135rd Year no.
3
RECORDER
SEC willing to strike a deal
Complying with investigations and other requirements
may result in non-prosecution letters from the commission
Jared Kopel
Corporate Governance and
Compliance
O
n Dec. 20, 2010, the Securities
and Exchange Commission
announced that it had en-
tered into its first non-prose-
cution agreement. The SEC entered into
the non-prosecution agreement with
Carter’s Inc., an Atlanta-based clothing
marketer, in connection with the SEC’s
enforcement action against a former ex-
ecutive of Carter’s based on allegations
of financial fraud and insider trading.
Non-prosecution agreements are
an element of the SEC’s initiative an-
nounced in January 2010 to encourage
individuals and companies to cooper-
ate with SEC investigations as part of a
broader effort to strengthen the SEC’s
enforcement program. In announcing
the initiative, the SEC stated that it had
authorized the SEC staff to enter into
deferred prosecution and non-prosecu-
tion agreements, which are formal writ-
ten agreements in which the SEC would
agree to forgo or not to pursue an en-
forcement action, respectively, against
an individual or company who agreed
to cooperate fully and truthfully in a SEC
investigation and comply with express
undertakings. Such deferred prosecu-
Jared Kopel is an attorney with Wilson
Sonsini Goodrich & Rosati in Palo Alto. He
specializes in representing companies and in-
dividuals in shareholder litigation and SEC
investigations.
www.therecorder.com
tion and non-prosecution agreements
long have been a staple of criminal
prosecutions by the Department of Jus-
tice, but had not been used in the SEC’s
civil enforcement program.
The initial non-prosecution agree-
ment arose from the SEC’s investiga-
tion and eventual enforcement action
against Joseph M. Elles, a former Cart-
er’s executive vice president. The SEC’s
complaint, filed on Dec. 20 in the U.S.
District Court for the Northern District of
Georgia, alleged that from at least 2004
through March 2009, Elles fraudulently
granted the company’s largest customer
greater rebates than had been budgeted
in order to induce the customer to pur-
chase additional product, and obtained
the customer’s agreement to defer tak-
ing the rebates until after the quarter in
which they were granted.
To conceal his actions, Elles allegedly
directed his assistant to create false re-
cords misrepresenting the timing of the
rebates that were submitted to Carter’s
accounting department. Elles’ actions
allegedly resulted in a material over-
statement of the company’s revenues
and earnings, and Carter’s restated its
financial statements covering the pe-
riod from 2005 through mid-2009. The
SEC also charged Elles with realizing a
pre-tax profit of approximately $4.7 mil-
lion by the exercise of stock options and
the sale of the resulting shares when he
purportedly knew that the company’s
financial results and stock price were
artificially inflated by his actions. The
SEC seeks permanent injunctive relief,
disgorgement of illicit gains, financial
penalties and a director and officer bar.
Because the Carter’s non-prosecution
agreement likely will be the model for
future agreements, it is useful to exam-
JANUARY 24, 2011
ine its significant features:
• Carter’s agreed to cooperate fully
and truthfully in the SEC’s investiga-
tion and any related enforcement liti-
gation or proceeding to which the SEC
is a party, regardless of the time period
in which cooperation is required. Thus,
the non-prosecution agreement is not
time-limited and applies to any other
SEC actions arising from the investiga-
tion.
• Carter’s agreed to cooperate fully
and truthfully in any official investiga-
tion or proceeding by any other federal,
state or self-regulatory organization as
may be directed by the SEC staff.
• Carter’s will produce all non-priv-
ileged documents, information and
other materials to the SEC as requested
by the SEC staff, “wherever located, in
the possession, custody, or control” of
the company. Carter’s appears there-
fore to have waived any objections to
the scope of all SEC document requests,
regardless of the burden or expense, or
whether the requested documents are
relevant to the investigation.
• Carter’s will use its best efforts to se-
cure the “full, truthful and continuing
cooperation” of current and former di-
rectors, officers, employees and agents,
including making these persons avail-
able as requested by the SEC staff, at
the company’s expense, for interviews
and testimony in any trial or other judi-
cial proceedings. These individuals also
would be required to produce all non-
privileged documents to the SEC.
Thus, the company has accepted an
open-ended obligation to locate and
persuade former employees to appear
before the SEC. In addition, because at-
torneys are considered “agents” of the
company, the agreement also may be
construed as requiring the company to
make outside counsel available at the
SEC’s request. There is no express re-
quirement for Carter’s to waive the at-
torney-client privilege and such waivers
are no longer required by the SEC or the
Department of Justice as evidence of a
company’s cooperation in a governmen-
tal investigation. But the SEC might as-
sert that by requiring Carter’s to secure
the cooperation of its agents, including
attorneys, the non-prosecution agree-
ment implicitly requires the company
to waive the attorney-client privilege if
the SEC concludes that is necessary to
further its investigation or for litigation
purposes.
