Forging ahead with the revamp of its Enforcement Division, the Securities and Exchange Commission unveiled new tools to incentivize individuals and companies to cooperate with the enforcement staff during investigations, including deferred- and non-prosecution agreements and a so-called Seaboard Memo for individuals.

For the first time, the SEC set out in a new policy statement how it will evaluate whether, how much, and in what manner to credit cooperation by individuals, to serve as an incentive for people to report violations and cooperate fully and promptly in enforcement cases. The guidance is similar to the so-called “Seaboard Report” issued in 2001 detailing the factors the SEC considers when evaluating cooperation by companies, and identifies four general considerations:

• The assistance provided by the cooperating individual;
• The importance of the underlying matter in which the individual cooperated;
• The societal interest in ensuring the individual is held accountable for his or her misconduct; and
• The appropriateness of cooperation credit based upon the risk profile of the cooperating individual.

The moves are part of an overhaul announced last summer that marks the most significant reorganization of the Enforcement Division in more than 30 years.

The Enforcement staff will also have new tools at its disposal, including: formal, written cooperation agreements, in which the staff agrees to recommend to the Commission that a cooperator get credit for cooperating in an investigation or enforcement action, if they provide substantial assistance, such as “full and truthful information and testimony”; Deferred Prosecution Agreements, by which the Commission agrees to forego enforcement action against a cooperator who agrees to cooperate and comply with certain reforms for the duration of the agreement; and rarer Non-prosecution Agreements, under which the Commission agrees not to pursue an enforcement action against a cooperator who agrees to cooperate and comply with express undertakings.

While such tools have long been used by prosecutors in criminal prosecutions and investigations, they were previously unavailable in civil proceedings.

Enforcement Division Director Robert Khuzami, who described the measures as “a potential game-changer for the Division,” noted in remarks at Wednesday’s press conference, that cases aided by cooperator testimony can be made quickly, since cooperators are most often insiders who’ve seen and heard what happened first-hand and charges supported by cooperator testimony can be resolved or litigated from a “position of strength.” Cooperating witnesses can also help investigators break cases involving complex transactions that might otherwise escape detection, or help apprehend “higher-ups” whose culpability can be hard to establish, Khuzami noted.

Russ Ryan, a partner with King & Spalding and a former assistant director in the Enforcement Division, says the move “represents a sea change in enforcement practice with respect to individuals.”

“Previously only companies ever got any tangible rewards for extraordinary cooperation, so individuals rarely had any incentive to come forward with information unless and until asked for it, especially if they knew they had potential liability,” says Ryan. “This could really change the dynamic in many investigations.”

The SEC also streamlined the process for submitting witness immunity requests to the Justice Department for witnesses who help in its investigations and related enforcement actions.

At the same time, Khuzami announced the heads of the five new national specialized units and the head of its newly created Office of Market Intelligence.

The new Office of Market Intelligence, led by Thomas Sporkin, who most recently served as deputy chief in the Office of Internet Enforcement, will be responsible for the collection, analysis, risk-weighing, triage, referral, and monitoring of the tips, complaints, and referrals that the SEC receives each year.

The Asset Management Unit, led by co-chiefs Bruce Karpati, head of the SEC’s Hedge Fund Working Group, and Enforcement Division Assistant Director Robert Kaplan, will focus on investment companies, investment advisers, mutual funds, hedge funds, and private equity funds.

The Market Abuse Unit, headed by Daniel Hawke, director of the SEC’s Philadelphia Regional Office, will focus on large-scale and organized insider-trading and market manipulation schemes, and will utilize some unique technology to aid in the investigations.

The Structured and New Products Unit, led by Kenneth Lench, an Assistant Director in the Enforcement Division, will cover all structured products, including collateralized debt obligations, both cash and synthetic Credit Default Swaps, securitized instruments, and other structured products, and will focus on developing products.

The Foreign Corrupt Practices Act unit, led by Cheryl Scarboro, an associate director in the Enforcement Division, will focus on enforcing the law and regulations that prohibit corporate bribery of foreign officials.

The Municipal Securities and Public Pension Unit, led by Elaine Greenberg, associate regional director of the Philadelphia Regional Office and Co-Chair of the Division’s national Municipal Securities Working Group, will focus on misconduct in the $2.8 trillion municipal securities market and at public pension funds.

Compliance Week will provide readers with full details in an upcoming edition.

The government has created a new task force to coordinate its efforts to fight fraud stemming from the massive financial crisis.

The Financial Fraud Enforcement Task Force, led by the Department of Justice, will include representatives from dozens of federal agencies, regulatory authorities, and inspectors general.

