White Collar and Regulatory Enforcement

Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum.

The last ten years have seen a continuous increase in white collar criminal and regulatory enforcement activity. 2011 was no exception, and we expect the trend to continue in 2012.

While not an entirely new phenomenon, the world of white collar and regulatory enforcement appears more politicized than ever. Corporations facing investigations in 2012 can expect extensive press scrutiny, serial leaks about the investigation, and, on occasion, parallel involvement of Congress and others at any stage of the matter. The credit a company can expect to receive for providing cooperation seems ever more uncertain, especially in cases receiving a high level of public focus, notwithstanding government protestations that cooperation will be rewarded. And, it is likely to get harder going forward to shepherd corporate resolutions of these kinds of cases through this politicized landscape. There is no simple solution to these challenges. But, as we discuss below, it remains critical for companies responding to multipronged investigations to keep clear lines of communication open with government investigators, to address questions candidly and with integrity, to correct identified problems promptly, and to build upon and strengthen investments made before the inquiry began in establishing a culture of compliance.

The stakes too are higher than ever. The trend toward longer prison sentences continued in 2011. Courts imposed record sentences for insider trading (Raj Rajaratnam—11 years), and FCPA violations (Joel Esquenazi—15 years). Similarly, Lee Farkas, former CEO of Taylor, Bean & Whitaker Mortgage Corp., received 30 years for his role in a bank fraud scheme. Corporations that resolved cases in 2011 were likewise subjected to larger settlement amounts than ever before. GlaxoSmithKline announced that it had agreed to pay $3 billion to settle criminal and civil charges arising out of its marketing practices. Google agreed to forfeit $500 million to resolve a criminal investigation of drug marketing law violations. And JGC Corporation paid a criminal fine of $218.8 million to resolve an FCPA investigation.

More aggressive investigatory techniques previously reserved for organized crime investigations, including the use of wiretaps, informants and sting operations, are now increasingly being used in white collar cases.

As we have regularly advised, every company should do an annual review, assisted by experienced advisors, of its regulatory and legal compliance procedures to assure that they are state-of-the-art. Equally important, when a compliance issue or potential violation first surfaces, it is critical to immediately get experienced expert advice and representation for the company and any employees who are or may be involved. (See Risk Management and the Board of Directors – An Update for 2012; Handling a Corporate Crisis: The Ten Commandments of Crisis Management)

Government Response to the Financial Crisis

The government’s sharp focus on banks and other financial institutions is likely to continue at a significant level in 2012. In the immediate aftermath of the financial crisis, as some commentators and public figures have urged that financial institutions and their senior executives be held responsible, the scope of investigative activity has been vast.

The Department of Justice, SEC, CFTC, and state attorneys general have all been focused on the financial community. Among major actions resolved in 2011 were the SEC’s claims against several major financial institutions for alleged deceptive practices in the sales of CDOs, as well as banking regulators’ imposition of far-reaching consent orders with 14 loan servicers related to so-called “robo-signing” practices in connection with home loan foreclosures. In addition, the SEC brought actions against six former senior executives of Fannie Mae and Freddie Mac, and a number of investigations of banks and financial institutions are continuing both at the state and federal level. The newly formed Consumer Financial Protection Bureau will be yet another enforcement agency examining this area.

Financial institutions should expect that their activities will continue to be highly scrutinized by these law enforcement agencies. The best protection is to take steps proactively to prevent misconduct from occurring. Investing in strong compliance systems, hiring experienced compliance and risk professionals, adopting improved technology for surveilling potential compliance lapses, rapidly and thoroughly reviewing any emerging issues, and setting a clear tone at the top of zero tolerance for inappropriate activity remain essential.

Whistleblower-Inspired Investigations

As expected, the Dodd-Frank whistleblower bounty program has triggered an increase in tips to the SEC, and in resulting investigations. In some instances, the SEC Enforcement Staff has launched broad investigations with sweeping requests for document production, without any overt acknowledgement that the investigation is based on a whistleblower complaint, and with little willingness to identify areas of potential concern for companies and their counsel to examine and address. In other cases, the SEC Enforcement Staff has expressly informed companies that the SEC has received a whistleblower complaint, and has requested that counsel examine specific transactions or practices and then make a presentation of the facts to the Staff. During the Dodd-Frank rulemaking process, the SEC endorsed using the latter approach where appropriate. (SEC Final Rules). It remains to be seen to what extent the Staff will take that endorsement to heart. Obviously, a more transparent approach allows for more efficient and proportional devotion of resources to put the Staff in a position to make a well-informed decision about whether further inquiry is warranted. It also puts companies in the best position to determine whether any improprieties have occurred and whether any remedial measures are warranted.

