When Corporate Counsel Becomes a Witness in SEC Investigations.

If you’re being investigated for making false disclosures, your in-house counsel, who may have drafted the disclosures in question, may be in possession of firsthand evidence relevant to the investigation. Because in-house counsel often fill both legal and business roles, it’s not always easy to determine what falls under the attorney-client privilege, necessitating close scrutiny and decision-making. Corporate counsel’s firsthand involvement can raise conflicts as well. For example, if the investigation could potentially expose any corporate employees, this scenario necessitates representation by lawyers independent of company counsel. If corporate counsel has been in contact with investigators, even if only to learn about the nature and timing of an investigation, any legal-preservation obligations he or she has should be addressed promptly.

The SEC’s Division of Enforcement conducts investigations to determine whether federal securities laws have been violated. If it finds evidence of a violation, it may pursue civil enforcement actions for injunctions, disgorgement, civil penalties, and bars on practicing as an accountant or reporting company before the commission. If it finds evidence of criminal conduct, it may refer the matter to the Department of Justice for criminal prosecution.

The SEC may issue subpoenas to the company, its corporate counsel, or other internal and external witnesses. SEC subpoenas may demand:

• Documents;
• Electronic data and documents;
• Books, records, and other documents; and,
• Sworn testimony and/or written answers.

When the SEC demands testimony, company auditors, broker-dealers, and other outside professionals are often subpoenaed as well.

What Makes Counsel’s Own Work Relevant Evidence?

When the SEC or another federal agency seeks access to counsel’s own work-product or communications with clients, courts apply three protections, with three different scopes:

• Attorney-Client Privilege: Applies to communications made by the client to counsel, and communications made by counsel to the client, if the communication is (i) confidential, (ii) made for the purpose of seeking or providing legal advice, and (iii) does not waive the privilege under a recognized exception.
• Work-Product Protection: Applies to materials prepared in anticipation of litigation. It provides protection against disclosure, and against compelling a witness to testify about the materials.
• Common Interest Privilege: Applies when two or more parties share a common legal interest. It protects communications between those parties and their common lawyer, or communications made through common lawyers.

Limits of Attorney-Client Privilege

The attorney-client privilege does not shield the underlying facts of a communication, even if the communication itself is privileged. So, even if a corporate employee’s communication to counsel was privileged, the underlying facts can still be relevant to the investigation and subject to discovery.

Copying counsel on an ordinary business message does not make it privileged either. This is especially true where the attorney-client privilege is asserted against a third-party subpoena; generally, for the privilege to apply, the communication must be made in confidence between the client and their counsel.

In SEC investigations, corporate counsel often serve multiple roles. As a result, counsel’s communications with corporate officers and other employees often combine legal advice and business advice. The rules regarding combined legal and business communications vary by jurisdiction, and courts in the Ninth Circuit and Eighth Circuit, in particular, use tests that generally restrict the application of attorney-client privilege.

Additionally, the attorney-client privilege does not protect transaction documents or other materials prepared for the company’s benefit that counsel transmits to counterparties, because these materials were not created in confidence.

Duties of Corporate Counsel under the Securities Exchange Act

Federal securities laws and regulations also impose duties on corporate counsel. Rule 21F-17(a) of the SEC’s Regulation 21F prohibits the company from taking any “action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including through the use of confidentiality agreements or other restrictive agreements.” 17 C.F.R. §205.3 requires an “attorney appearing and practicing before the Commission in the representation of an issuer” who becomes aware of evidence of a material violation of securities laws or breach of fiduciary duty to the shareholders to, among others, report this information to “the appropriate senior officers or other personnel within the issuer.” 17 C.F.R. §205.3(b).

Must Corporate Counsel Step Aside After Becoming a Witness?

When corporate counsel are outside counsel, their independence reduces concerns about having to defend the outside counsel’s own work, especially if the SEC is unlikely to target the defense counsel’s advice. If corporate counsel is in-house, this scenario is far more likely, and it raises questions about Model Rule 3.7.

Model Rule 3.7(a)

ABA Model Rule 3.7(a) generally prohibits a lawyer from serving as trial advocate if “the lawyer is likely to be a necessary witness” at that trial. This prohibits trial advocacy, but does not strictly prohibit participation in investigative interviews (and, if it did, the exception in Model Rule 3.7(a)(2) often protects a lawyer who will only be testifying about “the nature and value of legal services rendered in the case”). Three exceptions to Model Rule 3.7(a) are:

• (i) “The testimony is related to an uncontested issue;”
• (ii) “The testimony is related to the nature and value of legal services rendered in the case;” and,
• (iii) “Disqualification of the lawyer would otherwise cause substantial hardship to the client.”

Model Rule 3.7(b)

Under Model Rule 3.7(b), a lawyer from the firm can serve as the advocate in place of a lawyer prohibited by Model Rule 3.7, provided that he or she is not also prohibited from representing the client. Model Rule 1.0(c) defines “firm” to include “lawyers employed in an organization’s legal department as counsel.” In other words, if an in-house lawyer’s testimony disqualifies her from trial advocacy under Model Rule 3.7, then another in-house lawyer can serve as the advocate for her as long as she is not also subject to disqualification under Model Rule 1.7 or 1.9.