In announcing its creation this week, Attorney General Eric Holder said the group’s mission is “not just to hold accountable those who helped bring about the last financial meltdown, but to prevent another meltdown from happening.”

The task force, which replaces the Corporate Fraud Task Force established in 2002, will build on existing efforts to combat mortgage, securities, and corporate fraud. The group will hold its first meeting sometime in the next month. The Department of Treasury, Department of Housing and Urban Development and the Securities and Exchange Commission will serve on the steering committee.

Treasury Secretary Timothy Geithner said the task force’s creation makes clear that the Obama Administration “is going to act aggressively and proactively in a coordinated effort to combat financial fraud.”

However, former federal prosecutor Andrew Weissmann, now a partner at Jenner & Block, says the creation of such task forces, “while certainly signaling an increase in attention to the particular area, may not in fact result in increased prosecutions or even investigations.”

“Sometimes a task force has only a cosmetic effect,” says Weissmann, who served as director of the Enron Task Force. “If well done, a task force can help to coordinate information and investigations, increase resources, and provide consistency in prosecutorial decision making. Only time will tell which of the paths the new task force will go down.”

Meanwhile, SEC Enforcement Director Robert Khuzami noted that, in fiscal 2009, more than 150 of the SEC’s enforcement cases were filed in coordination with criminal charges filed by the Department of Justice and others, up 30 percent from last year.

“The Task Force should only increase those numbers and provide even greater opportunities for close collaboration and information sharing among law enforcement authorities,” he said.

As previously reported, Khuzami announced a revamp of the SEC’s enforcement unit earlier this year, including the creation of specialized units to focus on areas such as derivatives and securitized products; broad-based insider trading; and market manipulation and fraud among hedge funds and investment advisers, among others.

Some of the other groups participating in the task force include the Department of Homeland Security; the Commodity Futures Trading Commission; the Federal Trade Commission; the Federal Deposit Insurance Corp.; the Board of Governors of the Federal Reserve System; the Federal Bureau of Investigation; the Internal Revenue Service; the Secret Service; and U.S. Immigration and Customs Enforcement.

The independent commission investigating the financial crisis will begin holding hearings by December, according to its chairman.

The Financial Crisis Inquiry Commission, led by former California State Treasurer Phil Angelides, held its first public meeting on Sept. 17.

The 10-member Commission, created by the Fraud Enforcement and Recovery Act, will hold hearings on more than 20 areas of inquiry related to the financial crisis and report to Congress in December of 2010.

In a statement, Angelides said it is “essential that our investigation proceed on the basis of fact and evidence—and not according to the opinion or political leanings of any member of the Commission or the Congress that empowered us.”

Noting that the 9/11 Commission conducted over 1,200 interviews, reviewed over 2.5 million pages of documents, and held 12 days of public hearings, he said, “We should be similarly thorough.”

Angelides said the Commission’s job is to “pursue the evidence wherever it leads” and “… move as quickly as we can in fulfilling our duties.” He also noted that the group will use its subpoena power, if needed.

Meanwhile, commission member Keith Hennessey, senior White House economic adviser to President George W. Bush, called for the panel to move “quickly and aggressively,” and to develop a “mechanism to produce useful information” to the public and policymakers over the course of the next year and a quarter.

“If we hold all of our information until next December, our work will be irrelevant,” Hennessey said in a statement.

The independent commission tasked with investigating the financial crisis is set to hold its first open meeting on Sept. 17 in Washington.

As previously reported, the Financial Crisis Inquiry Commission was created under the Fraud Enforcement and Recovery Act passed in May to examine the domestic and global causes of the current U.S. financial and economic crisis.

According to the Federal Register notice, the meeting will include announcements, statements from Commissioners, and a discussion of the scope of work, work plan, and the Commission’s timeline.

A WilmerHale alert notes that Thomas Greene, of the California Attorney General’s office, has been tapped as the Commission’s Executive Director.

The 10-member Commission, chaired by former California State Treasurer Phil Angelides, is expected to examine and hold hearings on more than 20 areas of inquiry related to the financial crisis, and to examine the causes of major financial institutions that failed or were likely to fail if they hadn’t received exceptional government assistance. Its findings are due in a report to Congress in December of 2010.

The fallout from the Madoff debacle continues, as Senate lawmakers seek input on how to improve the performance of the Securities and Exchange Commission in the aftermath of the agency’s now well-documented failure to fully examine Bernard Madoff and his firm for operating a Ponzi scheme, despite ample tips and complaints over several years.

