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The Securities and Exchange Commission in 2001 made an important public statement about the factors it considers in determining whether, and to what extent, it would reward companies for cooperating in SEC investigations. Known as the Seaboard Report, this document, released in October 2001, provided the first detailed, written public guidance on the benefits of cooperation and showed that full cooperation could result in no enforcement action. The commission praised Seaboard Corp. for promptly investigating and disclosing its accounting errors, dismissing the responsible employee and two supervisors, providing “complete” cooperation with the SEC’s investigation, which included the company’s decision to not assert attorney-client privilege, and strengthening its financial reporting processes to prevent future problems. According to the Seaboard Report, “The paramount issue in every enforcement judgment is, and must be, what best protects investors. Self-policing, self-reporting, remediation and cooperation with law enforcement authorities, among other things, are unquestionably important in promoting investors’ best interests.” The SEC outlined 13 criteria it would consider in determining whether, and how much, to credit self-policing, self-reporting, remediation and cooperation. In judging a company’s cooperation, the commission noted that it considers whether the company shared the results of its internal investigation with the SEC, voluntarily disclosed relevant information not specifically requested, encouraged its employees to cooperate, and refrained from asserting the attorney-client privilege and the work-product protection. In the three years since the Seaboard Report, the commission has publicly declined to charge only two other companies that provided full cooperation. During the same period, however, it has obtained multimillion-dollar penalties against a number of companies based upon their lack of full cooperation. In 2002, the commission charged Xerox Corp. with securities fraud and imposed a then-unprecedented civil penalty of $10 million. The SEC explicitly stated that this penalty was “in part, a sanction for the company’s lack of full cooperation in the investigation.” Later that same year, the commission charged Dynegy Inc. with financial fraud and imposed a $3 million penalty, which reflected the SEC’s dissatisfaction with Dynegy’s cooperation in the early stages of the agency’s investigation. One day after taking action against Dynegy, the SEC announced that it declined to file any enforcement action against Homestore Inc. even though it charged several former Homestore executives with securities fraud. According to the SEC, Homestore’s “swift, extensive and extraordinary cooperation” in the investigation warranted this result. Homestore reported the suspected misconduct after discovery, conducted a thorough and independent investigation, shared the results with the SEC and did not assert any privileges. The company also terminated the employees who engaged in the misconduct and took remedial action to prevent a recurrence. Significantly, since Homestore, the SEC’s public messages regarding cooperation have taken the form of sanctions rather than rewards. In September 2003, the commission charged American International Group with fraud and criticized its document collection efforts and delay in producing a key document. The SEC imposed a $10 million civil penalty that was directly tied to AIG’s conduct. Similarly, the SEC in March 2004 ordered Bank of America Securities LLC to pay a $10 million civil penalty solely for its repeated failures during the investigation to produce requested documents. The SEC settled fraud charges with Lucent Technologies and imposed a $25 million civil penalty “for lack of cooperation,” including ineffective document preservation measures and incomplete document production. And in August 2004, the commission imposed a $7.5 million penalty against Halliburton for “lapses in conduct during the investigation,” not the underlying conduct itself, which did not result in a fraud charge. This evolution in the SEC’s approach to monetary penalties and cooperation offers three lessons to companies and their officers. First, when it comes to settlements, the SEC can be expected to demand significant monetary penalties for failure to cooperate fully, as the SEC interprets that phase, even if the underlying conduct would not otherwise warrant a penalty. Significantly, there is no statutory basis for such demands on the commission’s part. A federal court can impose monetary penalties for violations of the federal securities laws. But no provision permits imposition of a civil monetary penalty for “lack of cooperation.” Even so, the SEC demands — and receives — and gets such penalties in settlements. Second, a company should not assume that it can use litigation-style tactics during the early stages of an SEC investigation and then “make nice” by fully cooperating during the later stages of the investigation. In at least four cases, the commission acknowledged a company’s belated cooperation and good conduct but still demanded significant monetary penalties for uncooperative conduct during the early stages of investigation. In essence, the SEC is demanding that the company become its investigative arm from day one. Third, while the price of cooperation is obvious — waiving attorney privilege exposes the company to private liability and significantly increases defense costs — the benefits are not so clear. For example, in two recent settlements involving the Foreign Corrupt Practices Act, the SEC acknowledged both companies’ cooperation but still demanded monetary relief in amounts that went well beyond previous settlements. Likewise, in a non-fraud case against Fidelity Brokerage Services, the SEC acknowledged Fidelity’s prompt remedial action and cooperation, which included an immediate internal investigation, termination of involved employees, and sharing its investigative findings with the SEC. Yet the commission still insisted on a $1 million civil penalty. Finally, in a recent fraud settlement with Royal Dutch Petroleum, the SEC acknowledged the company’s cooperation and remedial actions while still extracting one of the highest civil penalties ever for such violations. The reality is, and the SEC knows, that public companies, unlike individuals, have little choice when it comes to its dealings with the commission. If any employee has committed securities fraud, that fraud is attributable to the company. So unless a company is certain that none of its employees engaged in misconduct, the company must curry favor with the SEC. This is especially true if there is an ongoing parallel criminal investigation where the stakes are even higher. Thus, unless a company is willing to litigate with the SEC in federal court, it has no choice but to cooperate. The Seaboard and Homestore examples illustrate the potential benefits of full cooperation. But the recent ratcheting up of penalties shows that even full cooperation provides no assurance of significant benefits. My next column will discuss the very different situation facing senior executives and other individuals targeted by the SEC — a situation where full cooperation with the SEC is, in my view, less often called for. David B. Bayless, a partner in the San Francisco office of Morrison & Foerster, specializes in SEC enforcement work. He formerly headed the SEC’s San Francisco office.

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