of the federal securities laws - i.e., just how closely are the SEC and the DOJ working together?   Prof. Henning continues...

It's no mystery the SEC and the Justice Department work closely together in pursuing cases, often filing parallel criminal and civil cases on the same day.  For lawyers involved in SEC investigations, an important consideration is whether there is any criminal interest in the case - information that the agency has historically been loath to reveal.

The SEC’s enforcement manual states ... that if a witness in an investigation asks whether there's a pending criminal inquiry, the response is to not respond to the question and only inform the person to get in touch with the DOJ directly.  Prosecutors typically give a "No comment" response - which means the SEC’s policy effectively stonewalls, even if there's knowledge of the DOJ's interest in the case.

As Sen. Grassley’s letter points out, it appears that the SEC is talking out of both sides of its mouth when its stated policy is to defer comment on a criminal investigation, but if it wants cooperation it will gladly disclose the DOJ's interest in the case. He states in his letter: "It looks like there is a big divide between the stated policy and the actual practice on this issue.  So, which is it?" 

Prof. Henning offers that the divide may not be as great as the senator asserts.

No policy is set in stone, and in special situations an exception can be a valuable card to play to obtain a greater benefit.  If the SEC wants its cooperation policy to be successful, it needs to offer something to entice individuals with valuable information to cooperate, so the price may be disclosing the extent of the DOJ's interest.

Mr. Khuzami’s message about the SEC’s willingness to trade information in exchange for cooperation is not so much a change in policy as a pragmatic response to the need to have something to offer in order for a witness to disclose possible securities law violations.

Two Potential Dangers.    This new approach of offering information about the DOJ's interest in a case in exchange for cooperation is fraught with 2 potential dangers, according to the Professor.

First, there is the potential for the exception to swallow the rule. Defense lawyers may demand that the SEC disclose information about a criminal investigation as the precondition for any testimony in a case and not just for a formal cooperation agreement, at least when there is a realistic potential for the DOJ to pursue its own investigation. No lawyer wants to expose a client to questioning if the testimony will then be turned over to the criminal investigators for use in their own inquiry.

Members of the securities bar communicate quite well with one another, so the SEC’s willingness to disclose in one case can become the perceived norm in others, perhaps making it a standard demand before a witness will testify. The need to know about a potential criminal investigation is so strong because the most effective protection a witness has to resist providing information in an investigation is the Fifth Amendment privilege against self-incrimination. Once a witness testifies, however, that protection is lost and cannot be reclaimed retroactively.

Second, the SEC and DOJ could be viewed as misleading a person if they rely just on the standard nondisclosure policy to deflect a question when there is in fact a pending criminal investigation. Courts are willing to allow the government to maintain the secrecy of its investigations, but generally are not tolerant of misrepresentations about their status, at least in white-collar crime cases.

A 2008 decision of the United States Court of Appeals for the Ninth Circuit in United States v. Stringer illustrates the fine line that the SEC has to walk when responding to a question about whether there is a criminal investigation.  Here, SEC Enforcement worked closely with the DOJ on the investigation, even coordinating where to take the testimony of witnesses so that the interested U.S. attorney’s office would have jurisdiction if there was any perjury.  When asked by a defense lawyer about possible criminal interest in the case, the SEC lawyer referred to the commission’s standard policy to deflect the question, and the witness then testified and turned over documents. 

A lower court found that response misleading because of the close cooperation between the two agencies, dismissing subsequent criminal charges that were based on the subject matter of the SEC investigation.  The appellate court reversed the dismissal -  because there were no “affirmative misrepresentations” made by the SEC, nor evidence of “trickery or deceit” to entice the witness to testify.

If the SEC’s new approach outlined by Mr. Khuzami to obtain cooperation agreements becomes more widespread, then there's the potential that a court would view invocation of the “no comment” policy as a subterfuge to lull the witness into testifying if there was in fact a criminal investigation. Moreover, the veracity of any response about a pending criminal investigation could be called into question if the S.E.C. does not fully disclose what it knows about the status of the Justice Department’s interest in the matter, which could amount to “trickery or deceit.”

The SEC’s new approach to cooperation that recognizes the need to reveal the status of a parallel criminal investigation may be quite beneficial to developing iformation about securities fraud and lead to successful enforcement actions. There is a danger, however, that the shift to greater disclosure may come back to haunt the SEC and DOJ if incomplete, or even misleading, information is provided to a witness.

For the complete text of the column, go to:   [NYT Dealbook, 2/14, "SEC Questioned..."]