Responding to SEC subpoenas: cooperation through credible assurances of complete production.

• Author: Gorman, Thomas O.

"[T]he Commission is bringing more cases for failures to preserve or produce required documents and records ... What such cases illustrate is that, no matter how bad the underlying conduct, you can always make things worse." (1)

RESPONDING to a subpoena from the Securities and Exchange Commission ("SEC") for documents can be a difficult, expensive, and time-consuming task. Locating and collecting all of the responsive paper documents from central files, offices at one or more sites, off-site storage facilities, individual desks, and personal briefcases can be a daunting task. Retrieving the responsive electronic material from central servers, individual computers, personal laptops, and handheld devices used by various executives can be even more difficult than compiling the responsive paper documents. (2)

Nevertheless, full and expeditious compliance with an SEC subpoena may be critical to successfully resolving the inquiry. At a minimum, certification by the company that it has produced all documents sought by a subpoena will be a condition of any settlement. (3)

Perhaps more important, however, is the question of cooperation. If the company can successfully claim that it has fully cooperated with the inquiry, (4) it may be able to obtain a closing letter (5) without receiving any sanction or at least minimum penalties. (6) In contrast, when a company fails to fully comply, it may face not only an enforcement action, but increased sanctions and penalties.

Cooperation and the beginning of a favorable resolution of an SEC inquiry usually starts with fully and expeditiously producing the documents typically sought at the beginning of any investigation. (7) If a company fails to produce all documents, or if, as often happens during investigations, responsive materials are "discovered" as the staff studies materials produced or takes testimony, a company's claim of cooperation may be undercut or destroyed regardless of the reasons for not initially producing the material. This failure can also result in increased penalties and fines as many companies have recently learned. (8)

In egregious situations, the SEC may refer the matter to the Department of Justice for criminal prosecution, as some companies have unfortunately learned. Perhaps the most well-known incident involved former accounting giant Arthur Andersen, which had a poorly administered document management program that was not comprehensive and not kept up to date. Although it should have halted the destruction of documents when the firm learned of various government inquiries, its continued document destruction eventually resulted in an indictment for obstruction of justice and the subsequent demise of the firm. (9)

Companies that want to be in a position to claim cooperation and opt for a more favorable resolution of an SEC inquiry or at least be in a position to complete a settlement by being able to execute a certification of full compliance as to the document subpoenas--may find that a standard business tool, a document management system, assists them. (10) A properly constructed and maintained system acts at once as a tool which can be used by to facilitate the use of its information and as an effective compliance mechanism for responding to an SEC subpoena or any other request for documents. A comprehensive system assists a company halt the destruction of materials once it receives notice of the materials which may be sought, quickly locate the responsive documents, and provide the SEC with credible assurances of full compliance. At the same time, in the event that materials are overlooked, the system should afford the company a ready explanation for the omission which may preserve its claim of cooperation.

Many companies opt not to create document management systems. Not only does this decision impede a company's ability to use its own information, it leaves it at risk in SEC and other government investigations and even in private litigation. Companies without a document management system typically rely on a makeshift approach to produce documents in response to an SEC subpoena, which can leave questions concerning the completeness of the production. Frequently, this approach begins with the general counsel sending out an e-mail ordering that all document destruction programs cease (or that certain responsive documents be preserved) and concludes with a search of locations that management assumes may contain responsive material. All too often, however, the SEC staff later discovers documents which have not been produced either during testimony or from an analysis of the materials produced. Late production may compromise any representations of completeness previously made by the company and can undermine claims of "cooperation" with the inquiry.

In order to adequately assess whether an existing document management system can adequately serve as a compliance program, or whether to construct a new system, companies should consider what will be required of the system. A set of principles and procedures can be constructed for creating or evaluating such a system after reviewing the obligations imposed by an SEC subpoena, court decisions which have reviewed the use of document systems (typically in the context of a claim for discovery abuse for not producing materials), and the needs of the business. (11)

What Does The System Have To Do: The Company's Obligations In Responding To An SEC Subpoena

In responding to an SEC subpoena for documents, four key points should initially be considered. First, the company must determine what must be produced. Second, the company must determine the point in time when its obligation to preserve responsive materials begins. Third, the company must determine whether any responsive materials are covered by privilege. Fourth, consideration must be given to the company's ability to provide an assurance of full compliance.

What Must Be Produced: The Scope Of The SEC's Subpoena Power

The SEC has broad authority to subpoena records in aid of its investigations. The SEC's subpoena power is coextensive with its investigative authority. (12)

The statutes administered by the SEC confer broad investigative authority on the agency. Section 21(b) of the Securities Exchange Act of 1934 is typical of these provisions. In pertinent part it provides:

(b) Attendance of witnesses; production of records

For the purpose of any such investigation, or any other proceeding under this title, any member of the Commission or any officer designated by it is empowered to administer oaths and affirmations, subpoena witnesses, compel their attendance, take evidence, and require the production of any books, papers, correspondence, memoranda, or other records which the Commission deems relevant or material to the inquiry. Such attendance of witnesses and the production of any such records may be required from any place in the United States or any State at any designated place of hearing. (13)

Under Exchange Act Section 21(a), the agency is authorized to conduct investigations, in its discretion, to determine whether any provision of the Securities laws or the rules or regulations promulgated thereunder, "have been or are about to be violated." (14) This investigative power is generally comparable to that of a grand jury (15) which is deemed to have the power of inquisition. (16) The SEC's investigative power is so broad that it has been held that the agency has the authority to investigate to determine whether or not it has jurisdiction--that is, the power to investigate to determine whether it has the power to investigate.

While the SEC's investigative authority and subpoena power is broad, it is not without limits. The SEC's investigative subpoenas are not self-executing. To enforce its subpoenas, the agency must petition the appropriate district court and seek an order directing compliance. (17)

Enforcement of an SEC subpoena is within the sound discretion of the district court. Before a court will enter an order enforcing an SEC subpoena, three factors are typically considered. First, the inquiry being conducted by the SEC must be for a legitimate purpose and within the powers delegated to the agency by Congress. The purpose of the inquiry is generally deemed proper if its purpose is to determine whether there has been, is at present, or is about to be a violation of a provision of the federal securities laws. The reason for initiating the inquiry is usually not considered. For example, in SEC v. Wheeling-Pittsburgh Steel Corp., (18) the court rejected a challenge to the enforcement of an SEC investigative subpoena where it was alleged that the entire investigation was being conducted in bad faith because it was politically motivated.

In Wheeling-Pittsburgh, the company refused to comply with an SEC subpoena for documents, claiming that the investigation was improper because it was initiated as a result of political influence exerted through a United States Senator at the behest of a competitor. The court rejected Wheeling Pittsburgh's claim and ordered the subpoena enforced, holding:

[T]his case raises the question whether. .. the SEC's decision to investigate reflected its independent determination, or whether that decision was the product of external influences. The reality of prosecutorial experience, that most investigations originate on the basis of tips, suggestions, or importuning of third parties ... need hardly be noted. That the SEC commenced these proceedings as a result of the importuning of Senator Weicker or [a business competitor], even with malice on their part, is not a sufficient basis to deny enforcement of the subpoena. (19) The court went on to note that as long as the objective purpose of the inquiry is within the scope of the federal securities laws, the investigation is proper and the motive of the Commission or its staff is not relevant. The court noted, however, that if the SEC failed to comply with its...