8/7/2019 SEC_strike_deal

1/2

135rd Year no. 3 www.th c .c m JanUarY 24, 2011

RECORDER

On Dec. 20, 2010, the Securitiesand Exchange Commissionannounced that it had en-tered into its first non-prose-

cution agreement. The SEC entered intothe non-prosecution agreement withCarters Inc., an Atlanta-based clothingmarketer, in connection with the SECsenforcement action against a former ex-ecutive of Carters based on allegationsof financial fraud and insider trading.

Non-prosecution agreements arean element of the SECs initiative an-nounced in January 2010 to encourageindividuals and companies to cooper-ate with SEC investigations as part of abroader effort to strengthen the SECsenforcement program. In announcingthe initiative, the SEC stated that it hadauthorized the SEC staff to enter intodeferred prosecution and non-prosecu-tion agreements, which are formal writ-

ten agreements in which the SEC wouldagree to forgo or not to pursue an en-forcement action, respectively, againstan individual or company who agreedto cooperate fully and truthfully in a SECinvestigation and comply with expressundertakings. Such deferred prosecu-

tion and non-prosecution agreementslong have been a staple of criminalprosecutions by the Department of Jus-tice, but had not been used in the SECscivil enforcement program.

The initial non-prosecution agree-ment arose from the SECs investiga-tion and eventual enforcement actionagainst Joseph M. Elles, a former Cart-ers executive vice president. The SECscomplaint, filed on Dec. 20 in the U.S.District Court for the Northern District of Georgia, alleged that from at least 2004through March 2009, Elles fraudulently granted the companys largest customergreater rebates than had been budgetedin order to induce the customer to pur-chase additional product, and obtained

the customers 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 therebates that were submitted to Cartersaccounting department. Elles actionsallegedly resulted in a material over-statement of the companys revenuesand earnings, and Carters restated itsfinancial statements covering the pe-riod from 2005 through mid-2009. The

SEC also charged Elles with realizing apre-tax profit of approximately $4.7 mil-lion by the exercise of stock options andthe sale of the resulting shares when hepurportedly knew that the companysfinancial results and stock price wereartificially inflated by his actions. TheSEC seeks permanent injunctive relief,disgorgement of illicit gains, financialpenalties and a director and officer bar.

Because the Carters non-prosecutionagreement likely will be the model forfuture agreements, it is useful to exam-

ine its significant features: Carters agreed to cooperate fully

and truthfully in the SECs investiga-tion and any related enforcement liti-gation or proceeding to which the SECis a party, regardless of the time periodin which cooperation is required. Thus,the non-prosecution agreement is nottime-limited and applies to any otherSEC actions arising from the investiga-tion.

Carters agreed to cooperate fully and truthfully in any official investiga-tion or proceeding by any other federal,state or self-regulatory organization asmay be directed by the SEC staff.

Carters will produce all non-priv -ileged documents, information and

other materials to the SEC as requestedby the SEC staff, wherever located, inthe possession, custody, or control of the company. Carters appears there-fore to have waived any objections tothe scope of all SEC document requests,regardless of the burden or expense, or whether the requested documents arerelevant to the investigation.

Carters will use its best efforts to se -cure the full, truthful and continuingcooperation of current and former di-rectors, officers, employees and agents,

including making these persons avail-able as requested by the SEC staff, atthe companys expense, for interviewsand 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 anopen-ended obligation to locate andpersuade former employees to appearbefore the SEC. In addition, because at-torneys are considered agents of thecompany, the agreement also may be

Complying with investigations and other requirements may result in non-prosecution letters from the commission

SEC willing to strike a deal

Jared Kopel

Jared Kopel is an attorney with WilsonSonsini Goodrich & Rosati in Palo Alto. Hespecializes in representing companies and in-dividuals in shareholder litigation and SEC investigations.

Corporate Governance andCompliance

8/7/2019 SEC_strike_deal

2/2

construed as requiring the company tomake outside counsel available at theSECs request. There is no express re-quirement for Carters to waive the at-torney-client privilege and such waiversare no longer required by the SEC or theDepartment of Justice as evidence of acompanys cooperation in a governmen-tal investigation. But the SEC might as-

sert that by requiring Carters to securethe cooperation of its agents, includingattorneys, the non-prosecution agree-ment implicitly requires the company to waive the attorney-client privilege if the SEC concludes that is necessary tofurther its investigation or for litigationpurposes.