Early experience is not sufficient to assess whether the fear will be realized that whistleblowers will stop raising concerns through their employer’s internal compliance or ethics reporting mechanisms and instead contact the SEC directly. It continues to be critical therefore that companies continue emphasizing a commitment to ethical business practices, while also communicating effectively to employees the importance of utilizing internal reporting mechanisms in the event they become aware of possible wrongdoing. When whistleblowers do come forward internally, it is essential to respond appropriately, investigate promptly and take action where warranted. (See The New Dodd Frank Whistleblower Rules: Hype and Reality)

Impact of the SEC Inspector General

The advent of increased scrutiny by the SEC Inspector General of the SEC Staff’s conduct and resolution of investigations has further complicated the landscape. In the best of circumstances, defending an SEC investigation is challenging. The SEC Enforcement Staff is skeptical and thorough, and they have powerful investigative tools at their disposal. But now companies face an agency whose Inspector General has been frequently in the news for conducting numerous highly publicized investigations of the Staff’s own activities, each of which has culminated in the public release of an extensively detailed investigative report, and often sharp criticism of the Staff, including decisions made to settle or close cases. (See e.g. Investigation of the SEC’s Response to Concerns Regarding Robert Allen Stanford’s Alleged Ponzi Scheme)

Some observers might react with a bit of schadenfreude at the sight of the tables being turned on the SEC, but such a reaction would be shortsighted. Today, everyone who works at the SEC knows that they are only one judgment call away from being summoned for testimony before the Inspector General, or from having their emails reviewed, with the risk of a publicly released report and Congressional hearings to follow dissecting their conduct. This state of affairs can make it more difficult for the Staff to be comfortable about closing a case, or reaching a reasonable compromise in a settlement in recognition of defense arguments, litigation risks and similar appropriate considerations.

The public interest would be best served by a change in these circumstances. Until that happens, however, parties involved in SEC inquiries should be mindful of the extraneous factors that may impact an investigation. It is more critical than ever to maintain credibility and lines of communication with the Staff. This maximizes the possibility of learning of unanticipated shifts in the investigation, as well as the opportunity to be heard before the Commission takes action. It is also an unavoidable reality that the Staff is doing considerably more work than in the past before closing unpromising investigations. Counsel must be alert to opportunities to assist the Staff in developing a sufficient evidentiary basis to make a confident decision to close the inquiry, whenever they are ready to do so.

Judicial Review of SEC Settlements

One of the biggest developments in 2011 in the white collar and regulatory enforcement area came at the very end of the year when U.S. District Judge Jed Rakoff rejected a $285 million settlement negotiated by Citigroup and the SEC to resolve charges that Citigroup engaged in securities fraud in connection with the marketing of CDOs. Judge Rakoff stated it was impossible to evaluate whether the proposed settlement was fair, reasonable or adequate because the Court did not have a “sufficient evidentiary basis” to know whether the requested relief was justified and whether the underlying allegations were supported by “any proven or acknowledged facts.” More fundamentally, Judge Rakoff made clear his view that the SEC’s long-standing practice of settling with defendants while allowing them to neither “admit nor deny” the allegations asserted against them “deprives the Court of even the most minimal assurance that the injunctive relief it is being asked to impose has any basis in fact.” A federal judge in Wisconsin, citing Judge Rakoff’s recent Citigroup opinion, has refused to approve an SEC consent settlement involving Koss Corp., requesting that the SEC provide a written factual predicate to establish that the proposed judgments are fair, reasonable, adequate and in the public interest. (SEC v. Koss). And, Congress has ordered hearings on the SEC’s “no admit, no deny” settlement practices, which are no different, in fact, than those of numerous other federal agencies with civil enforcement power. (Announcement of Hearing on SEC Settlement Practices)

The SEC has filed a notice of appeal of Judge Rakoff’s ruling and on December 28, 2011, the Second Circuit Court of Appeals granted a temporary stay of the proceedings. (SEC v. Citigroup) More recently, on January 6, the SEC announced some slight changes to its policy—it will no longer allow companies to negotiate a “no admit or deny” SEC civil settlement when there is a corporate acknowledgement of wrongdoing in connection with the resolution of a parallel criminal proceeding—but otherwise reaffirmed its policy of allowing a “no admit or deny” resolution in the vast majority of its cases where there is no parallel criminal inquiry.

