SEC's First Non-Prosecution Agreement Exemplifies Government Trend Toward Soliciting Cooperation, Raises New Questions

SEC's First Non-Prosecution Agreement Exemplifies Government Trend Toward Soliciting Cooperation, Raises New Questions



Almost a year after the U.S. Securities and Exchange Commission's ("SEC") Division of Enforcement said that it would consider entering into non-prosecution agreements ("NPA"), the SEC announced its first one on December 20, 2010.1

While the NPA between the SEC and children's clothing company Carter's Inc. is an important first for the agency, it should be understood in the broader contexts of both a general government trend over recent years toward soliciting cooperation and the SEC's endorsement of prosecutorial tools used by the U.S. Department of Justice ("DOJ"). In that light, the Carter's NPA represents an example of another way that corporate defendants may obtain leniency by investigating themselves and providing the results of their work to government enforcement agencies. By publicly announcing the Carter's NPA, the SEC has sent a clear message that it is committed to encouraging cooperation and that rewarding a cooperating company is an important component of its Enforcement program.

I. SEC's "Cooperation Initiative"

In January 2010, Director of the SEC Division of Enforcement Robert S. Khuzami – who had previously been an Assistant U.S. Attorney for the Southern District of New York (and the head of its Securities and Commodities Fraud unit) – announced a trio of cooperation tools that would be used by the SEC as part of a "Cooperation Initiative": NPAs, deferred prosecution agreements ("DPA"), and individual cooperation agreements.2 The DOJ had long used such agreements to solicit and reward cooperation.3 Indeed, NPAs and DPAs have a long history in criminal enforcement of the Foreign Corrupt Practices Act ("FCPA"), which often spills over into SEC inquiries.4 It is, nevertheless, a significant policy change for these tools to be applied to civil and administrative procedures.

According to the January 2010 revisions to its Enforcement Manual, the Commission itself must approve NPAs and DPAs,5 which are defined as written agreements that the SEC will not pursue enforcement actions provided that the individual or corporation agrees to "cooperate truthfully and fully" in the SEC's investigation and in "related" enforcement actions.6 "Cooperation" includes, but is not limited to: (1) producing all potentially relevant non-privileged documents and materials to the SEC; (2) responding to all inquiries; (3) appearing for interviews; (4) testifying at trials and other judicial proceedings as requested by the staff; and (5) waiving the territorial limits on service contained in Rule 45 of the Federal Rules of Civil Procedure.7 The Enforcement Manual also describes the framework for evaluating cooperation by companies, citing the SEC's 2001 Seaboard Report, which first established such cooperation standards.8 The Enforcement Manual expressly states that Enforcement "staff should not ask a party to waive the attorney-client privilege or work product protection without prior approval of the Director or Deputy Director."9 This obviously leaves open the possibility that a request will be made for a waiver – nevertheless, in the context of assessing cooperation, the Enforcement Manual also provides that a "party's decision to assert a legitimate claim of attorney-client privilege or work product protection will not negatively affect their claim to credit for cooperation."10 The Enforcement Manual is silent on whether an evaluation of cooperation includes a corporation's advancement of attorneys' fees on behalf of employees called as witnesses or whether the corporation has entered into joint defense agreements with employees or other parties.11

II. Carter's: The First SEC NPA

a. Background

On December 20, 2010, the SEC released a four-page NPA with Atlanta-based children's clothing company Carter's Inc.

