For more than a decade, the U.S. Department of Justice (the DOJ) has used Deferred Prosecution Agreements (DPAs) and Non-Prosecution Agreements (NPAs) as a leading instrument to resolve allegations of corporate criminal misconduct.1 The DOJ's DPAs and NPAs (collectively "settlement agreements" or "agreements") occupy a middle ground between a guilty plea that results in a company's criminal conviction and a declination to prosecute.
The U.S. Securities and Exchange Commission (SEC) recently entered the DPA and NPA arena, expanding its toolset to remedy violations of federal securities laws. On January 13, 2010, the SEC announced its new Cooperation Initiative: "a series of measures to further strengthen its enforcement program by encouraging greater cooperation from individuals and companies in the agency's investigations and enforcement actions," including cooperation agreements, DPAs, and NPAs.2 In announcing the Initiative, Robert Khuzami, Director of the SEC's Division of Enforcement, called the use of these tools "a potential game-changer for the Division of Enforcement."
This article summarizes the SEC's recent use of DPAs and NPAs against the backdrop of the DOJ's more established practice.
History of DPAs/NPAs
The need for DPAs and NPAs in the criminal context crystalized after the disintegration of Arthur Andersen LLP--one of the then "Big Five" accounting firms--following its criminal indictment in 2001 and subsequent conviction in 2002 related to its alleged role in shredding documents related to its auditing of Enron Corp. Within months of its indictment, Andersen had reportedly lost about 170 clients and had announced layoffs of nearly one-third of its domestic workforce.3 And even before the jury reached a verdict, The Wall Street Journal was reporting that the company was doomed regardless of the outcome of the trial.4 While Arthur Anderson was initially found guilty at trial, by the time the U.S. Supreme Court unanimously reversed the company's conviction in 2005, the damage had been done: the company had effectively dissolved, its more than 85,000 innocent employees, including approximately 28,000 in the U.S. alone, were out of work, and thousands of companies lost their auditor.5 Andersen's precipitous collapse illustrates how a mere indictment can result in massive collateral consequences to a corporation, and the need for alternative methods to resolve alleged corporate wrongdoing.
The SEC's Settlement Practice and the Use of NPAs and DPAs
Historically, the SEC resolved enforcement actions by filing consent judgments based on civil complaints in a U.S. District Court or an administrative order instituting proceedings and imposing sanctions to which the respondent consented. In both types of actions, the defendants (or respondents) neither admitted nor denied the Commission's allegations or findings. In recent months, the SEC's traditional practice has been under review. In November, U.S. District Judge Jed Rakoff rejected an SEC settlement with Citigroup Global Markets Inc., challenging the SEC's long-standing practice of seeking injunctive relief without the company admitting or denying the allegations.6 Both Citigroup and the SEC have appealed Judge Rakoff's decision, which is pending before the U.S. Court of Appeals for the Second Circuit. Additionally, on January 6, the SEC announced it would modify its "neither admit nor deny" policy for settlements in which a company has already admitted to, or been found guilty, of criminal conduct. This change will apply to defendants who enter DPAs or NPAs with the DOJ, although the DOJ typically prohibits defendants from denying that it accepted responsibility for the criminal conduct alleged in a DOJ settlement agreement.
In addition to the those developments in the SEC settlement practices, in January 2010, the SEC implemented a formal Cooperation Initiative, enabling individuals and companies to avoid a civil enforcement action or receive a lesser sanction. Building on the principles first articulated in its 2001 Seaboard Report,7 the SEC's Enforcement Manual identifies four measures of a company's cooperation: (1) self-policing prior to the company's discovery of the misconduct; (2) self-reporting after discovering the misconduct; (3) remediation of the misconduct; and (4) cooperation with law enforcement.8 The Manual identifies a continuum of tools designed to reward cooperation from proffer and cooperation agreements, to DPAs and NPAs, to criminal immunity requests.