Model Rule 1.7(a)(2)

Model Rule 1.7(a)(2) addresses the potential conflict of interest that arises when there is a “significant risk” that the representation of a client “will be materially limited . .. by a personal interest of the lawyer.” If in-house counsel is both a witness and the company’s advisor, this raises potential issues.

Model Rule 1.7(b) permits “consentable” joint representation if:

• (i) The lawyer “reasonably believes [he or she] will be able to provide competent and diligent representation to each affected client;”
• (ii) The representation is not prohibited by law;
• (iii) The representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and,
• (iv) “Each affected client gives informed consent, confirmed in writing.”

Who Can Represent and Contact Company Witnesses?

Company Representation

Generally, company lawyers represent the organization, and not automatically any corporate employees they interview. As a result, when conducting interviews, company lawyers must:

• Warn the interviewed employee that the corporation is the holder of any attorney-client privilege;
• Explain that the corporation can choose to disclose what the employee shares if this would be in the corporation’s interest (despite employee’s objections); and,
• Recommend that the employee seek independent representation if this is necessary.

When conducting interviews, company lawyers must also be clear about whose interests they represent. As a result, the company and the employees the company’s lawyers interview both require separate lawyers if their concurrent conflict is nonconsentable under Model Rule 1.7(b).

Contacting Company Witnesses

Model Rule 4.2 prohibits lawyers from communicating “about the subject of the representation with a person the lawyer knows to be represented by another lawyer in the matter, unless the lawyer has the consent of the other lawyer or is authorized to do so by law or a court order.” This does not apply to communications between lawyers. In many cases, company counsel will, however, have contact with these persons before a client-side lawyer is appointed. Model Rule 4.2 also applies to “the constituent agents, employees, and officers whose acts or omissions may be imputed to the organization.” This restriction of Model Rule 4.2 does not extend to outside parties that have entered into transactions with the organization and who are potentially witnesses, because such counterparties are not constituents of the represented organization.

If corporate counsel are contacted regarding their own representation before a client-side lawyer is appointed, Model Rule 4.3 prohibits implications that they are disinterested.

In addition to corporate employees, the SEC may contact customers, suppliers, and other service providers (such as accountants, auditors, and appraisers) to seek their assistance as witnesses. Similarly, the SEC may contact other entities with which the target entity may have a transactional or contractual relationship as a result of the investigations it has been pursuing. As such, outside lawyers and consultants will need to determine what is best suited for protecting their interests as witnesses in these investigations.

Contacting Witnesses Who Are Not Employees or Counterparties

The SEC investigates and prosecutes cases based on evidence from multiple sources including corporate officers and directors, as well as potential witnesses such as auditors, financial advisors, former employees, consultants, financial institutions, vendors, and others. Often, these parties are contacted by SEC investigators via a subpoena or the request for documents and interview attendance. This is due to the wide scope of the SEC’s authority to conduct investigations.

Todd Spodek is the managing partner of Spodek Law Group, a second generation criminal defense firm that has been practicing since 1976.

Can the Company Cooperate Without Waiving Privilege?

Confidentiality and Privilege

When corporate counsel helps with cooperating with the SEC, there are several concerns:

• Waiver Implications: Because the SEC is a third party for privilege purposes, producing privileged materials to it generally waives the protection, and most federal courts have rejected “selective waiver,” so the waiver extends to private litigation (i.e. from shareholders or other plaintiffs).
• Waiver Enforcement: There are two ways that the federal courts can allow the use of this confidential information in private litigation: either the SEC makes it public (waiver), or the party seeking information can compel disclosure under the laws of the state in which the information is held.
• Internal Investigations: When cooperating, the target company may share the results of its internal investigation with the SEC. While this is often advisable in order to earn a “cooperation credit,” sharing internal investigations can result in waiving privilege protection and work-product protection.
• Confidentiality Agreements: Joint defense and common-interest agreements do not create the attorney-client privilege; instead, they extend the existing attorney-client privilege to communications involving third parties who share a common legal interest. For example, sharing the corporate counsel’s work-product with employees’ attorneys when it is not privileged would generally waive the attorney-client privilege.
• Corporate Governance: In a scenario where there is a change of management (such as in the case of a criminal investigation that has targeted former officers), the current management ordinarily controls the company’s attorney-client privilege and can waive the privilege if he or she determines that this is necessary to protect the company’s interests.

The SEC’s Request for the Attorney-Client Privilege and Work-Product Protection Waivers

The SEC’s Enforcement Manual expressly states that receiving cooperation credit does not depend on a target entity’s waiver of the attorney-client privilege and work-product protection. The manual states: “While Enforcement may take into account an entity’s willingness to voluntarily waive the attorney-client privilege and/or the attorney work product protection, an entity’s waiver of the attorney-client privilege or the attorney work product protection is not required to earn cooperation credit.”

