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Independent Consultants Can Further Real Time Enforcement

By: Nina Rodriguez


Introduction


The SEC’s enforcement prowess is considerable, judging solely by the fact that each day’s news identifies companies under government investigation. But investigating matters is time-consuming—document subpoenas invariably will be issued (and frequently haggled over), testimony will be taken, requests for so-called “white papers” or “Wells Notices” will be issued, settlement discussions frequently ensue, an action memorandum must be drafted by the SEC Staff and, ultimately, the Commission itself will review Staff recommendations that enforcement actions should be instituted.[1]


For companies engaged in this process, the longer it takes to resolve an investigation, the greater the likelihood of suffering serious adverse consequences—most companies disclose SEC investigations (even though not legally required to do so), and the overhang of a potential enforcement action can preclude significant efforts to raise capital, affect business development prospects, and cause key employees to consider alternative employment possibilities.[2] From the SEC Staff’s perspective, this lengthy enforcement process frequently means that misconduct goes unannounced and unredressed for months or years after it occurs. In effect, the longer the enforcement process takes, the greater the likelihood that wrongdoers may enjoy a “grace period,” during which their ill-gotten gains can be spent. The fact that misconduct remains undetected, and the proceeds from that misconduct can be consumed before public awareness occurs, may diminish investor confidence in the efficacy of the SEC’s enforcement efforts.


These distinct interests in assuring that nascent investigations are promptly resolved can be addressed by utilizing Independent Consultants to assure that matters can be quickly resolved, while protecting the public interest by assuring that significant wrongdoing is exposed and corrected.


Independent Consultants


The use of Independent Consultants as a remedy in securities enforcement actions has grown sharply over the last few decades. An Independent Consultant’s primary responsibility is to assess and monitor a company’s compliance with the terms of the agreement that are specifically designed to address and reduce the risk that the company’s misconduct will recur, including evaluating internal controls, corporate ethics, and compliance programs.[3] In some instances, Independent Consultants are tasked with engaging in factual investigations and drawing conclusions about prior conduct.[4] The SEC typically requires Independent Consultants to provide written reports describing the procedures performed, conclusions reached, and recommendations for changes or improvements to the company’s policies.[5]


Effective enforcement of the federal securities laws is a critical component of maintaining investor confidence in the fairness and transparency of the securities markets. To maximize the potential of the Independent Consultant and better protect investors, the SEC should weave the Independent Consultant into a real time enforcement initiative. The goal of this initiative would be to discover potential on-going fraud in a quick and effective manner, with the help of the Independent Consultant. Preventing future misconduct altogether, or discovering it early enough to recover ill-gotten gains, would bolster investor confidence in the marketplace.


Real Time Enforcement


The SEC’s tri-partite mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.[6] Its perceived success in these efforts relies upon investor confidence, which ultimately requires swift and sure enforcement action against those who break the law. Thus, it is imperative that wrongdoers (and their wrongs) are quickly identified, and misconduct redressed. The concept of “real time enforcement” was designed to accelerate the pace of investigations by


(1) stopping illegal conduct promptly and preventing improperly obtained investor funds from being squandered;


(2) compelling timely disclosure of questionable conduct to alert the public and prevent further misconduct; and

(3) deterring future misconduct by imposing swift and stiff sanctions on those who engage in serious misconduct.[7]


One vehicle the SEC can utilize to halt ongoing misconduct in its tracks, even before it has completed its investigation is an application for an emergency temporary restraining order.[8] The SEC can seek to halt an ongoing fraud, freeze the alleged wrongdoer’s assets, and preclude the destruction of documentary evidence critical to determining whether, in fact, wrongdoing has occurred.[9] This also enhances investor protection through the quick dissemination of information regarding questionable conduct, permitting investors to take steps to protect themselves from further detrimental conduct. An integral aspect of real time enforcement is conducting investigations and bringing enforcement actions rapidly. Ultimately, real time enforcement is a most powerful tool for protecting investors. By acting quickly and effectively, the Commission can take immediate action to undo the adverse consequences of misconduct.


Independent Consultants and Real Time Enforcement


The Commission is most effective when it learns of potential violations while misconduct is still ongoing and investigates those matters quickly. Given the finite nature of the SEC’s resources, this is a difficult prospect—but, the utilization of Independent Consultants can make the Commission’s real time enforcement initiatives more productive, can provide better oversight of the markets, and can accomplish that without the need to increase the SEC’s limited enforcement resources.


Once potential misconduct has been identified, the SEC can formulate a generic settlement that enables it to enlist the help of an Independent Consultant to conduct a thorough, and independent, investigation. The Independent Consultant would present its findings and make recommendations vis-à-vis any additional remedies as a result of its study. An Independent Consultant could devote more resources to the investigation, allowing it to conduct investigations quickly and efficiently. Following the investigation, the Commission could proceed as it deems appropriate, minimizing the risk that any ill-gotten gains already have been dissipated. The use of Independent Consultants at the early stages of an enforcement matter might also prevent wrongdoers from becoming entrenched recidivists—potential recurrent offenders would no longer have a “grace period” to enjoy their ill-gotten gains.