Despite a record number of enforcement actions in 2011, the SEC has only used these agreements sparingly to date, publicly announcing three NPAs and one DPA in the two years since the initiative was announced. Although this small data set permits only preliminary conclusions on the SEC's use of these agreements, there appear to be some important differences in how the SEC is using these agreements in contrast to the DOJ. First, the NPAs entered by the SEC have not imposed any financial penalties on the corporate defendants. Second, the SEC's NPAs read more like formal declinations with cooperation provisions than vehicles used to reform corporate behavior with ongoing compliance obligations, which is how they are used at the DOJ. This is consistent with the SEC's public comments on NPAs indicating that they will only be used in "very limited and appropriate circumstances," and the Commission's Enforcement Manual, which explains that an NPA with the SEC imposes one overarching requirement in every case: "to cooperate truthfully and fully" with the SEC's enforcement efforts.9 By contrast, the SEC's one DPA closely resembles an injunction or cease and desist order in its substantive remedies and financial penalties, albeit for a much shorter duration.
Overall, the SEC's NPAs appear to be animated by a different policy goal than the DOJ's agreements by the same name. An enforcement action by the SEC, while serious and potentially damaging to a defendant corporation's business and public image, does not usually create the type of existential threat posed by an indictment or criminal plea, particularly in the case of established public companies. Whereas the DOJ's DPAs and NPAs represent a true middle ground between the potentially disastrous consequences of criminal charges and a pass from prosecution, the SEC's three NPAs appear to represent efforts by the Commission to secure continuing cooperation from a corporation while the SEC pursues enforcement actions against the allegedly culpable individual employees.
While the SEC's use of NPAs appears to fill a void, the Commission's rationale for DPAs is less obvious. Given the similarity of the penalties and remedial actions, it is unclear whether, why, and under what circumstances the SEC will turn to a DPA in lieu of a traditional enforcement action. Nor is it apparent, on balance, whether a company is better off entering into an untested DPA instead of a traditional settlement. Insights into these questions are likely to arise as the SEC continues to use these new cooperative initiatives.
Carter's, Inc.'s NPA
On December 17, 2010--almost a year since the SEC authorized its Division of Enforcement to use these tools--the SEC entered its first settlement agreement, an NPA, with children's clothing-maker Carter's, Inc., resolving allegations of accounting manipulation at the company. The NPA appears to set the stage for the SEC's enforcement action (and subsequent DOJ prosecution) against the individual allegedly responsible for the wrongdoing by guaranteeing the company's continued cooperation with the SEC in the Commissions' efforts to prosecute the individuals allegedly involved in the wrongdoing.
Emphasizing the use of an NPA as a cooperation tool--and not necessarily as an alternative method of resolving corporate wrongdoing--the central provisions of the SEC's NPA with Carter's contain far-reaching terms securing the company's indefinite cooperation with the investigation and resulting litigation against that executive. In fact, the SEC's press release places the culpability squarely on a senior executive allegedly responsible for the claimed wrongdoing and was announced in conjunction with an unsettled civil complaint against the former Carter's executive accused of committing the violations. Unlike NPAs entered by the DOJ, which typically require companies to accept responsibility for the criminal acts, the SEC's first NPA expressly does not allege that Carter's was responsible for any wrongdoing and does not include any statement of facts, recitations that are routinely included in DOJ's NPAs that establish the factual basis for the alleged violations.10 In a press release accompanying the Carter's NPA, the SEC identified "relatively isolated nature of the unlawful conduct, Carter's prompt and complete self-reporting of the misconduct to the SEC, its exemplary and extensive cooperation in the investigation, including undertaking a thorough and comprehensive internal investigation, and Carter's extensive and substantial remedial actions" as the factors that supported the SEC's decision not to prosecute the company. Also unlike typical NPAs entered by the DOJ, the Carter's NPA did not include any fines or penalties or ongoing compliance obligations.
Fannie Mae and Freddie Mac's NPA
On December 16, 2011, more than a year after its first NPA, the SEC announced two additional NPAs with the government-sponsored home mortgage entities Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) for alleged wrongdoing in the period from 2006 to 2008 related to the subprime loan collapse.11 Both companies have been under government conservatorship since September 6, 2008 and owe more than $140 billion to the government.12 Like the Carter's NPA, the NPAs with the housing entities involved no financial penalties and were announced in conjunction with unsettled civil charges against three top former executives of each company for securities fraud. The Fannie Mae and Freddie Mac NPAs contain detailed cooperation provisions running nearly two pages and appear to represent the heart of each agreement. To the point, each agreement states, "[I]ts ongoing cooperation with the Commission is an important and material factor underlying the Commission's decision to enter into this Agreement."