Although this is the manual’s general statement, it still allows for a waiver request. The manual says: “However, an entity’s waiver of the attorney-client privilege or attorney work product protection may also be relevant in demonstrating the entity’s commitment to cooperate.” The manual also requires that SEC staff receive “senior Enforcement approval before requesting that an entity waive the attorney-client privilege and/or the attorney work product protection.”

What Happens Before and During Counsel’s SEC Testimony?

Before Testimony

Once the SEC staff, by the Commission, is appointed in a formal investigation, it has the power to subpoena documents and witness interviews.

After getting subpoenaed, corporate counsel’s outside counsel or an employee’s outside counsel may interview and prepare potential witnesses, including employees, former employees, contractors, and corporate officers and directors.

During testimony, counsel is limited in how he or she can interact with the witness. Counsel can object, but cannot answer questions, suggest answers, or provide explanations. While counsel cannot offer a replacement answer, counsel can ask the investigator to ask a clarifying question that might provide the desired information without violating the rules of witness testimony.

During Testimony

Formal SEC testimony is given under oath and transcribed by a court reporter. An individual receiving a subpoena is required to appear and testify unless his or her counsel negotiates an alternative or can establish a legal protection. For example, while SEC testimony is generally required unless exempted, individuals may invoke the Fifth Amendment in situations where being compelled to testify could have incriminating effects.

The SEC may instruct all witnesses to respond to any questions with truthful and complete answers. If so, the SEC may ask witnesses to sign Form 1662, which warns them that the information given can be used to support charges brought by the SEC in civil enforcement proceedings. Form 1662 also warns that “the information you provide may be made available to other federal agencies including, but not limited to, the Department of Justice Criminal Division.”

As a result, in situations where criminal charges are a possibility, witnesses must carefully determine when the privilege against self-incrimination can be invoked.

This is particularly important in situations where the SEC is targeting corporations. Corporations cannot invoke the Fifth Amendment. As a result, in these cases, the only way for a corporation to shield potentially incriminating information would be for its employees to invoke their own Fifth Amendment rights.

Access to Corporate Records

When an organization is the target of an investigation, its employees may be subpoenaed for their records and documents (e.g. emails) with the intent of uncovering the corporation’s involvement and culpability. If so, the employee may invoke the Fifth Amendment privilege. However, if the employee is appointed as the organization’s custodian, his or her personal Fifth Amendment rights cannot shield the corporation’s records.

In Braswell v. United States, 487 U.S. 99 (1988), the Supreme Court held that an employee’s privilege against self-incrimination does not protect corporate records. The Court noted: “Even if the record is incriminating, the custodian does not ‘make a statement’ by producing it. He merely assists in a third party’s, the corporation’s, discovery.” The only exception is if the witness may be personally subject to prosecution for refusing to produce corporate documents.

How Long Will the SEC Investigation Take?

The Wells Process

The Wells process is a customary procedure during an SEC investigation. It involves the SEC staff issuing a Wells Notice stating that enforcement action is contemplated, followed by the target’s Wells Submission, the SEC staff’s decision on whether to pursue the action, and the Commission’s final decision to approve or deny the staff’s recommendation. However, there is no guarantee that the SEC will follow the Wells process, as it only occurs if the SEC intends to file a formal enforcement action.

Timeline of an SEC Investigation

With respect to timeline, there are no universal deadlines for SEC investigations, and, in fact, they vary from months to years.

The 2020 SEC annual report cited the median time between the opening of an investigation and the filing of an enforcement action at 21.6 months.

The figures listed here do not necessarily apply to current investigations.

The Four-Stage Process

Investigations are often described as consisting of four stages: Matter Under Inquiry (MUI), informal investigation, formal investigation, and prosecution. This, however, is a general description, not a rule. While SEC procedures contemplate these stages, no statute or SEC rule mandates that investigations follow this four-stage sequence.

Matter Under Inquiry (MUI)

An MUI is an internal SEC procedure used to initially assess an investigation subject. During an MUI, the SEC does not have the authority to issue subpoenas and is limited to gathering information from public sources and cooperating sources.

If the SEC finds an MUI helpful for opening a formal or informal investigation, it will evaluate the investigation subject’s possible violations with the relevant SEC staff. While the SEC’s Enforcement Manual says that investigators should “make a recommendation by approximately 60 days after opening the MUI,” this doesn’t mean that an investigation cannot open beyond the 60-day mark.

The SEC’s Enforcement Manual also specifically allows for a case-by-case evaluation when an investigation subject will benefit from an extension of the 60-day MUI evaluation period. The Enforcement Manual says “MUI extensions for approved extensions must be filed within 60 days of opening the MUI. The Enforcement Manual, however, provides for approved extensions for MUI evaluation in certain circumstances, stating, ‘Enforcement may extend the 60-day MUI deadline, on a case-by-case basis, with supervisory approval.’”

Talk to Spodek Law Group

Every case turns on its own facts, and general information is no substitute for advice about yours. Todd Spodek, managing partner of Spodek Law Group, and the firm's attorneys defend federal criminal and white collar matters nationwide. Reach the firm at 212-300-5196.