Among other suggestions relating to transparency, Commissioner Atkins proposed that the SEC publish an enforcement manual that describes the internal policies and procedures of the Enforcement Division, “similar to the U.S. Attorney Manual.”

On Oct. 6, 2008 — eight months after Commissioner Atkin’s remarks, and amid the most significant market turmoil since 1929 — the SEC’s Division of Enforcement issued a 122-page Enforcement Manual that addresses a multitude of subjects, ranging from waiver of the attorney client privilege to the best practices for Bates stamping documents.[FOOTNOTE 2]

Although some of the practices described in the manual are already mandated by federal law,[FOOTNOTE 3] the manual articulates many policies and procedures that until now, have been gleaned only through informal conversations with SEC staff attorneys and the lore that has developed from the collective experience of those practicing before the SEC. Accordingly, the manual will undoubtedly be an important tool for anyone who interacts the with SEC’s Enforcement Division. Among the plethora of issues addressed in the manual, two issues — the appropriateness of parallel investigations and waiver of the attorney-client privilege — are subjects that have been closely followed, as they have drawn fire from the judiciary and led to revisions in the policies of the Department of Justice.

PARALLEL INVESTIGATIONS

Parallel investigations can create complicated issues for government attorneys, especially if the lines become blurred between the various investigating bodies. The manual addresses issues arising from parallel investigations in two different circumstances: (1) simultaneous investigations of the same conduct by the SEC (a governmental body) and by a private entity, such as a self-regulatory organization (SRO) like the Financial Industry Regulatory Authority (FINRA) and the Public Company Accounting Oversight Board (PCAOB); and (2) simultaneous investigations of the same conduct by the SEC (whose jurisdiction is limited to civil enforcement) and by criminal authorities, usually the DOJ.

Each of these situations has created issues that have been addressed by several courts. For example, in United States v. Solomon[FOOTNOTE 4] — one of the earliest cases addressing the issue of parallel investigations involving an SRO — the SEC began investigating the defendant’s role in fraudulent valuation of securities the day before the defendant was scheduled to give testimony to investigators at the New York Stock Exchange (NYSE), who were investigating the same conduct. The defendant knew that if he declined to answer the NYSE’s questions, he would be suspended and/or expelled from the Exchange; accordingly, he testified truthfully and incriminated himself. After being indicted based in part on his NYSE testimony, the defendant moved to suppress his statements as constitutionally coerced because the SEC’s involvement in the investigation turned the NYSE into a state actor. The court held that even though the SEC opened an investigation one day before the defendant’s testimony and gained access to the entire NYSE’s investigative file, the NYSE was not acting as an agent of the government, and therefore, “interrogation by the [NYSE] in carrying out its own legitimate investigatory purposes does not trigger the privilege against self-incrimination or … render [the defendant's] statement involuntary.”[FOOTNOTE 5]

More recently, the 2nd U.S. Circuit Court of Appeals handed down a watershed decision on the subject of state action in United States v. Stein.[FOOTNOTE 6] Although Stein did not involve the SEC or an SRO, and instead involved DOJ and the private accounting firm KPMG, the court’s decision established important parameters regarding the extent to which governmental pressure on private parties can convert private decision-making into state action. Specifically, the 2nd Circuit in Stein held that the government turned KPMG into a state actor when the government’s coercive influence caused KPMG to cut off the advancement of attorney fees to the defendants (who were former KPMG partners and employees). Because the government transformed KPMG into a state actor regarding the attorney fees, the firm’s decision to stop advancing the fees to the defendants violated their Sixth Amendment right to counsel.

The same day that the 2nd Circuit handed down its decision in Stein, the DOJ amended the United States Attorney’s Manual to prohibit prosecutors from requesting a corporation to refrain from providing attorney fees to its employees, officers and directors.[FOOTNOTE 7] In addition, the new DOJ policy states that in evaluating a company’s cooperation, “prosecutors should not take into account whether a corporation is advancing or reimbursing attorney’s fees or providing counsel to employees, officers or directors under investigation or indictment.”[FOOTNOTE 8] Interestingly, the SEC’s manual does not address the Stein attorney fees issue, or provide any guidance regarding the extent to which an SEC staff attorney should exert influence over internal corporate decisions, especially in the context of corporate cooperation. However, the manual does generally advise its staff attorneys how to avoid the issues arising out of the state actor doctrine.

First, the manual explains the elements of the “state actor” doctrine, according to which, state action will be imputed to a private entity if (1) the private entity willfully engages in joint action with state officials; or (2) state officials coercively influence or significantly encourage a private entity to engage in a given course of conduct.[FOOTNOTE 9]

Second, the manual advises that to prevent a finding that state action is imputed to a private entity, “[i]n fact and appearance, the SEC and the private entity’s investigations should be parallel and should not be conducted jointly. Staff should make investigative decisions independent of any parallel investigation that is being conducted by a private entity.”