It is difficult, and possibly misleading, to infer too much into these NPAs with the government-created, government-owned, and government-controlled entities. The SEC recognized as much in its announcement of the agreements, explaining that it "considered the unique circumstances [and the public interest] presented by the companies' current status, including the financial support provided to the companies by the U.S. Treasury [representing an ownership stake by the federal government of up to 79.9%], the role of the Federal Housing Finance Agency as conservator of each company, and the costs that may be imposed on U.S. taxpayers" had the entities been required to pay a fine.13
Nonetheless, some differences between the Carter's and housing entities' NPAs bear mention. First, in contrast to the Carter's NPA, which contained no statement of facts or allegations of corporate wrongdoing, the housing entities both agreed, "without admitting or denying liability, to accept responsibility for [their] conduct and to not dispute, contest, or contradict" the statement of facts tailored to each company's alleged misconduct appended to each agreement. Should one of the housing entities breach its agreement, by materially failing to cooperate with federal authorities or providing false or misleading information, the NPAs provide that the housing entities cannot dispute, contest, or contradict the admissibility or accuracy of the statement of facts in any future Commission enforcement action against it. This provision is also entirely absent in the Carter's NPA. Relatedly, the housing entities' NPAs toll the statute of limitations for the duration of any related SEC enforcement litigation against the individual defendants. By contrast, the Carter's NPA appears to toll the statute of limitations indefinitely, a risk that is mitigated by the fact that the Carter's NPA does not contain any allegations of misconduct or a statement of facts that could result in the company being prosecuted for any past misconduct.
Tenaris S.A.'s DPA
On May 17, 2011, the SEC announced its first and only DPA to date with Luxembourg-based Tenaris S.A., a global steel pipe manufacturer and supplier for the energy industry, to resolve alleged violations of the Foreign Corrupt Practices Act (FCPA).14 In contrast to the Commissions' NPAs, the Tenaris DPA contained a financial component--Tenaris agreed to pay disgorgement and prejudgment interest of $5.4 million--but did not charge any individuals. The DPA, which had a two-year term, also required Tenaris to adopt and maintain certain fundamental anti-corruption compliance measures.
Separately, Tenaris resolved a parallel investigation by the DOJ, entering into a separate NPA and agreeing to pay $3.5 million in fines. It is interesting that the DOJ and SEC entered into different types of agreements on the same facts, demonstrating that the prosecutors have different approaches and criteria for deciding whether a company merits a DPA or an NPA. Moreover, DOJ's NPA with Tenaris requires the company to adopt more robust, farther-reaching anti-corruption compliance measures than the SEC's DPA, consistent with the DOJ's now-standard Corporate Compliance Program appendix to its FCPA settlement agreements.
Analysis of the SEC's Agreements
In announcing the DPA with Tenaris, the SEC went to great lengths to explain why a DPA was appropriate, but an NPA was not--because although "Tenaris's conduct was clearly in violation of the FCPA," which appeared to disqualify it from being an NPA candidate, the SEC explained that Tenaris exhibited "high levels of corporate accountability" in responding to internal red flags, self-reporting the violation, and demonstrated "extensive, thorough, real-time cooperation" throughout the process.15 By drawing (and adhering to) a principled line between conduct meriting a DPA in contrast to actions which an NPA is appropriate, the SEC will encourage predictable and consistent enforcement.
The value of an NPA over a DPA appears clear: NPAs do not carry any financial penalties. The value of a DPA over traditional enforcement action is less readily apparent, however. In the case of the SEC's DPA with Tenaris, SEC sought to "credit [companies that] fully and completely support our investigations and [that] display an exemplary commitment to compliance, cooperation, and remediation."16 Although the SEC described the DPA as a benefit to Tenaris, it is unclear how the DPA benefits Tenaris over a traditional SEC remedy. Between its DOJ and SEC settlements, Tenaris paid nearly $9 million in fines and penalties, nearly double the $4.79 million of profit that the company reportedly earned off the improperly obtained contracts. Beyond the substantial financial penalty, under the terms of its DPA Tenaris can be prosecuted by the SEC for the conduct underlying the agreement should it breach the agreement, which can happen in a number of ways, including if Tenaris were to violate any federal or state securities laws--not only the FCPA.