Leaders of the Senate Banking Committee have slated a hearing for this week, entitled “Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance.”

The latest Congressional hearing follows the release of the summary and full text of the long-awaited SEC Inspector General’s report detailing—and the SEC’s statement in response to—the Commission’s bungled handling of the investigation into the massive fraud tied to the Wall Street money manager. Madoff was sentenced back in June to 150 years in prison.

The release of the report also coincided with reports that New York Democratic Senator Charles Schumer plans to introduce legislation allowing the SEC to be self-funded—an idea touted back since at least March by SEC Commissioner Luis Aguilar.

So far, the witness list for the hearing includes SEC IG H. David Kotz, Certified Fraud Examiner and Madoff whistleblower Harry Markopolos, Barry Minkow, the mastermind behind the ZZZZ Best fraud and now co-founder of the Fraud Discovery Institute, and SEC Enforcement Division Director Robert Khuzami.

Given the economic downturn, record levels of government spending, and the uptick in enforcement, it’s not surprising most executives expect fraud and misconduct risks to stay the same or increase over the next year.

That’s one finding from KPMG’s 2009 Fraud Survey, which polled more than 200 executives on the nature of fraud and misconduct risks in their organizations and the challenges they face in trying to prevent, detect, and respond to those risks.

When asked which categories of fraud and misconduct pose the most significant risk, more than a third said misappropriation of assets (35 percent), while 31 percent cited other illegal or unethical acts, such as bribery and corruption. Fourteen percent said fraudulent financial reporting, while 20 percent said all three are an equal threat.

The nature of perceived fraud and misconduct risks varied by industry. For instance, executives from consumer markets were more likely to cite asset misappropriation as a concern, while respondents from health care and pharmaceuticals tended to cite other illegal and/or unethical acts, such as bribery, corruption, market rigging, or conflicts of interest as threats.

Looking ahead over the coming year, most executives believe fraud and misconduct risks will either stay the same or increase over the next twelve months. Nearly a third of the group expect an increase in at least one form of fraud and misconduct risk. One-quarter of executives expect increases in asset misappropriation, while 20 percent expect other illegal and unethical acts to increase, and 8 percent expect more fraudulent financial reporting.

Meanwhile, over the same period, the vast majority of executives (75 percent) expect the amount of funding their organization dedicates to combating fraud stay the same, while 16 percent expect it to increase and only 9 percent expect it to decrease.

As for the factors that executives say most enable fraud and misconduct to occur, two-thirds cited inadequate internal controls or compliance programs. Almost half (47 percent) cited management override of controls, while 44 percent cited inadequate director oversight over management. Nearly the same number (43 percent) cited collusion between employees and third parties, while almost a third cited collusion between management and third parties, and 27 percent cited collusion between employees and management.

When asked which sources they believed would mostly likely uncover fraud and misconduct within their organizations, almost half said internal audit, legal, or compliance personnel were most likely to uncover fraud and misconduct. Twenty percent cited employee whistleblowers, while 13 percent cited line managers and 9 percent cited external auditors.

However, the report points out that that might not be the reality, citing data from the Association of Certified Fraud Examiners which shows that frauds were more likely to come to light through whistleblower tips than through audits, controls, or any other means and KPMG survey data reporting internal audit as among the least likely channels to which employees said they’d feel comfortable reporting misconduct.

While the majority of executives report that their organizations have effective protocols in place to address how to respond when allegations of fraud arise, the report notes that some gaps remain. For example, just over one-quarter of respondents lack effective protocols on how investigations should be conducted and at what point the board of directors should be alerted to potential concerns. One-third lack protocols on how to determine remedial actions, and 38 percent lack protocols to address when a voluntary disclosure to the government should be made.

Respondents also acknowledged room for at least moderate improvement across the majority of their anti-fraud efforts. Areas where executives cited the most amount of improvement needed include employee communication and training, technology-driven continuous auditing and monitoring techniques, and fraud and misconduct risk assessment.

While procurement fraud risks are often thought of as the domain of large federal contractors, small and mid-sized firms are at risk as well, and thanks to increased enforcement, the stakes are higher than ever.

Recent changes to federal regulations; growth in federal, state, and local contracting activity; and vigorous enforcement activity mean increased procurement risk for corporations of all sizes, especially those that don’t traditionally focus on selling goods and services to the public sector, according to a report by PricewaterhouseCoopers examining procurement fraud enforcement activity.

“Procurement fraud is perceived as something that happens often and isn’t really a big deal,” says the report’s author, Dalit Stern, a partner in PwC’s forensic service group. “But the amounts associated with it could be significant.”