Even more specifically, the manual admonishes staff attorneys from taking any investigative step “principally for the benefit of the private entity’s investigation or suggest investigative steps to the private entity.”

In addition, the manual advises that in a parallel investigation between the SEC and an SRO, when a witness has asserted his or her fifth amendment right to remain silent before the SEC, the SEC staff attorneys should not suggest any line of questioning to the private entity or provide any document to the private entity except pursuant to an formal access request for documents.[FOOTNOTE 10]

The manual also addresses parallel investigations involving the second scenario described above — simultaneous investigations by the SEC and criminal authorities, where there is a danger that criminal authorities will use the SEC’s civil discovery mechanisms to obtain evidence for criminal cases.[FOOTNOTE 11]

The SEC’s concern in this regard stems primarily from two cases, United States v. Scrushy and United States v. Stringer. In both those cases, the defendants succeeded at the district court level in attacking the joint nature of the SEC’s and DOJ’s investigations.[FOOTNOTE 12]

In Scrushy, prior to revealing the existence of the criminal investigation to the defendant, the prosecutor persuaded the SEC staff member, who was conducting a civil enforcement investigation, to take the following steps to help the criminal investigation (which would not necessarily further the SEC investigation): to take testimony from the defendant in another state so that, among other reasons, the prosecutor would have venue over a possible perjury charge; to ask certain questions supplied by the government and to refrain from asking other questions; and to not reveal the existence of the criminal investigation.[FOOTNOTE 13] The court in Scrushy suppressed the statements obtained during the defendant’s deposition, holding that the government’s manipulation of the simultaneous investigations and its use of the SEC’s civil deposition to procure statements from the defendant “departed from the proper administration of justice.”[FOOTNOTE 14]

Similarly, the district court in Stringer held that because the SEC facilitated the criminal investigation and declined to inform the defendant of its existence, the government violated the defendant’s due process rights by “using trickery and deceit to conceal the criminal investigation from defendants,” and by “conducting a criminal investigation under the auspices of a civil investigation.”[FOOTNOTE 15] Although the 9th Circuit ultimately reversed the district court’s decision in Stringer and held that the parallel investigations at issue were conducted appropriately,[FOOTNOTE 16] both Stringer and Scrushy have made SEC staff attorneys, prosecutors and the private bar acutely aware of the issues that can arise from parallel SEC/DOJ investigations.

Against this background, the SEC manual states that “[i]t is important that the civil investigation has its own independent civil investigative purpose and not be initiated to obtain evidence for a criminal prosecution.”[FOOTNOTE 17] The manual advises SEC staff attorneys that they “should not take an SEC civil investigative action for which the sole aim is to benefit the criminal authorities,” and that the staff “should make its own independent decision about what documents to request, what investigative testimony to take, what questions to ask during testimony, the location of testimony and similar matters.”[FOOTNOTE 18]

In addition, in accordance with the 9th Circuit’s decision in Stringer, the manual advises its staff to not answer the question from private counsel as to whether there is a criminal investigation:

If asked by counsel or any individual whether there is a parallel criminal investigation, staff should direct counsel or the individual to the section of Form 1662 dealing with “Routine Uses of Information,” and state that it is the general policy of the Commission not to comment on investigations conducted by law enforcement authorities responsible with enforcing criminal laws. [FOOTNOTE 19]

Form 1662 is the standard SEC form given to all witnesses that states, “The Commission often makes its files available to other government agencies, particularly United States Attorneys and state prosecutors, agencies where appropriate.” The manual further advises that the staff attorney “should invite any person who raises such issues to contact criminal authorities if they wish to pursue the question of whether there is a parallel criminal investigation.”[FOOTNOTE 20] However, if a private attorney asks the staff member which criminal authorities she should contact, the manual advises that the staff attorney should decline to answer.[FOOTNOTE 21] This formalization of the SEC’s nondisclosure policy, in conjunction with the 9th Circuit’s decision in Stringer, gives further credence to the prudent practice of assuming the existence of a criminal investigation when advising clients of the risks and benefits of giving testimony or otherwise cooperating in an SEC investigation.

CORPORATE COOPERATION

• And Waiver of the Attorney Client Privilege. The manual also addresses an issue that has been the subject of intense debate over the past few years: to what extent should prosecutors and regulators weigh a corporation’s willingness to waive its attorney-client privilege in deciding whether it should get full credit for cooperating with the government?

This issue has been the subject of many DOJ memoranda and has most recently come to the attention of the U.S. Congress, which held hearings on the issue and currently has before it the proposed Attorney-Client Privilege Protection Act, which would bar government officials from giving any weight to whether or not a company waives its attorney-client privilege in making civil or criminal charging or enforcement decisions about that company.[FOOTNOTE 22]

To stem the tide of impending legislation, the DOJ amended its guidelines on this issue, which now state that “eligibility for cooperation credit is not predicated upon the waiver of attorney-client privilege or work product protection,” but rather the disclosure of relevant facts regarding corporate misconduct.[FOOTNOTE 23] The new DOJ guidelines, therefore, prohibit prosecutors from requesting privilege waivers relating to “nonfactual or ‘core’ attorney-client communications or work product,” and from requesting notes and interview memoranda of corporate employees that were generated by lawyers for the corporation during an internal investigation. The SEC has now followed suit.

