Voluntary Disclosure to the SEC: Benefits and Risks.

Can voluntary self-reporting to the SEC itself alone reduce enforcement risk? Our lawyers’ analysis of Seaboard indicates it does not. We list some key reasons:

1. Other Seaboard Cooperation Considerations

As noted above, voluntary self-reporting is one of multiple Seaboard cooperation considerations. As the SEC explains, its cooperation policies “apply to disclosures made pursuant to an enforcement investigation... To the extent that a company or an individual affirmatively takes steps to assist the Commission in its investigation.” We believe companies that proactively disclose an issue, in addition to taking affirmative steps in their cooperation, can be more likely to realize the benefits of a favorable Seaboard analysis.

2. Concurrent Investigations with the DOJ and Other Regulators

The SEC also explains, “The Commission’s enforcement staff and other federal and state authorities may be conducting concurrent investigations.” This means it is possible for a company to have multiple concurrent investigations, each subject to its own set of enforcement guidelines and cooperation requirements. This raises the risk of an unfortunate, and perhaps even inevitable, scenario in which a company’s efforts to cooperate with the SEC ultimately fail to stem its disclosure obligations to other regulators.

3. No Fixed Percentage Penalty Discount for Voluntary Self-Reporting

The SEC also “does not apply a fixed percentage penalty discount for voluntary self-reporting or cooperation.” Rather, “each case must be evaluated on its own merits.” The key takeaway is that voluntary self-reporting is a substantial factor in the government’s penalty calculations, but it is just one factor that plays into a company’s defense efforts.

4. No Guarantee of a Closing Letter

While closing letters are not issued in all cases, they serve as “no assurance” to companies that “their prior transactions or future conduct will not subject them to investigation or enforcement action.” In other words, a closing letter will confirm whether an investigation ended without charges, but it will not provide a conclusive “release” of a company or its executives or officers.

5. Unclear Consequences for D&O Coverage

Finally, the SEC does not explicitly address the issues that voluntary self-reporting can potentially raise with respect to D&O coverage. As mentioned, these issues are likely to vary based on a company’s specific policy terms regarding notice and consent, cooperation, conduct, prior knowledge, and other policy-specific conditions.

What Cooperation Credit Can Voluntary SEC Disclosure Earn?

In what respect is voluntary SEC disclosure relevant to the federal enforcement decision-making process? The Seaboard Report (published in 2001) remains a principal framework. Under Seaboard, the SEC will consider an organization’s voluntary self-reporting separately from several other factors, including:

• “Self-policing”
• Cooperation
• Remediation

What Does it Take to Earn Cooperation Credit?

What “conduct” must a company’s counsel engage in to demonstrate cooperation? The SEC does not prescribe a fixed checklist. However, a former U.S. Attorney’s Office Senior Litigation Counsel, then-Enforcement Director Gurbir Grewal, describes a company as cooperating “only if, and to the extent that, it affirmatively takes steps to assist the Commission with the Commission’s investigation.”

As we discuss in further detail in several subsections of this page, acknowledging a violation and taking prompt steps to implement a remediation plan may strengthen a company’s ability to satisfy the “affirmative conduct” showing. In an SEC investigation involving an issuer subject to the Exchange Act’s anti-fraud provisions, acknowledgment and remediation are often critical considerations as well.

Are There Any Benefits to Being a Company That Earned Cooperation Credit?

As we discuss in further detail in several subsections of this page, companies that get credit for their cooperation (including voluntary self-reporting, if warranted) will potentially avoid SEC civil enforcement charges as a result of an investigation. SEC staff can close investigations without recommending enforcement action to the Commission in several circumstances. For example, companies that earn cooperation credit in a non-fraud investigation can potentially avoid enforcement action without facing any prejudgment or other penalties, with a closing letter being issued to confirm the SEC’s decision not to seek charges.

What Percent Discount for Voluntary SEC Disclosure Does a Company’s Counsel Need to Expect?

If a company earns a credit for cooperating and other positive factors, it can be impossible to distinguish what specific cooperation factor (including voluntary self-reporting, if warranted) resulted in a favorable outcome. This is true since the SEC does not publish a fixed percentage penalty discount for voluntary self-reporting. As specified in the Seaboard Report, if an enforcement outcome credits a combination of factors for a company’s favorable outcome, it is impossible to quantify what percent discount the voluntary self-reporting earned as a standalone factor.

What Other Cooperation Factors Does the SEC Consider?

1. Prompt, Accurate, and Truthful Identification of Violations, Persons Involved, Supporting Documentation, and Remediation Efforts

As stipulated in Seaboard, companies and individuals that proactively “offer prompt, accurate and truthful identification of violations, the persons involved and the supporting documentation and other materials, and any remedial efforts undertaken” will be credited for “having cooperated in providing the Commission with full and accurate disclosure of relevant facts.”

