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SEC Enters First Ever Non-Prosecution Agreement With a Cooperating Company
Kit Addleman, Ronald W. Breaux
The U.S. Securities and Exchange Commission announced on December 20, 2010, that it entered into a non-prosecution agreement with Carter’s, Inc., an Atlanta-based provider of children’s clothing. This is the first non-prosecution agreement entered since the SEC announced its new cooperation initiative in January 2010 to encourage cooperation from corporations and individuals. These agreements, which protect cooperating entities from enforcement actions, previously had not been a tool used by the SEC and the Carter’s agreement is the first of its kind. The release of the agreement, and explanation of the concerns surrounding its use in this case, offer a new hope for entities facing corporate difficulties.
Non-Prosecution Agreements: A Cooperation Initiative
In January 2010, the SEC introduced an initiative designed to encourage greater cooperation in the agency’s investigations and enforcement actions. Through the initiative, the SEC’s Division of Enforcement was authorized to offer non-prosecution agreements to corporations or individuals who reported securities violations and provided substantial assistance in the Commission’s investigations and enforcement actions. A non-prosecution agreement is a written agreement between the SEC and a cooperating entity that provides that the Commission will not pursue an enforcement action against the entity if the entity agrees to “cooperate truthfully and fully” with the Commission.
The SEC analytical framework used to determine whether a corporation qualifies for a non-prosecution agreement includes four key measures of cooperation: self-policing and compliance efforts prior to the discovery of the misconduct, prompt self-reporting of the misconduct, appropriate remediation, and cooperation with enforcement authorities. Additionally, the SEC must consider whether there are alternative means of obtaining the desired cooperation. If the SEC determines that a non-prosecution agreement is warranted, then it will require continued cooperation. “Cooperation” is not defined, and the SEC has discretion in fashioning its demands.
The Carter’s Agreement
In 2009, Carter’s discovered that its Executive Vice President of Sales had been cooking the books for at least five years by granting undisclosed discounts to one of Carter’s largest customers. The executive hid his conduct by submitting false authorizations to the accounting group. Because of the undisclosed discounts—which totaled more than $18 million—Carter’s was required to issue restated financials.
According to the SEC’s press release, Carter’s promptly reported the issue to the SEC, undertook extensive remedial measures, conducted a thorough internal investigation, and provided the SEC with “exemplary and extensive cooperation.” Although the press release does not specifically describe the extent of Carter’s cooperation, it presumably shared the results of the internal investigation with the SEC staff. In light of Carter’s efforts, the SEC determined that a non-prosecution agreement was warranted. Pursuant to the agreement, Carter’s agreed to provide continuing cooperation, including the prompt production of all non-privileged documents requested by the Commission and the use of best efforts to ensure the cooperation of its officers, directors, employees, and agents. With regard to the second requirement, Carter’s must agree to produce the individuals, at its expense, for interviews and testimony, as requested by the staff.
The Consequences of Violating a Non-Prosecution Agreement
Companies can expect tailored non-prosecution agreements, and may face “cooperation” requirements above and beyond those in the Carter’s agreement. Companies should carefully review any agreements the SEC offers, because the consequences of non-compliance are severe. If a cooperating entity violates a non-prosecution agreement, the SEC may pursue an enforcement action against it. The statute of limitations is no bar: Each non-prosecution agreement provides that the SEC may pursue any claims that would have been timely on the date the agreement was signed. Moreover, in the enforcement action the Commission may use any documents or materials that it obtained pursuant to the terms of the agreement.
Implications of Non-Prosecution Agreements
Although this is the first time the SEC has used a non-prosecution agreement, it will not be the last. The SEC has a strong motivation to encourage cooperation. The Director of Enforcement, Robert Khuzami, noted in January that “there is no substitute for the insiders’ view into fraud and misconduct that only cooperating witnesses can provide.” And now that the possibility of avoiding costly, lengthy enforcement actions is on the table, companies and individuals have an equally strong motivation to assist the SEC. With this in mind, and with an eye toward the cooperation and remediation undertaken by Carter’s, companies should revisit their internal controls to ensure that they are adequately policing for misconduct and responding to instances of employee violations. Upon discovering issues that could lead to SEC Enforcement action, companies should investigate promptly the availability of a non-prosecution agreement in exchange for cooperation.
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