According to the SEC's complaint, Carter's former Executive Vice President Joseph Elles, who is contesting SEC civil charges,12 manipulated and concealed discounts on the sale of Carter's products to its largest wholesale customer.13 As a consequence of Elles's alleged conduct, Carter's misstated its financial results over five years.14 The SEC also alleges that Elles realized nearly $5 million in profits through trading of Carter's common stock during the five-year period.15

When Carter's discovered the problems, it moved quickly to make things right. Soon after it found out about the misconduct in or around October 2009, Carter's said that it would delay the release of its third-quarter financial results pending a review of accounting for margin support to wholesale customers.16 In a Form 8-K issued on November 10, 2009, Carter's announced that: (1) a management review had uncovered issues related to accounting for margin support payments; (2) the Audit Committee of its Board of Directors had begun an internal investigation; and (3) Carter's would have to restate its financial results from its Forms 10-K for fiscal years 2004 through 2008 and from its Forms 10-Q for the fiscal quarters from September 29, 2007 through July 4, 2009.17 And on January 15, 2010, Carter's filed amended Forms 10-K and Forms 10-Q.

b. The NPA

Although the SEC charged Elles with committing securities fraud, falsifying books and records, and aiding and abetting the filing of false documents, Carter's avoided an enforcement action; moreover, unlike typical FCPA-related NPAs with the DOJ, Carter's paid no financial penalty.

Under its NPA, Carter's agreed to produce in a "responsive and prompt manner" all non-privileged documents requested by the Enforcement staff and to use its "best efforts" to secure the cooperation of individuals, including making them available at Carter's expense for interviews and/or testimony.18 These cooperation provisions are important to the SEC as it proceeds against Mr. Elles; however, the NPA requirement that Carter's "cooperate" is far reaching, extending well beyond just the case involving Mr. Elles. Carter's is required to cooperate "when directed by" Enforcement Division staff in "other proceedings" that are defined as any "official investigation or proceeding by any federal, state, or self-regulatory organization."19

Based on the SEC press release, Carter's qualified for the agreement because: (1) the misconduct was of a "relatively isolated nature"; (2) Carter's "prompt[ly] and complete[ly] self-report[ed] ... the misconduct to the SEC"; (3) the company showed "exemplary and extensive cooperation[,]... including undertaking a thorough and comprehensive internal investigation"; and (4) it took "extensive and substantial remedial actions."20

What is perhaps most notable about the NPA is what it leaves out. First, it does not define "exemplary and extensive cooperation" in a way that illuminates why the SEC determined that an NPA was the appropriate result for Carter's, as opposed to a DPA or other disposition. Because the NPA is short and lacks factual detail, it is difficult to discern from the document itself how Carter's behavior can be distinguished from other examples where a corporation has cooperated with an Enforcement investigation but has nevertheless been charged with misconduct. Based on public statements by the SEC and Carter's, it is not apparent that Carter's waived attorney-client privilege or work product protections. Carter's public disclosures, however, reveal that the company turned over to the SEC staff and to the U.S. Attorney's Office for the Northern District of Georgia the results of its internal investigation, which was conducted by outside counsel and forensic accountants engaged by counsel.21 It is also possible – particularly in view of the requirement that Carter's cooperate with other "federal, state, or self-regulatory" investigations – that Carter's has provided or will provide information about its competitors and business partners, to the extent it had any information of wrongdoing on their parts.22 In addition, we know that the SEC concluded that Carter's promptly and completely self-reported and took extensive and substantial remedial measures, including restating more than five years of financial statements. The bottom line, however, is that the NPA does not provide a clear roadmap that corporations may follow in future cases when seeking to engage in the type of "exemplary and extensive" cooperation that would warrant resolution through an NPA.

Perhaps the SEC was comfortable with this agreement because, in its view, Carter's had taken corrective action quickly and fully; indeed, due in large part to Carter's self-reporting and cooperation, the SEC brought its enforcement action just a little more than a year after Carter's announced that it had identified accounting issues. In other words, there was nothing left for Carter's to do, and any additional sanction would only have imposed a penalty on the shareholders, who were themselves victims of Mr. Elles' supposed malfeasance. This is not to suggest that the SEC is likely to completely eschew DPAs in favor of NPAs; rather, on a case-by-case basis, the SEC may well insist on the chance to reconsider an enforcement action if the agreeing company has not yet fulfilled its end of the deal – whether remedial action or the payment of a penalty.