2. Depth of Internal Review in an Internal-Review Report

If companies disclose an internal-review report in order to facilitate a Seaboard analysis, the SEC will assess the report to determine if it is “thorough, probing and comprehensive.”

Is the Disclosure Voluntary or Already Required by SEC Rules?

When companies file under Form 8-K, this does not constitute volunteering information. Rather, companies are performing their mandatory disclosure obligations under the SEC’s current rules and reporting requirements. For example, under Item 1.05, companies must file Form 8-K “within four business days after determining that an incident [is] material.” Similar to a company’s obligations under Item 1.05, self-reporting an issue to the SEC’s Enforcement Division “cannot serve as an appropriate substitute for the company’s Exchange Act reporting obligations.”

Generally, opening an internal investigation with respect to a suspected issue does not trigger the filing of a Form 8-K under any item. That said, disclosures may still be required under Exchange Act Rule 10b-5 in order to avoid rendering any and all of a company’s prior statements misleading. A company’s SEC reporting obligations are not necessarily limited to issues that company employees discover through internal audits, internal inspections, or the results of a government investigation. For example, the SEC’s Division of Examinations (formerly the Office of Compliance Inspections and Examinations) is responsible for conducting examinations, inspections, and audits of the entities it regulates.

Additionally, as a result of the SEC’s extremely broad subject-matter jurisdiction, the SEC may have authority to enforce reporting obligations for a wide variety of entities and individuals. This includes issuers, investment advisers, broker-dealers, funds, officers, directors, and many other persons and entities as well.

SEC enforcement matters can also raise reporting obligations for a company’s outside counsel. Section 307 of the Sarbanes-Oxley Act directed the SEC to establish standards of professional conduct for attorneys appearing and practicing before the Commission in the representation of issuers, and the Commission adopted those standards in 2003 as 17 C.F.R. Part 205. These standards remain in effect and impose affirmative reporting obligations on counsel to the SEC when appropriate.

Spodek Law Group, led by managing partner Todd Spodek, defends clients in federal criminal and white collar matters.

When Should a Company Make Its Initial SEC Disclosure?

When contemplating voluntary SEC disclosure, companies have several considerations, and companies’ counsel should work closely with companies’ executives and boards to determine whether it makes sense for a company to self-report.

1. Seaboard Considerations

Seaboard explicitly calls out several considerations when evaluating companies’ cooperation and “self-policing” efforts. These considerations include:

• Whether the results of a company’s internal review “promptly came to the attention of the Commission’s enforcement staff”
• Whether the company’s internal review resulted in the production of documentation supporting “the company’s, its officers’ and directors’ timely response to the misconduct in question”

2. Opportunity to Evaluate the Decision Before Outside Intervention

Another consideration is whether a company’s counsel has the opportunity to evaluate the decision to voluntarily self-report before any regulator contacts the company. Self-reporting prior to outside intervention can give a company more leverage and potentially shift a company’s relationship with the SEC from one defined as an investigation and one characterized as cooperation.

3. Opportunity to Evaluate and Address Potential Remediation

Companies’ counsel can evaluate whether remediation will be necessary as well. Remediation will generally be expected regardless of whether a company self-reports, and remediation may be a compelling argument for self-reporting.

4. Opportunity to Consider Reporting Obligations

Companies’ counsel can also determine whether a disclosure of the issue is already required under federal securities laws before deciding whether to make a voluntary SEC disclosure. This is a critical, yet potentially underestimated, factor in the decision to voluntarily self-report.

Does a Company Have to Finish Its Internal Investigation Before Contacting the SEC’s Enforcement Staff?

No. The SEC does not have a rule that says companies that are thinking about voluntarily contacting its enforcement staff need to complete their internal investigation. Instead, a company’s counsel should take a thorough and disciplined approach to its internal investigation, while also considering whether it needs to preserve any and all relevant evidence to support an effective defense. Note that a preservation duty arises once litigation is reasonably anticipated.

Should a Company wait Until it Has Fully Implemented Remediation to voluntarily Report to the SEC’s Enforcement Staff?

Similarly, there is no SEC rule that says a company has to fully implement any and all necessary remediation before it can voluntarily make an initial report to the SEC’s enforcement staff. While remediation is one of the factors the SEC considers under Seaboard, it is one factor among several others that can either justify (or not justify) civil or criminal prosecution. In some cases, delays in reporting may have adverse consequences for a company, such as:

• Suspected wrongdoers could dissipate their assets
• Companies could engage in further violations (if the issue hasn’t been identified or corrected)
• Companies’ failure to preserve evidence might allow it to get into trouble in an SEC proceeding

In light of these concerns, companies should make informed decisions based on the facts at hand.

Will an SEC Disclosure Waive Privilege or Create Damaging Admissions?