Carters may not take any action ormake or permit any public statementthrough present or future attorneys,employees, agents or other persons au-thorized to speak for the company thatdeny, directly or indirectly, the factualbasis of any aspect of the non-prosecu-tion agreement. This prohibition doesnot apply to legal proceedings in whichthe SEC is not a party, including pre-sumably private shareholder litigation,or any statement made by an individualin any civil, criminal or regulatory pro-ceeding so long as the individual is notspeaking for the company. It remains tobe seen, however, whether a non-prose-cution agreement would be deemed ad-missible or otherwise used adversely todefendants in shareholder lawsuits.

In exchange for these undertakings,the SEC agreed not to bring any enforce-ment action against Carters arising fromthe current investigation. The non-pros-ecution agreement does not bind otherfederal, state or regulatory organiza-tions but the SEC may, at its discretion,advise these other organizations in writ-ing of the companys cooperation. Oneassumes that the SEC would providesuch a letter and that other governmen-

tal or regulatory agencies would refrain

from bringing any enforcement actions,because otherwise the incentive to co-operate with the SEC would be severely diminished.

Further, the SECs Division of En-forcement is entrusted with the solediscretion to determine whether thecompany has failed to comply with itsobligations under the non-prosecution

agreement and if so, recommend thatthe SEC commissioners authorize anenforcement action against Cartersbased on securities law violations aris-ing from the investigation. (Carters would be able to make a so-called Wells submission that would argue why no enforcement action should beauthorized). The company essentially is compelled to comply with any SECrequest for documents and informa-tion, either from Carters or current orformer employees and agents, giventhe enduring threat that the Division of Enforcement will deem the company tobe non-compliant and recommend anenforcement proceeding. That threatis magnified by the SECs ability to useany documents, testimony or other in-formation that Carters provided pur-suant to the non-prosecution agree-ment. The non-prosecution agreement, which would remain effective after anacquisition or merger, also tolls thestatute of limitations in any SEC action

against the company.The SECs release announcing thenon-prosecution agreement stated thatit reflected the relatively isolated na-ture of the unlawful conduct, Cartersprompt and complete self-reporting of the misconduct to the SEC, its exemplary and extensive cooperation in the inves-tigation, and Carters extensive and sub-stantial remedial actions. These factorshearken back to so-called Seaboardfactors announced by the SEC in 2001,in connection with the SECs publicly

announced decision not to bring an en-

forcement proceeding against the Sea-board Corp. when its financial resultshad been misstated due to misconductby 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 themisconduct of its employees dependedon the nature of the misconduct and the

corporations self-policing, self-report-ing, remediation and cooperation.

But there is a more fundamental is-sue: Why should the SEC ever punisha company and its stockholders withan enforcement proceeding causedby the actions of a rogue employee,particularly when the employee in-tentionally subverted the companysinternal accounting system? The SECacknowledged that the companys ac-tions were exemplary: Carters self-policed, self-reported and took appro-priate remedial measures. Such factorsunder the Seaboard standard shouldhave been sufficient to avoid any SECaction against the company. Yet theSEC apparently insisted on the non-prosecution agreement as an essentialrequirement to preclude an enforce-ment proceeding, and one assumesthat will be SECs position henceforth. A company of course should take swiftremedial action whenever employeemisconduct surfaces and coopera-

tion with the SEC always is preferable.However, Carters non-prosecutionagreement imposes significant, con-tinuing burdens on the company andits management.

Most companies likely will enter into anon-prosecution agreement if that is theprice of averting an SEC action. But atsome point, a company and its counselmay be forced to decide whether the bur-dens from such an agreement outweighthe benefits where an SEC enforcementproceeding against the company is not

warranted by the underlying facts.

Reprinted with permission from the July 19, 2010 edition of The Recorder. Copyright 2010. ALM Media Properties, LLC. All rights reserved. Further duplication withoutpermission is prohibited. For information, call 415.490.1054 or pryplewski@alm.com.