/>iThe SEC recently sent letters “to a number of companies asking for years of nondisclosure agreements, employment contracts and other documents”. According to the Wall Street Journal, the SEC is seeking information since the enactment of the Dodd-Frank Act (i.e., 2010).
Because the SEC sent letters and not subpoenas, the SEC appears to be pursuing an informal inquiry. Typically, informal inquiries are initiated by the SEC staff without the approval of the Commission. In this case, however, the inquiry may have been initiated by SEC Chairman Mary Jo White, reports indicate that a group of members of Congress wrote Chairman White last year to express concerns about employment agreement provisions that vitiate the effectiveness of the SEC’s whistleblower program.
While there is no obligation to respond to informal SEC requests for information, I expect that the recipients of these letters will choose to respond (although they will likely try to negotiate the scope of the request). However, one should not underestimate the costs associated with voluntary compliance. Each company will likely spend tens, if not hundreds, of thousands of dollars in responding.
The SEC is clearly fishing, and one might wonder why these companies would voluntarily swallow the hook. Most recipients probably believe that they have not violated the law and a response is the least costly and quickest route to closure. Even those less certain of their innocence are likely to respond because they judge that a refusal to cooperate is likely to result in a subpoena. In addition, resistance will deprive the respondent of the opportunity to claim leniency on the basis of cooperation. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions, SEC Rel. Nos. 34-44969 and AAER-1470 (Oct. 23, 2001).
SEC subpoenas, however, are not self-executing and a refusenik may challenge the subpoena in court. The SEC will have the burden of establishing a prima facie case by showing that it has met the standard enunciated by Justice John Marshall Harlan II in United States v. Powell, 379 U.S. 48, 57-58 (1964). Then the burden shifts to the company to challenge the subpoena. Although challenges are rarely successful, Ms. Ensign’s article suggests one possible ground – bad faith. In SEC v. Wheeling-Pittsburgh Steel Corp., 684 F.2d 118 (3rd Cir. 1981), a company was successful in convincing the District Court to refuse to enforce an SEC subpoena. The company alleged that the SEC proceedings were “tainted because of improper interference by United States Senator Lowell Weicker of Connecticut” on behalf a competitor. In vacating the District Court’s order, the Third Circuit Court of Appeals instructed the District Court to determine whether enforcement of subpoena would result in an abuse of the judicial process. The Third Circuit’s opinion makes it clear that improper influence (political or otherwise) could be a grounds for challenge:
But they are entitled to a decision by the SEC itself, free from third-party political pressure, that a “likelihood” of a violation exists and that a private investigation should be ordered. See 17 C.F.R. § 205.2(a). The SEC order must be supported by an independent agency determination, not one dictated or pressured by external forces. If an allegation of improper influence and abdication of the agency’s objective responsibilities is made, and supported by sufficient evidence to make it facially credible, respondents are entitled to examine the circumstances surrounding the SEC’s private investigation order. The court should be guided by twin beacons: the court’s process is the focus of the judicial inquiry and the respondent may challenge the summons on any appropriate ground.
There is much to question here. On what basis did the SEC select companies? If the SEC had no basis for suspecting wrongdoing at the targeted companies, is it reasonable or fair to impose burdensome costs on these companies? Was the SEC influenced by external forces in the selection of its targets? Did Chairman White initiate the inquiry? If so, was she responding to political or other external pressure? If the SEC has concerns, is enforcement the best way to set policy?