When contemplating voluntary SEC disclosure, companies’ counsel can take several steps to structure their disclosure and cooperation in a way that preserves their client’s privilege and work-product protections while minimizing the risk of making damaging admissions.

1. Use a Proffer Agreement

A proffer agreement (or “disclosure agreement”) can control the specific direct and derivative uses of the information that a company or individual discloses. Companies’ counsel should ensure the proffer agreement is custom-tailored to protect their client’s interests.

2. Limit Disclosures to Oral Proffers

As a result of oral disclosures, a company or individual does not necessarily waive privilege or work-product protection unless there is an underlying document or other tangible material that is delivered to the SEC’s staff.

3. Avoid “Selective Waivers”

Generally, most federal appellate courts reject a party’s attempt to selectively waive privilege in a way that would allow the party to use the information in its defense while still asserting privilege against its opponents in litigation. Federal Rule of Evidence 502(a) codifies a limited exception and states that “the court may extend the waiver to other communications of the same subject when the opposing party’s inability to prove or disprove its claim would unfairly prejudice it.”

4. Control Disclosure to SEC Staff

Controlling the nature and scope of a company’s (or individual’s) cooperation can be critical. In most SEC investigations, when companies’ counsel is asked to share the findings of its internal investigation with SEC staff, a decision must be made as to whether to conduct a voluntary oral disclosure of a selected set of information, voluntarily produce documents, or limit disclosure to what is required. In some cases, the SEC staff can be considered to be in an adversarial relationship with the company, in which case disclosures to them could waive work-product protection.

5. Avoid Making Admissions of Materiality or Intent

When dealing with the SEC’s enforcement staff, companies’ counsel must be careful not to make admissions of materiality, intent, or any other elements of a violation. Admissions made to the SEC’s enforcement staff can be used as an opposing-party statement under Federal Rule of Evidence 801(d)(2), and a statement by a company’s agent or employee is an opposing-party statement only if it concerns a matter within the scope of that relationship and was made while the relationship existed.

6. Avoid Asserting Questionable Privilege Protections

Companies’ counsel should be prepared to avoid assertions of privilege and work-product protection that are unlikely to hold up in court. If a company’s (or individual’s) counsel makes assertions that the SEC’s staff then contests, the results could be an expensive and potentially embarrassing subpoena-enforcement proceeding in federal district court.

7. Be Careful not to Overstate Facts or Make False Statements

While voluntary self-reporting is generally viewed favorably, companies’ counsel must be careful not to overstate facts, and they must avoid making materially false statements. As well, it is important not to intentionally provide false information to SEC staff, as that could violate 18 U.S.C. § 1001.

Will the SEC Keep the Disclosure Confidential from Other Authorities?

17 C.F.R. § 200.83 establishes a procedure for companies and individuals that submit information to the SEC to request confidential treatment. We recommend that this procedure be used as appropriate, although companies and individuals should be aware that these requests are subject to the conditions and requirements of the SEC rules, and filing a Rule 83 confidential-treatment request does not guarantee that the SEC will withhold information from other authorities.

17 C.F.R. § 203.5 provides that formal SEC investigative proceedings are nonpublic, unless the Commission orders otherwise. This regulation, however, does not prevent the SEC from sharing information with other authorities. Specifically, U.S.C. § 78u(d)(1) expressly authorizes the SEC to transmit evidence that it has gathered during its investigative proceedings to the Attorney General of the United States. Under Section 24(c) of the Exchange Act, the SEC may share information with self-regulatory organizations, domestic or foreign authorities, other government agencies, and even foreign entities when necessary to support cross-border enforcement efforts. In short, while the SEC may generally keep information confidential, it can also share information with other authorities when warranted by law or SEC rules.

When dealing with anonymous whistleblowers, the SEC has a somewhat different approach. Under Rule 21F-9(c), if an anonymous whistleblower files a report through counsel and seeks an award from the SEC if it is ultimately able to implement an enforcement action as a result, the SEC will protect the whistleblower’s identity. However, if they seek to come forward and qualify for a whistleblower award without counsel, then the whistleblower will need to disclose their identity to the SEC. According to the SEC’s Whistleblower Information Page:

“To remain anonymous... You must come forward through an attorney. If you are willing to disclose your identity, you can come forward directly to the SEC without an attorney.”

As a result, companies and individuals that are thinking about coming forward voluntarily should work closely with their legal counsel to consider what steps they should take if they have concerns about maintaining confidentiality. This will be particularly important for anonymity and other protections under the SEC’s whistleblower rules and regulations.

Contact a Federal Criminal Defense Attorney

Nothing here is legal advice, and the details of your case matter. Todd Spodek and Spodek Law Group take federal criminal and white collar cases nationwide, from offices in New York, Brooklyn, Queens and Los Angeles. You can reach the firm at 212-300-5196.