And if you think Sarbanes-Oxley compliance eliminates procurement fraud risk, think again. Stern says the biggest misconception companies have about procurement fraud is that resources they’ve devoted to SOX compliance “make them largely immune to fraud in general and to procurement fraud in particular.”

However, internal controls over financial reporting and fraud management processes may be less effective against procurement risk schemes. Why? Because fraudsters who successfully perpetrate their schemes over long periods usually do so by operating under monetary thresholds determined for SOX testing purposes, according to the report, “Cracking down—The facts about risks in the procurement cycle.”

“The variety of industries, plethora of government agencies involved, and the spread of the crime’s geographical reach indicate that the common denominator of procurement fraud is vulnerability in corporate controls,” the report states.

Moreover, Stern notes that the stakes are higher during a downturn.

“Individuals have less loyalty and they’re under greater pressure, and recession causes management to focus on revenue generating activity,” she says. “This isn’t perceived as the best time to look at improving processes and controls.”

Add stepped up enforcement to the mix, and doing so is even more important.

A PwC review of enforcement data from the National Procurement Fraud Task Force shows that, since the Task Force’s creation in 2006, more than 400 procurement fraud cases have been pursued, resulting in more than 300 criminal convictions and the recovery of hundreds of millions of dollars in civil settlements and judgments.

From June 2007 through June 2008, more than 500 schemes or combinations of schemes were investigated. The vast majority of prosecutions addressed bribery (27 percent), bid rigging (21 percent), embezzlement (21 percent), and false claims (16 percent), according to PwC.

While the government is exposed and more focused on prosecution in defense and related industries, almost two-thirds of reported cases during the period reviewed don’t involve military-related spending. Of the non-military industries, procurement fraud cases involving the construction industry were most prevalent. Other industries subject to Task Force prosecutions include education, aerospace, and telecommunications.

While the Army, Navy, Air Force, and Department of Defense accounted for 38 percent of prosecuting agencies, the majority of cases (62 percent) were scattered across 62 different government agencies. The most prevalent non-military agencies involved in procurement fraud cases were those that most engage in contracting activity, such as the Department of Transportation, the Department of Housing and Urban Development, and the Department of Education.

More than half of defendants were vendors or their employees, and close to 32 percent of cases involved public servants, which PwC says underscores how purchasing authority tempts individuals engaged in procurement activities in the public or private sectors.

“Procurement fraud schemes are a combination of greed and lax or limited controls,” says Stern. “You can’t eradicate greed, but you can enhance your controls in your procurement cycle sub-processes, or at least in the sub-processes that are the most risky.”

She recommends companies assess their risk and focus on the processes that are most vulnerable.

Vendor maintenance is “a good place to start,” says Stern, “since not many companies go through a rigorous vendor due diligence process.”

The report includes a checklist for companies to assess their vulnerability to procurement fraud and provides a list of potential red flags for procurement risk.

Corporate and white-collar defendants wondering what the cost of settling a Securities and Exchange Commission enforcement action is these days should take note—it isn’t cheap.

That’s according to the latest research by NERA Economic Consulting, which shows that the median value of SEC settlements for both companies and individuals in 2009 could match or outpace 2008 levels.

Through the first half of the year, the SEC settled with 335 defendants, compared with 330 during the same period last year, NERA reports. The Commission settled with 160 defendants in the second quarter of 2009, compared to 175 in the previous quarter and 174 in the second quarter of 2008.

Two of the three largest settlements in the quarter, American Skandia Investment Services ($68 million) and UK-based hedge fund advisor Headstart Advisers Ltd. ($17 million) related to market-timing allegations. Other allegations among the 10 largest settlements in the second quarter were insider trading, public company mis-statements, microcap fraud, investment manager fraud, and bribery of foreign officials, according to the second-quarter update on SEC settlement trends.

Sixty-two percent of company settlements and 57 percent of individual settlements involved monetary payments, authors Jan Larsen and Elaine Buckberg note.

Among companies whose settlement included a monetary payment, the average settlement was $6.6 million, a decrease from the $12.8 million average in the first quarter. However, the average through the first half of 2009 was $10.1 million, driven largely by two huge settlements early in the year. That’s an increase over the full-year average of $8.4 million in 2008.

The median company settlement was $1.6 million during the second quarter, off slightly from $1.7 million in the first quarter. However, if the 2009 median remains at $1.6 million through the rest of the year, the report notes that it will be the highest median value in any year since the passage of the 2002 Sarbanes-Oxley Act.