On the other hand, for a company that does not go on to violate the agreement, a DPA can be favorably described as the SEC's decision not to take an enforcement action against the defendant, a meaningful distinction for a company's public image and reputation. Additionally, the SEC's comments regarding the company's extensive cooperation and remediation can bolster a company's efforts to demonstrate to constituents, investors and other regulators that it is an earnest, law-abiding entity. A second potential advantage of a DPA is its avoidance of the collateral consequences, such as disclosure obligations or disqualifications from participation in the securities or other industries that arise from the entry of an injunction, which a DPA may avoid. Lastly, the SEC's DPA with Tenaris was term-limited to two years, unlike an SEC injunction which does not sunset.
Potential defendants need to consider the risks and benefits of a DPA carefully. In particular, the DPA model is untested and lacks a track record. One reason defendants settle SEC proceedings is to avoid the collateral estoppel effect of adverse findings of fact and conclusions of law in contested litigation which an adversary in related litigation may use against a defendant for damages or other relief. Generally, courts have concluded that they will not impose collateral estoppel based on factual recitations contained in settled SEC enforcement actions and that settled SEC complaints or administrative orders are not evidence.17 Because DPAs are new, there is less precedent on how courts will view similar factual recitations contained in them. Moreover, the SEC's new policy regarding settlement of SEC actions that are parallel to DOJ deferred prosecution agreements is wholly untested. Beyond their effect in courts, DPAs may carry other collateral effects, such as potential suspension or disbarment of companies that obtain government contracts in the U.S. or Europe, or companies that perform projects with funds from international development banks (e.g., the World Bank). Such decisions are discretionary and based on facts and circumstances, but the untested nature of the DPA creates unknown risks as to how contracting authorities may view them. For example, under the Federal Acquisition Regulation, a U.S. government agency may have the discretion to suspend a company "on the basis of adequate evidence" and disbar a company "based upon a preponderance of the evidence."18 Companies considering a DPA resolution should consider how, if at all, the agreement and its statement of facts could affect these relationships.
A Brief Comparison of Settlement Agreements by the DOJ and SEC
As described in the chart below, based on the four SEC agreements and the nearly 200 agreements by DOJ, certain comparisons can be made between the two agencies' settlement agreements. Differences in the agreements between the two agencies reflect their different legislative mandates and historical approaches to enforcement.
-- Not filed with court, but public upon request
-- No complaint
-- Includes statement of facts
-- Tolls statutes of limitation (SOLs)
-- Financial penalties
-- Deniable in collateral litigation
-- Filed with court as public record
-- Accompanies criminal information
-- Includes statement of facts
-- Tolls SOLs
-- Financial penalties
-- Rarely deniable in collateral litigation
-- Not filed with court, availability unspecified
-- No complaint
-- May include statement of facts
-- Indefinite term, until related litigation concludes
-- Tolls SOLs, at least until the related litigation concludes19
-- No financial penalties
-- Deniable in collateral litigation
Not filed with court, but often public
-- No charging documents
-- Includes statement of facts
-- Usually term-limited
-- Tolls SOLs
-- Financial penalties common
-- Rarely deniable in collateral litigation
Perhaps the most significant difference between the agencies' agreements relates to a defendant's ability to contest the allegations contained in the agreements in court, particularly for agreements that lack DOJ counterparts like the Fannie Mae and Freddie Mac NPAs. While the SEC's settlement agreements provide that companies are generally not able to make any public statements denying or undermining the factual basis of the agreement, they do provide an exception that permits the companies to do exactly that in legal proceedings in which the Commission is not a party. This exception stands in stark contrast to the majority of the DOJ's settlement agreements that, depending on the jurisdiction, prevent companies from disavowing the factual basis of a settlement agreement in any venue.
In the criminal context, the DOJ's DPAs and NPAs are essential tools that enable prosecutors to obtain meaningful enforcement results without unduly penalizing a company's many innocent stakeholders for conduct that is often attributable to a small number of individuals. Consistent with its recent Cooperation Initiative, the SEC appears to be judiciously using NPAs in limited circumstances where cooperation--not punishment--is the primary goal. It remains to be seen in what circumstances the SEC will rely on DPAs, and whether those agreements will be an equally effective tool in resolving allegations of corporate misconduct.