III. What the Future Holds

Only time will tell how the Carter's agreement and other NPAs, DPAs, and individual cooperation agreements will affect the enforcement landscape.

a. Disproportionate Effect on Individual Targets. A major open question is the extent to which the SEC's adoption of NPAs and DPAs will encourage corporations to sacrifice individual actors for the sake of the corporation. This is not a new issue, but the prospect of securing an NPA in SEC enforcement actions is likely to bring a renewed focus to it. Indeed, a feature of the NPA that will be viewed favorably by companies dealing with parallel criminal investigations or civil litigation is that an NPA ensures that the respondent need not admit or agree not to contest the Commission's factual allegations.23

b. Potential Competition with Individual Bounty/Whistleblower Incentives. The SEC's willingness to use NPAs and DPAs underscores the potential interplay between corporate cooperation incentives, and the incentives to individuals either to make confidential complaints about potential misconduct to the SEC directly or to cooperate with SEC Enforcement inquiries for personal benefit but corporate detriment. The substantial bounties available to whistleblowers under Dodd-Frank may encourage individuals to go straight to the SEC with information about misconduct, such that corporations will have little or no opportunity to evaluate, disclose, and remediate misconduct before the commencement of an enforcement inquiry.24 Similarly, the SEC's cooperation toolbox includes incentives for individuals to cooperate with the Enforcement investigations in exchange for their own NPAs or DPAs, which may increase the potential competition between individuals and their employers to cooperate with SEC inquiries.25

c. Challenges of Multiple Representation. The availability and use of these cooperation incentives are additional reasons to be alert to potential ethical issues associated with multiple representation. Internal and external corporate counsel will have to continue to evaluate rigorously whether a corporation's and an individual's (or, in some cases, multiple individuals') respective interests in cooperation may lead to conflict of interest, or divergence of strategic interests, that compels separate representation. Counsel must remain vigilant in identifying potential conflicts, so that they and their clients may respond by seeking waivers (if appropriate) or by recommending the engagement of separate counsel.26

Plainly, the SEC is well aware of these representation issues. As Mr. Khuzami noted in advance of the launch of the Cooperation Initiative: "[T]he broader availability of cooperation credit will increase the risk of conflicts of interest in situations where counsel seeks to represent multiple clients. It may be in the interest of one client to be the first to report the misconduct to the Commission or offer his or her cooperation. But, obviously, only one client can be first. Similarly, it may be in the interest of one client to provide evidence that is not helpful to another client of the same counsel. Accordingly, this new program could pose heightened ethical concerns for counsel representing more than one person who could potentially benefit from cooperating in a Commission investigation. It is something that counsel and their clients should carefully consider."27

Additionally, SEC Deputy Director of Enforcement Lorin Reisner (who also had been an Assistant U.S. Attorney for the Southern District of New York) has signaled that the SEC will scrutinize multiple representations28 – certainly to guard against ethics problems, but just as likely to encourage cooperation, by pitting potential targets against one another and reducing their ability to protect their mutual interests through common interest or joint defense protections.

d. "Façade of Enforcement." The SEC's decision to post the Carter's NPA on a new, separate webpage for "Cooperation Program Agreements"29 suggests that the SEC believes it is important to publicize the fruits of its cooperation initiative, as distinct from its ordinary enforcement agenda. One academic commentator has criticized cooperation initiatives by enforcement agencies because they lead to privately-negotiated agreements30 which – unlike civil settlements – are not subject to oversight by the courts or any other third party. Under these circumstances, it may well be difficult to evaluate the fairness of how and when NPAs and DPAs are employed.31

* * *

The SEC's disposition of the Carter's matter has shown that it is prepared to reward what it views as model corporate citizenship. That initiative, however, accentuates a difficulty that has long existed for parties in SEC Enforcement inquiries, as well as their counsel – when it is best to cooperate with an enforcement inquiry to the detriment of an employee, employer, or counterparty. Given the novelty of DPAs and NPAs in SEC proceedings, corporations and individuals should remain cautious as they evaluate how to respond to the SEC's new enforcement toolbox.