Whatever the result of the SEC’s appeal of Judge Rakoff’s ruling and the future of the SEC’s policy, it is clear that in 2012 and beyond the settlement process for an SEC matter, or any regulatory enforcement matter, cannot be taken for granted. Companies must anticipate that there will be significant scrutiny of the settlement when it becomes public, including whether the agreed-upon penalties are sufficient. The pending appeal will not affect settlements of administrative proceedings and it remains to be seen whether the SEC will choose to file more of its settlements administratively in 2012.

Insider Trading

This past year has seen a continuation of the government’s relentless drive against insider trading, with a special focus lately on cases involving hedge funds. The leading case, against Raj Rajaratnam, has resulted in a conviction and an unprecedented 11 year sentence, and it could have been double that but for his poor health. There were a number of other successful convictions and SEC charges against other insider traders.

These cases are based on the new use in the insider trading context of techniques that traditionally had been limited to investigations of organized crime and other non-white collar crimes. Legal challenges to evidence obtained by these methods in the insider trading context have failed so far, and the latest challenge by Rajat Gupta to the use of wiretap evidence against him will likely, based on comments by the court, be an uphill battle.

While the current wave of cases has been highly publicized, it has not involved an expansion of the reach of insider trading law. The Galleon-related and expert network cases brought to date have generally involved highly material information communicated in clear breach of confidentiality duties. The thing to watch for in 2012 is whether the government ventures further in the next wave of cases. The cases pursued to date have not called into question the types of legitimate research that are performed every day by investment professionals. The work of investment analysts will become much more perilous if future cases involve information as to which materiality is more debatable, or circumstances in which the existence of a duty of confidentiality is more uncertain.

Unless regulators and prosecutors exercise restraint and follow established precedent on the elements of insider trading, there is a danger to investment professionals that the line between legitimate research and insider trading will become more blurred and uncertain. This could expose investment professionals and their firms to outsized risks, even when they are acting in good faith. It is thus even more imperative that investment firms implement compliance systems designed to ensure that their personnel are appropriately trained, and that any judgment calls are escalated and thus can be made at an appropriate level within the firm, with the benefit of legal and compliance advice where warranted.

International Anti-Corruption Enforcement

2011 was one of the most active years for FCPA enforcement on record. The government’s enforcement efforts also included a significant number of individual prosecutions, reinforcing a recent trend in which the DOJ and SEC have pursued charges against responsible employees and other parties in matters resulting in corporate settlements. In December 2011, for example, the DOJ and SEC brought criminal and civil charges against a number of former executives and two former outside agents of Siemens AG relating to the same conduct giving rise to Siemen’s corporate FCPA settlement in 2008.

The government did not always win in the FCPA arena. In the first trials arising out of the SHOT Show sting operation, the jury deadlocked and the federal district court declared a mistrial. In December, a federal district court in California, citing grounds of prosecutorial misconduct, vacated convictions and dismissed indictments with prejudice against Lindsey Manufacturing and two of its officers who had been found guilty after trial. (U.S. v. Lindsey Manufacturing) (Prior to that ruling, the case had represented the first-ever conviction of a corporation after trial on FCPA charges.)

The DOJ and SEC reemphasized in 2011 their oft-stated position that, when FCPA problems do arise, companies can gain benefits from strong compliance programs, selfdisclosure, self-remediation and cooperation. These benefits came in a variety of forms, including significant fine reductions (J&J, Deutsche Telekom), avoiding required retention of an independent monitor (J&J), a DOJ non-prosecution agreement (Aon, Comverse Technologies) or the SEC’s first-ever deferred prosecution agreement (Tenaris S.A.). The DOJ and SEC also made clear in the latter part of 2011 that in appropriate cases they have declined, and will continue to decline, to bring FCPA charges.

Reflecting mistrust of these promised benefits from cooperation, the U.S. Chamber of Commerce will likely continue its recent efforts in 2012 to seek greater clarity through proposed legislative amendments to the FCPA, including express affirmative defenses for an effective anti-corruption compliance program and a more narrow approach to the definition of what constitutes a “foreign official” under the FCPA. In response, the DOJ has said it will provide new FCPA guidance in 2012, though it is unlikely to adopt the full array of proposed reforms. (http://www.justice.gov/criminal/pr/speeches/2011/crm-speech-111108.html)

Overseas, the biggest development in 2011 was the coming into force of the U.K. Bribery Act on July 1. The Act, which covers official and commercial bribery and is in some respects broader than the FCPA, is most noteworthy for establishing a strict liability corporate offense of “failure to prevent bribery,” as well as a complete defense to such charges where a company can demonstrate that it had implemented “adequate procedures” to prevent conduct that violates the Act. The detailed guidance issued by the U.K. Ministry of Justice and the Serious Frauds Office in advance of the Act’s effective date, emphasized that U.K. authorities will exercise significant discretion in enforcing the Act and, in doing so, generally will take a proportionate approach in evaluating conduct that might be within the scope of the Act, as well as evaluating the adequacy of corporate compliance efforts.