Alternatively, business entities that find themselves confronting potential charges of improper conduct could reach out to independent consultants during preliminary stages of an enforcement investigation and, as a demonstration of their good faith desire to remediate the consequences of improper behavior, prepare policy and procedural solutions to present to the Enforcement Division. This encourages firms to self-report, self-correct, and self-remediate those who have been injured by violations of law or policies. The Commission has long encouraged companies to identify instances of securities infractions, bring them to the SEC’s attention, and take steps to correct the misconduct, such as hiring an Independent Consultant, and has assured firms that the SEC will, in appropriate cases, consider giving "credit" for such efforts.[10]

[1] For an overview of the SEC Enforcement Process, see SEC Office of Chief Counsel, Enforcement Manual, (Nov. 28, 2017) https://www.sec.gov/divisions/enforce/enforcementmanual.pdf; see also R. Fons , A Primer on SEC Investigations and Enforcement Actions Related to Financial Reporting and Accounting Cases, Mondaq (Jan. 28, 2014), https://www.mondaq.com/unitedstates/securities/288982/a-primer-on-sec-investigations-and-enforcement-actions-related-to-financial-reporting-and-accounting-cases. [2] See, e.g., A. McElhanney, SEC Investigating Your Company for Fraud? Disclosure Could Be Harmful, Institutional Investor (June 24, 2019) https://www.institutionalinvestor.com/article/b1fzvkz8mpm9n9/SEC-Investigating-Your-Company-For-Fraud-Disclosure-Could-Be-Harmful ( Firms that choose to disclose investigations suffer—even those that are ultimately found not to have violated the law, citing D. Solomon & E. Soltes, “Is ‘Not Guilty’ the Same as ‘Innocent’? Evidence from SEC Financial Fraud Investigations,” SSRN (rev. Aug. 3, 2020) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3402780. [3] See, e.g., C. Morford, Selection and Use of Monitors in Deferred Prosecution Agreements and Non-Prosecution Agreements with Corporations, Dept. of Justice Mem. (Mar. 7, 2008), available at https://www.justice.gov/sites/default/files/dag/legacy/2008/03/20/morford-useofmonitorsmemo-03072008.pdf. [4] See, e.g., In re MBIA Inc., SEC Admin. Proc. File No. 3-12551, 2007 SEC LEXIS 171 (Jan. 29, 2007) (requiring an independent consultant to report on, among other topics, ‘‘whether MBIA acted in a manner consistent with generally accepted accounting principles and the federal securities laws’’). One valid concern the SEC Staff must confront is the possibility that circumscribing the length of an investigation may allow additional serious misconduct to escape detection. By utilizing Independent Consultants to assess whether there are related activities that may involve securities law violations, this legitimate concern can be satisfied. [5] See, e.g., S. Peikin, Remedies and Relief in SEC Enforcement Actions, (Oct. 3, 2018), available at https://www.sec.gov/news/speech/speech-peikin-100318, (Explaining that the Commission may “require the settling party to retain a compliance consultant or monitor to make recommendations to the issuer and to report to the Commission on terms specifically defined in the settlement papers”); see also, e.g., SEC Press Rel. No. 2019-95, KPMG Paying $50 Million Penalty for Illicit Use of PCAOB Data and Cheating on Training Exams, (June 17, 2019) https://www.sec.gov/news/press-release/2019-95 (Describing the KPMG settlement, which included “retaining an independent consultant to review and assess the firm’s ethics and integrity controls and its compliance with various undertakings”). [6] See SEC Website, About the SEC, , https://www.sec.gov/about.shtml. [7] For a description of the SEC’s “Real Time Enforcement” Program, see H. Pitt, Remarks at the PLI 33rd Ann. Inst. on Securities Reg. (Nov. 8, 2001), available at, https://www.sec.gov/news/speech/spch520.htm; SEC, What We Do, https://www.sec.gov/about/what-we-do.

[8] See SEC Press Rel., SEC Obtains Preliminary Injunctions Against Frack Master and Four Others in Purported House Flipping Scheme(Aug. 31, 2018), https://www.sec.gov/sec-obtains-preliminary-injunctions-against-frack-master-and-four-others-purported-house (“The SEC has obtained court-ordered emergency relief to halt a real-estate scam”); M. del Castillo, SEC Files ‘Emergency’ Restraining Order Against $1.7 Billion Telegram ICO, Forbes (Oct. 11, 2019), https://www.forbes.com/sites/michaeldelcastillo/2019/10/11/sec-files-emergency-restraining-order-against-17-billion-telegram-ico/?sh=1e8511ef29cb (The SEC has obtained a temporary restraining order against Telegram, the encrypted messaging app that raised $1.7 billion by selling tokens similar to bitcoin that could be used on a future service”).

[9] See SEC, Report Pursuant to Section 308(c) of the Sarbanes Oxley Act of 2002, , https://www.sec.gov/news/studies/sox308creport.pdf(Stating that temporary restraining orders have a “positive impact on the Commission’s ability to obtain money from defendants”).

[10] See Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, U.S. Securities and Exchange Commission (Oct. 23, 2001) (stating the SEC will give credit businesses when they “seek out, self-report, and rectify illegal conduct”); see also A. Ceresney, The SEC’s Cooperation Program: Reflections on Five Years of Experience, (May 13, 2015), available at https://www.sec.gov/news/speech/sec-cooperation-program.html (Noting that “the Commission has been formally granting credit for cooperation by entities for more than five years” and the Division of Enforcement considers four factors for assessing cooperation: assistance provided by the cooperator, importance of the underlying matter, interest in holding the individual accountable, and the profile of the individual)

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