1See U.S. Secs. & Exch. Comm'n, Release No. 2010-252, SEC v. Elles, Civ. Action No. 10-CV-4118 (N.D. Ga. Dec. 20, 2010) (the "Carter's Release"), available at

2See Robert S. Khuzami, "Speech by SEC Staff: Remarks at News Conference Announcing Enforcement Cooperation Initiative and New Senior Leaders" (Jan. 13, 2010), available at

3See, e.g., Eric Holder, Jr., DOJ, "Federal Prosecution of Corporations" (Jun. 16, 1999), at § VI.B ("In some circumstances, therefore, granting a corporation immunity or amnesty may be considered in the course of the government's investigation. In such circumstances, prosecutors should refer to the principles governing non-prosecution agreements generally. ... Specifically, these principles permit a non-prosecution agreement in exchange for cooperation when a corporation's timely cooperation appears to be necessary to the public interest and other means of obtaining the desired cooperation are unavailable or would not be effective.") (internal citations and quotations omitted); Larry D. Thompson, DOJ, "Principles of Federal Prosecution of Business Corporations" (Jan. 20, 2003), at § VI.B (adding that pretrial diversion may also be an appropriate method through which to solicit cooperation, and explicitly referencing how prosecutors may measure the extent and authenticity of a corporation's cooperation).

4See, e.g., Appx. A to Letter from DOJ to John L. Hardiman, Esq., "Re: Fiat S.p.A., et. al." (Dec. 22, 2008) (memorializing Fiat S.p.A.'s entry as part of the United Nations Oil-for-Food investigation into a DPA whereby it agreed to a $7 million criminal penalty for illegal bribes paid to former Iraqi government officials by three subsidiaries, and the payment of $3.6 million in civil penalties and disgorgement); Appx. A to Letter from Mark F. Mendelsohn, Esq. to Gregory S. Bruch, Esq., "Re: Faro Technologies, Inc." (Jun. 3, 2008) (memorializing two-year NPA whereby Faro agreed to pay a $1.1 million criminal penalty for making kickbacks to Chinese officials, as well as to the imposition of an independent corporate monitor).

5 See Enforcement Manual, U.S. Secs. & Exch. Comm'n Div. of Enforcement (Jan. 13, 2010), §§ 6.2.2.-6.2.4 at 131, 134, 136.

6See id., §§ 6.2.2-6.2.4, at 130, 133, 135.

7See id., §§ 6.2.2-6.2.4, at 131, 134, 136.

8See id., § 6.1.2, at 123-4.

9See id., § 4.3, at 95. (emphasis in original)

10See id., § 4.3, at 96.

11 In the criminal context, prosecutors' conditioning whether KPMG would receive cooperation credit on its refusing to advance attorneys' fees to individuals whom the prosecutors deemed non-cooperative led first to dismissal of indictments against a number of the individuals (see United States v. Stein, 495 F. Supp. 2d 390 (S.D.N.Y. 2007), aff'd 541 F.3d 130 (2d Cir. 2008)) and then to revisions to the DOJ guidance on permissible means to elicit cooperation from corporate defendants (see Principles of Federal Prosecution of Business Organizations (Aug. 28, 2008), §§ 9-28.710-20, available at

12 Elles' counsel issued a strongly worded release questioning the decision to charge Mr. Elles. (

13See Complaint for Injunctive Relief, SEC v. Elles, Civ. Action No. 10-CV-4118 (N.D. Ga. Dec. 20, 2010) [hereinafter, the "Elles Complaint"], at ¶¶ 34-53.

14See id. at ¶¶ 57-58.

15See id. at ¶¶ 60-62.

16See id. at ¶ 54.

17See id. at ¶¶ 55-57.