Other key international developments in 2011 involved efforts in several jurisdictions to implement anti-corruption legislation for the first time. In February 2011, the Chinese government adopted an amendment to its criminal laws which prohibits bribery of foreign public officials or officials of an international public organization in order to obtain an illegitimate commercial benefit. In May 2011, similar anti-corruption amendments took effect in Russia. Similar legislation is being considered in other countries, including India. While it remains to be seen just how these developments affect anti-corruption enforcement efforts in China and Russia and other affected countries, the clear trend is that lawmakers and regulators in foreign jurisdictions are devoting more attention than ever to combating international corruption.

Companies doing business internationally should ensure that they have implemented and maintain state-of-the art anti-corruption compliance programs, including up-todate risk assessments to ensure that the program is appropriately tailored to the actual risks faced in conducting the company’s business, effective policies, procedures and monitoring protocols, including with respect to promotional expenditures, evaluation of foreign counterparties and third-party agents or representatives, up-to-date training, as well as reaffirmation of top management’s commitment to a corporate culture that reinforces the company’s anti-corruption efforts. (See Recent Developments in Antibribery Enforcement)

False Claims Act

A record-high level of False Claims Act enforcement remained part of the white collar terrain in 2011. The federal government recovered a total of $3 billion in FCA cases in the past year. Many of these cases originate with whistleblowers, and they received over $500 million of the government’s recoveries in 2011. The most active areas continued to be the health care and pharmaceutical industries, followed by defense and procurement cases. The FCA is now being invoked in financial crisis cases as well, with at least two civil actions filed against a financial institution challenging mortgage-related practices, and widespread press reports of ongoing similar investigations involving other firms.

Criminal Antitrust Enforcement

Criminal antitrust enforcement continues to be a top priority of the Antitrust Division. In 2011, there were 90 Sherman Act cases yielding a corporate fine or financial penalty of $10 million or more—18 of $100 million or more, and six of $300 million or more. And the average prison sentence is now 30 months as compared with eight months in the 1990s.

Of particular importance in 2011 was the Antitrust Division’s close collaboration with the Financial Fraud Enforcement Task Force. The Task Force was established to investigate and prosecute a wide array of financial crimes, and it currently is working in tandem with the Antitrust Division on an investigation of the municipal bond industry that has resulted in multiple guilty pleas by individuals and settlements by firms. In addition, in 2011, the Task Force and Antitrust Division teamed up to investigate bid-rigging and fraud at public auctions of foreclosed real estate in California. We anticipate further joint investigations of this type—with criminal antitrust theories, especially as to bid-rigging and market allocation, figuring more prominently into broad-based fraud investigations.

We expect that rates of conviction, length of imprisonment and levels of penalties will remain high—if not ratchet further upward—for the foreseeable future. Federal prosecutors will be more creative, and will push the boundaries further, in using criminal antitrust theories to combat financial fraud more generally. And, taking a page from their colleagues in the Task Force and many foreign antitrust authorities who favor pre-dawn raids of offices, we would not be surprised to find increasingly aggressive use of wiretapping and similar technology in aid of cartel inquiries.

Electronic Discovery

Virtually all white collar criminal and regulatory enforcement investigations involve significant amounts of electronically stored information of an ever-increasing variety. More and more, investigators have been requesting not only email and word processing documents, but also instant messages, text messages, information from smartphones, SharePoints, and social media, to name but a few.

Government entities have shown an increasing sophistication in their handling of ESI. Production protocols have become more standardized and detailed, and investigators are better able to sift through mounds of information effectively and efficiently. This is due, in part, to increased hiring and training of personnel knowledgeable about e-discovery, and, in part, to improvements in the government’s technological tools and capabilities. This has increasingly required the recipients of investigatory requests and subpoenas to be nimble in handling electronic data in order to identify and produce evidence quickly.

In the past year, there has been a growing reliance on technology-assisted approaches in the search and review of electronic information. These approaches combine the skills of attorneys and the use of artificial intelligence to sift through massive volumes of ESI. Recent studies have shown that these approaches are more accurate than manual review, and can be conducted at a fraction of the time and cost. In our experience, the government has shown a remarkable receptivity to sound and defensible e-discovery protocols that employ these technology-assisted methods. We can expect to see their use grow in the coming year.

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