• Carter’s may not take any action or
make or permit any public statement
through present or future attorneys,
employees, agents or other persons au-
thorized to speak for the company that
deny, directly or indirectly, the factual
basis of any aspect of the non-prosecu-
tion agreement. This prohibition does
not apply to legal proceedings in which
the SEC is not a party, including pre-
sumably private shareholder litigation,
or any statement made by an individual
in any civil, criminal or regulatory pro-
ceeding so long as the individual is not
speaking for the company. It remains to
be seen, however, whether a non-prose-
cution agreement would be deemed ad-
missible or otherwise used adversely to
defendants in shareholder lawsuits.
In exchange for these undertakings,
the SEC agreed not to bring any enforce-
ment action against Carter’s arising from
the current investigation. The non-pros-
ecution agreement does not bind other
federal, state or regulatory organiza-
tions but the SEC may, at its discretion,
advise these other organizations in writ-
ing of the company’s cooperation. One
assumes that the SEC would provide
such a letter and that other governmen-
tal or regulatory agencies would refrain
Reprinted with permission from the July 19, 2010 edition of The Recorder. © Copyright 2010. ALM Media Properties, LLC. All rights reserved. Further duplication without
permission is prohibited. For information, call 415.490.1054 or pryplewski@alm.com.
from bringing any enforcement actions,
because otherwise the incentive to co-
operate with the SEC would be severely
diminished.
Further, the SEC’s Division of En-
forcement is entrusted with the sole
discretion to determine whether the
company has failed to comply with its
obligations under the non-prosecution
agreement and if so, recommend that
the SEC commissioners authorize an
enforcement action against Carter’s
based on securities law violations aris-
ing from the investigation. (Carter’s
would be able to make a so-called
Wells submission that would argue
why no enforcement action should be
authorized). The company essentially
is compelled to comply with any SEC
request for documents and informa-
tion, either from Carter’s or current or
former employees and agents, given
the enduring threat that the Division of
Enforcement will deem the company to
be non-compliant and recommend an
enforcement proceeding. That threat
is magnified by the SEC’s ability to use
any documents, testimony or other in-
formation that Carter’s provided pur-
suant to the non-prosecution agree-
ment. The non-prosecution agreement,
which would remain effective after an
acquisition or merger, also tolls the
statute of limitations in any SEC action
against the company.
The SEC’s release announcing the
non-prosecution agreement stated that
it reflected “the relatively isolated na-
ture of the unlawful conduct, Carter’s
prompt and complete self-reporting of
the misconduct to the SEC, its exemplary
and extensive cooperation in the inves-
tigation, and Carter’s extensive and sub-
stantial remedial actions.” These factors
hearken back to so-called “Seaboard”
factors announced by the SEC in 2001,
in connection with the SEC’s publicly
announced decision not to bring an en-
forcement proceeding against the Sea-
board Corp. when its financial results
had been misstated due to misconduct
by the controller of a Seaboard subsid-
iary. The SEC then stated that a determi-
nation not to bring an enforcement ac-
tion against a corporation based on the
misconduct of its employees depended
on the nature of the misconduct and the
corporation’s self-policing, self-report-
ing, remediation and cooperation.
But there is a more fundamental is-
sue: Why should the SEC ever punish
a company and its stockholders with
an enforcement proceeding caused
by the actions of a rogue employee,
particularly when the employee in-
tentionally subverted the company’s
internal accounting system? The SEC
acknowledged that the company’s ac-
tions were “exemplary”: Carter’s self-
policed, self-reported and took appro-
priate remedial measures. Such factors
under the Seaboard standard should
have been sufficient to avoid any SEC
action against the company. Yet the
SEC apparently insisted on the non-
prosecution agreement as an essential
requirement to preclude an enforce-
ment proceeding, and one assumes
that will be SEC’s position henceforth.
A company of course should take swift
remedial action whenever employee
misconduct surfaces and coopera-
tion with the SEC always is preferable.
However, Carter’s’ non-prosecution
agreement imposes significant, con-
tinuing burdens on the company and
its management.
Most companies likely will enter into a
non-prosecution agreement if that is the
price of averting an SEC action. But at
some point, a company and its counsel
may be forced to decide whether the bur-
dens from such an agreement outweigh
the benefits where an SEC enforcement
proceeding against the company is not
warranted by the underlying facts.