18See Non-Prosecution Agreement, SEC v. Elles, Civ. Action No. 10-CV-4118 (N.D. Ga. Dec. 20, 2010) [hereinafter, the "Carter's NPA"], ¶ 2, available at

19 Carter's NPA, ¶ 2.

20See Carter's Release.

21See "Carter's, Inc. Provides an Update on Customer Accommodations Review and Announces Management Changes," (Dec. 23, 2009), According to recent statements by Assistant Attorney General Lanny Breuer in the context of the FCPA, conducting a thorough internal investigation and providing the results to the DOJ are prerequisites to receiving cooperation credit from the Criminal Division. See Lanny A. Breuer, "Assistant Attorney General Lanny A. Breuer Speaks at the 24th Annual Conference on the Foreign Corrupt Practices Act" (Nov. 24, 2010), available at ("To give you a sense, Panalpina engaged counsel to lead investigations encompassing 46 jurisdictions, hired an outside audit firm to perform forensic analysis, and promptly reported the results of its internal investigation in over 60 meetings and calls with the Department and the SEC. In part because of its extensive cooperation, we entered into a deferred prosecution agreement with the Panalpina parent company.").

22See, e.g., id. ("That's because one way in which corporations obtain credit for their cooperation is by providing us with information about their competitors and their clients.").

23 Recent revisions to the Enforcement Manual have been understood by many commentators to imply that the SEC might begin requiring that respondents admit SEC allegations even in settlement, notwithstanding that historical practice has been that settlements of SEC matters have been made on the basis that the respondent will "neither admit nor deny" the SEC's allegations. See Enforcement Manual, U.S. Secs. & Exch. Comm'n Div. of Enforcement (Jan. 13, 2010), § 6.2.3 at 134. While hardly disposing of that concern, the Carter's NPA at least suggests that the SEC staff may bring a nuanced and tailored approach to resolution of the issue.

24 Pub. L. No. 111-203, § 922(a), 124 Stat 1841 (2010); see also WilmerHale, "SEC Proposes Whistleblower Protection Rules" (Nov. 17, 2010), available at

25 According to SEC Deputy Director of Enforcement Lorin Reisner, the SEC had entered into 14 cooperation agreements through November 18, 2010. "SEC Signed 14 Cooperation Agreements This Year," Just Anti-Corruption (Nov. 18, 2010), available at

26 To that end, this is yet another reason corporate counsel should be alert to the need to provide Upjohn warnings in appropriate circumstances. See, e.g., United States v. Nicholas, 606 F. Supp. 2d 1109, 1116-17 (C.D. Cal. 2009) (criticizing outside counsel for giving – and failing to memorialize – Upjohn warning to the CEO).

27 Robert S. Khuzami, "Speech by SEC Staff: Remarks at AICPA National Conference on Current SEC and PCAOB Developments" (Dec. 8, 2009), available at

28 "Beware Cooperation Conflicts, Attorneys Warned," Compliance Reporter (Feb. 12, 2010).


30 Joe Palazzolo, "Professor Says FCPA Enforcement Is a 'Façade,'" Wall Street Journal Law Blog (Nov. 10, 2010), available at

31See, e.g., SEC v. Citigroup Inc., No. 10-cv-1277 (ESH), Transcript of Status Hearing, Dkt. No. 13 (Aug. 16, 2010) (refusing to approve a $75 million settlement where there was no "guidepost" to gauge whether $75 million was fair and where it was unclear why the SEC charged two individuals and not others); SEC v. Bank of America Corp., 653 F. Supp. 2d 507 (S.D.N.Y. 2009) (declining to approve a $33 million settlement where the "proposed consent judgment would leave uncertain the truth of the very serious allegations made in the complaint" and the proposed settlement "in no way specifie[d] the basis for the $33 million figure or whether any of this money is derived directly or indirectly from the $20 billion in public funds previously advanced to Bank of America as part of its 'bailout[]'").