In the halcyon pre-Enron days, the U.S. Securities and Exchange Commission (SEC) rarely referred investigations to the U.S. Department of Justice (DOJ) for criminal prosecution.
Those days are long gone and the two agencies now frequently work together in joint civil (SEC) and criminal (DOJ) investigations and prosecutions. Two recent federal district court decisions, however, have attacked this common "duel investigation" practice, and resulted in the significant sanction of dismissing criminal indictments. As a result of these decisions, both of the agencies, as well as white-collar defense counsel, are taking a hard look at whether joint civil/criminal investigations compromise constitutional rights, and whether the practice should be allowed to continue.
Online encyclopedia "Wikipedia" defines a "stalking horse" as "someone whose role is to become the focal point for, or the initiator of, a debate or challenge. In reality, however, their leadership role may be an illusion, and the stalking horse is really working to promote a challenge or debate that will benefit a third party whose identity remains a secret." This describes perfectly the situation and concerns that arise when the SEC utilizes its very broad discovery powers in a civil investigation to obtain documents and testimony from witnesses that are unwitting targets of criminal inquiry. While the SEC's enforcement powers are nothing to sneeze at -- it has the power to obtain injunctive relief, civil money penalties and suspensions or even bars of regulated persons, such as officers and directors of public companies, and of accountants and attorneys who practice before the SEC -- it does not have the power to seek or impose the ultimate sanctions, criminal convictions and prison time. Those weapons are reserved for the criminal authorities, such as the DOJ.
There is no question that the SEC is the agency most skilled at enforcing the federal securities laws, and it makes perfect sense that the DOJ would seek to benefit from that expertise. This is even more reasonable considering that it is difficult, even in the civil context where the burden of proof is more relaxed, for even the most skilled SEC lawyer to prove all four elements of a securities fraud claim: (1) a material (2) false or misleading statement (3) made with scienter (intent) (4) in connection with the purchase or sale of securities (unlike a private plaintiff, the government typically is not required to prove causation or damages). As a result, it became commonplace years ago for the SEC to "loan" its attorneys to the DOJ in cases involving the enforcement of the federal securities laws. That practice, however, used to be reserved for situations where the SEC had wrapped up its case, and the DOJ felt the violations were egregious enough to seek criminal sanctions. What has happened in the past few years' post-Enron frenzy, however, is that the SEC's enforcement staff itself has become a real-time undisclosed investigation team for the DOJ -- not just a resource.
To some, this may seem like a minor concern. It is not. Rather, it is one that implicates and potentially compromises due process and Fifth Amendment rights. In the face of an SEC investigation, a person likely will employ very different legal strategies if he or she knows that a criminal investigation is under way or even lurking in the shadows. As the Frank Quattrone and Martha Stewart cases illustrate, the DOJ prefers to focus its cases on more traditional and easier to prove criminal misconduct, such as obstruction of justice and perjury, rather than complex securities law violations. As such, the risk of providing testimony to the SEC while the criminal authorities lie in wait is a dangerous situation. The SEC's "fact-finding" investigations are not restrained by the Federal Rules of Civil Procedure or Evidence, and courts broadly interpret the SEC's investigative subpoena powers.
Further, a potential civil defendant may think nothing of outlining all of his or her defenses to a potential SEC enforcement action as part of a "Wells" submission to the SEC staff, which is a written submission designed to illustrate why the SEC should not pursue enforcement. In a criminal context, however, where the DOJ's burden of proof is higher, it is often more advantageous for a target to invoke Fifth Amendment protection rather than testifying, and to seek a stay of any separate ongoing civil SEC matter. If the SEC defendant does not know about the criminal DOJ investigation and cannot take such protective actions in the SEC matter, the DOJ likely will utilize SEC testimony transcripts and Wells submissions to obtain admissions or other tactical advantages that it normally could not get from a defendant standing mute.
Two recent federal district court opinions illustrate this growing concern. The first decision came in the much-publicized HealthSouth criminal case in the Northern District of Alabama involving its former CEO, Richard Scrushy. In United States v. Scrushy, the court dismissed perjury charges against Scrushy, which were based on his testimony to the SEC, after concluding that the SEC and the local U.S. Attorney's Office (USAO) improperly colluded. The decision primarily was based on the fact that the USAO and the SEC had worked together to determine that Scrushy's SEC testimony should be held in Birmingham, Ala., rather than, as was typical, at the SEC's Atlanta, Ga., offices in order to give the local USAO jurisdiction. The USAO also influenced the SEC's questioning of Scrushy by having the SEC avoid certain areas in order to allow the USAO to develop witnesses on the issues.
A more obvious case of government misconduct is outlined in the recent District of Oregon case, United States v. Stringer, where the court dismissed the entire indictment against three former executives of FLIR Systems Inc., and even suppressed the defendants' statements to the SEC and information obtained based on those statements just in case the dismissal was reversed on appeal, based on findings of improper collusion between the SEC and the USAO. For example, as in Scrushy, the SEC's Los Angeles office agreed to conduct witness testimony in Oregon in order to provide potential jurisdiction to the local criminal prosecutors after being told by the USAO that it was "interested in false testimony cases." Further, the court found that, in response to direct questions posed by defendants' counsel, the SEC kept the defendants in the dark about the DOJ's active participation in the SEC's investigation. In fact, internal memoranda revealed that this was not a "parallel" investigation at all, but rather one that the SEC conducted for the USAO, which did not even convene a grand jury to gather evidence. As one internal email revealed, the USAO expected "to be spoon-fed" by the SEC. The court wrote, "[a] government agency may not develop a criminal investigation under the auspices of a civil investigation," and doing so compromises due process rights. The defendants argued that had they known of the criminal inquiry, they would have invoked their constitutional rights against self-incrimination and would not have produced information to the SEC. After a lengthy hearing, the judge found it to be an abuse of the investigative process to conceal the criminal investigation from the defendants whom the SEC was deposing.
There is nothing inherently wrong with true "parallel" DOJ/SEC investigations or perhaps even "joint" investigations so long as the potential defendants are properly advised of the collaborators' true identities and roles. Now that courts have begun to recognize that regulators' covert tandem investigations may compromise important constitutional rights, defense lawyers certainly will be pressing regulators early to disclose all of the teams on the playing field. A failure to truthfully and explicitly respond may result in the regulators forfeiting a few more games. Ultimately, if courts continue to follow Scrushy and Stringer, there may be a significant decline in the number of criminal prosecutions arising from federal securities law violations.
Prosser, a former SEC enforcement attorney, is a partner in Morrison & Foerster LLP's San Diego office, and is a member of the firm's securities litigation, enforcement and white-collar practice group. His e-mail address is email@example.com, and his phone number is (858) 720-5100.