Section 4.3 of the SEC Enforcement Manual addresses waiver of the attorney-client and work product privileges. Along the lines of the revised DOJ policy, the SEC manual states that both entities and individuals can provide significant cooperation by disclosing relevant information, which “need not include a waiver of privilege to be an effective form of cooperation, as long as all relevant facts are disclosed.”[FOOTNOTE 24] Moreover, during internal investigations, in which a company’s lawyers typically interview employees, the manual asserts that although the notes and memoranda of those interviews may be privileged, “the underlying factual information disclosed by the witnesses during the interviews is not privileged.” Based on this premise, the manual directs the SEC staff not to “ask a party to waive the attorney-client or work product privileges.”

According to the manual, the waiver of privilege “is not a prerequisite to obtaining credit for cooperation,” and a “party’s decision to assert a legitimate privilege will not negatively affect their claim to credit for cooperation.” The question, remains, however, whether and to what extent a party can enhance its cooperation by not only disclosing the facts, but also waiving privilege and turning over attorney’s notes and memoranda. Indeed, one of the thrusts of Congress’ proposed Attorney-Client Privilege Protection Act is to prohibit government attorneys from attaching any weight to a privilege waiver in making charging or enforcement decisions about the corporation.

CONCLUSION

The SEC’s Enforcement Manual is a welcome reference tool that contains a multitude of detailed provisions relating to the SEC’s Division of Enforcement. Given the market events of the past few months, and the heightened SEC activity that inevitably will ensue, this manual is requisite reading for any attorney who interacts with the Division of Enforcement. The question remains whether the SEC will broaden its trend toward greater transparency by publishing similar guidelines that relate to other important divisions of the SEC, such as the Division of Investment Management and the Division of Trading and Markets, both of which attempt to prevent and detect regulatory violations before such infractions come to the attention of the Division of Enforcement.

Amy Walsh is a partner at Kostelanetz & Fink and was formerly chief of the business and securities fraud section of the U.S. Attorney’s Office in the Eastern District of New York.

:::::FOOTNOTES:::::

FN1 Speech by SEC Commissioner: “Remarks to the ‘SEC Speaks in 2008′ Program of the Practising Law Institute,” by Commissioner Paul S. Atkins (Feb. 8, 2008) (expressing caveat that the views he expresses are his own and not that of the commission or of other commissioners), available at www.sec.gov/news/speech/2008/spch020808psa.htm.

FN2 Securities and Exchange Commission Division of Enforcement, Enforcement Manual (Oct. 6, 2008), available at www.sec.gov/divisions/enforce/enforcementmanual.pdf.

FN3 See, e.g., SEC Rules of Practice, SEC Informal and Other Procedures and SEC Rules Relating to Investigations, 17 C.F.R. §§201-02.

FN4 United States v. Solomon, 509 F.2d 863, 866-69 (2d Cir. 1975).

FN5 Id. at 867; see also United States v. Shvarts, 90 F.Supp.2d 219, 222 (E.D.N.Y. 2000) (questions put to defendants by National Association of Securities Dealers (NASD) in carrying out its own investigation did not activate privilege against self-incrimination or protections of Fourth Amendment); D.L. Cromwell Investments Inc. v. NASD Regulation Inc., 279 F.3d 155, 162 (2d Cir. 2002) (fact that testimony in NASD proceeding may entail exposure to criminal liability is not enough to establish requisite government nexus to create state action on part of NASD).

FN6 F.3d, 2008 WL 3982104 (2d Cir. 2008).

FN7 Principles of Federal Prosecution of Business Organizations, United States Attorney’s Manual, at 9-28.730.

FN8 Id.

FN9 Manual, §3.1.4, at 44-45.

FN10 Id. at 45.

FN11 Id., §5.2.1, at 110.

FN12 Scrushy, 366 F.Supp.2d 1134 (N.D. Ala. 2005); Stringer, 408 F.Supp.2d 1083 (D. Or. 2006), reversed, 521 F.3d 1189 (9th Cir. 2008).

FN13 Scrushy, 366 F.Supp.2d at 1136-37.

FN14 Id. at 1137, 1139-40.

FN15 Stringer, 408 F.Supp.2d at 1080, 1088-89.

FN16 Stringer, 521 F.3d 1189, 1191 (9th Cir. 2008).

FN17 Manual, §5.2.1, at 110.

FN18 Id. §5.2.1, at 110.

FN19 Id. at 111.

FN20 Id.

FN21 Id.

FN22 See Attorney Client Privilege Protection Act, S. 3217, 110th Congress (2008).

FN23 Principles of Federal Prosecution of Business Organizations, United States Attorney’s Manual, at 9-28.720.

FN24 Manual, §4.3, at 98.