1. The DOJ's DPAs and NPAs are similar in form and substance in most respects except one. With DPAs, the DOJ typically files criminal charges in federal court, while with NPAs, nothing is filed with the court as long as the company complies with the terms of the settlement agreement. See Craig S. Morford, Memorandum for Heads of Department Components and United States Attorneys, n.2 (Mar. 7, 2008).
2. SEC Press Release, SEC Announces Initiative to Encourage Individuals and Companies to Cooperate and Assist in Investigations, available at http://www.sec.gov/news/press/2010/2010-6.htm.
3. Shawn Young, Quest Ends Some Andersen Jobs, Wall St. J., Apr. 11, 2002; Cassell Bryan-Low, Andersen to Cut 27% of U.S. Staff, Wall St. J., Apr. 9, 2002.
4. Ken Brown and Ianthe Jeanne Dugan, Andersen's Fall from Grace Is a Tale of Greed and Miscues, Wall St. J., June 7, 2002.
5. Arthur Andersen LLP v. United States, 544 U.S. 696 (2005) (reversing the conviction because the jury instructions failed to properly convey the elements of corrupt persuasion under the obstruction of justice statute); Elizabeth K. Ainslie, Indicting Corporations Revisited: Lessons of the Arthur Andersen Prosecution, 43 Am. Crim. L. Rev. 107 (2006).
6. See SEC v. Citigroup Global Markets Inc., 2011 WL 5903733 (S.D.N.Y. Nov. 28, 2011).
7. Seaboard Report (Oct. 23, 2001), http://www.sec.gov/litigation/investreport/34-44969.htm.
8. Enforcement Manual, section 6.1.2, http://www.sec.gov/divisions/enforce/enforcementmanual.pdf.
9. Speech by SEC Staff: Remarks at News Conference Announcing Enforcement Cooperation Initiative and New Senior Leaders (Jan. 13, 2010), http://www.sec.gov/news/speech/2010/spch011310rsk.htm; Enforcement Manual, section 6.2.4, http://www.sec.gov/divisions/enforce/enforcementmanual.pdf.
10. The NPA does contain language that explains that the NPA is not an "exoneration" of Carter's and should not be seen as a decision by the SEC that "no violations of the federal securities laws have occurred." Non-Prosecution Agreement between the SEC and Carter's, Inc., ¶ 11.
11. SEC Press Release, SEC Charges Former Fannie Mae and Freddie Mac Executives with Securities Fraud; Companies Agree to Cooperate in SEC Actions (Dec. 16, 2011), http://www.sec.gov/news/press/2011/2011-267.htm; Non-Prosecution Agreement between the SEC and Fannie Mae (Dec. 13, 2011); Non-Prosecution Agreement between the SEC and Freddie Mac (Dec. 13, 2011).
12. NPAs between the SEC and Fannie Mae and Freddie Mac (Dec. 13, 2011); Nick Timiraos, Fannie, Freddie Bailout Costs Revised Lower, Wall St. J., Oct. 28, 2011.
13. SEC Press Release No. 2011-267. NPAs between the SEC and Fannie Mae and Freddie Mac (Dec. 13, 2011).
14. SEC Press Release No. 2011-112, Tenaris to Pay $5.4 Million in SEC's First-Ever Deferred Prosecution Agreement (May 17, 2011), http://www.sec.gov/news/press/2011/2011-112.htm.
15. SEC Press Release No. 2011-112; SEC Deferred Prosecution Agreement with Tenaris S.A. (May 17, 2011).
16. SEC Press Release No. 2011-112.
17. See Lipsky v. Commonwealth United Corp., 551 F.2d 887, 893 (2d Cir. 1976); see also, e.g., Bernheim v. Elia, 05-cv-118A, 2010 WL 743887, at *8 (W.D.N.Y. Feb. 25, 2010) (statements made in settlement agreement inadmissible), aff'd, 410 F. App'x 407 (2d Cir. 2011); United States v. Gilbert, 668 F.2d 94, 97 (2d Cir. 1981) (consent decree may not be used to prove underlying facts of liability); Oei v. Citibank, N.A., 957 F. Supp. 492, 516 (S.D.N.Y. 1997) (statements in settlement agreement inadmissible).
18. Federal Acquisition Regulation (FAR), 9.406-2(b)(1) and 9.407-2(a). The FAR was established to codify uniform policies for acquisition of supplies and services by U.S. federal executive agencies.