Post-SOX, the highest median company settlement was $1.5 million in both 2005 and 2006, according to NERA’s 2008 settlement data. Last year’s median company settlement was $1.3 million.

The average company settlement declined more sharply in the second quarter of 2009, largely due to the two settlements of over $100 million in the first quarter: the $200-million UBS settlement and the $177-million Halliburton settlement. The largest settlement in the second quarter was $68 million (American Skandia Investment Services).

The average settlement with individual defendants was $1.6 million in the second quarter, an increase from $0.7 million in the first quarter, while the median settlement for individuals was $0.2 million in the second quarter, compared to $0.1 million in the first quarter. The median individual settlement for all of 2008 was $0.1 million, as it has been in every year since SOX.

In 2008, the SEC settled with 672 defendants in all-515 individuals and 157 companies—the second lowest in any full year since the passage of the Sarbanes-Oxley Act in 2002, according to previous NERA research.

Meanwhile, the authors note that, though the outcome of plans to seek expanded SEC enforcement powers and proposed regulatory reforms that may affect the agency’s powers remain to be seen, the new regulatory landscape “will doubtlessly affect future SEC enforcement actions and their resolutions.”

Congressional leaders have tapped former California State Treasurer Phil Angelides as chairman of the 10-member Financial Crisis Inquiry Commission tasked with examining the domestic and global causes of the financial crisis.

Angelides served as California State Treasurer from 1999 to 2007. As required under the Fraud Enforcement and Recovery Act, the statute that created it, he was jointly appointed by House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid.

Pelosi also appointed former Commodities Futures Trading Commission chair Brooksley Born; John W. Thompson, Chairman of the Board of Directors of security software maker Symantec Corp.

Reid also appointed former U.S. Senator and Florida Governor Bob Graham; Heather Murren, a retired managing director for Global Securities Research and Economics at Merrill Lynch and Co-Founder and Chairman of the Board for Nevada Cancer Institute, and Georgiou Enterprises president Byron Georgiou, a Las Vegas-based businessman and attorney who also serves on the advisory board of the Harvard Law School Program on Corporate Governance.

The commission will also include four additional members, two appointed by the House Minority Leader and two appointed by the Senate Minority Leader. The Vice-Chair is selected jointly by the House Minority Leader and the Senate Minority Leader.

As previously reported, the 10-member Commission will conduct a comprehensive examination of, and hold hearings on, more than 20 specific areas of inquiry related to the financial crisis, including the role of fraud and abuse in the financial sector; state and federal regulatory enforcement; tax treatment of financial products; credit rating agencies; lending practices and securitization; unregulated financial products and practices; and corporate governance and executive compensation. The Commission will also examine the causes of major financial institutions that failed or were likely to fail if they hadn’t received exceptional government assistance. Its findings and conclusions are due in a final report due to Congress on Dec. 15, 2010.

The Commission is empowered to hold hearings and to issue subpoenas either for witness testimony or documents. At the chair’s discretion, the commission’s report may include specific findings on any financial institution examined by the commission.

The independent commission tasked with investigating the causes of the financial crisis is ramping up-and that means companies that may find themselves in its cross-hairs ought to be prepared, according to lawyers in the law firm Gibson, Dunn & Crutcher.

The bipartisan Financial Crisis Inquiry Commission, which was created by the Fraud Enforcement and Recovery Act enacted in May, is expected to announce its 10 members shortly, according to Mark Oesterle, chief republican counsel and deputy chief of staff for the Senate Committee on Banking, Housing, and Urban Affairs.

“That should happen pretty imminently,” Oesterle said during a June 19 Webcast sponsored by Gibson Dunn & Crutcher.

Michael Bopp, Chair of Gibson Dunn’s Financial Services Crisis Team, noted that the Commission is remarkable for its “incredibly broad and yet detailed investigative mandate.”

“It’s very rare for Congress to create investigative committees and even rarer to create one with such broad and expansive authorities,” Bopp said, noting that there have been just six investigative congressional committees in the last 20 years.

Unlike the Pecora Commission of the 1930s, which was actually an inquiry of the Senate Banking Committee, the FCIC is an independent commission. The Commission, which is tasked with examining the domestic and global causes of the financial crisis and investigating specific institutions, will have subpoena power and will likely have staff deposition authority. He also pointed to language in the statute that created the Commission as evidence that the FCIC’s information gathering won’t be limited to federal agencies.

As a result, any companies that received a substantial amount of federal assistance—not just TARP direct investments, but those participating in the various federal guarantee and liquidity facilities—ought to be prepared, said GDC Partner John Olson.

“Those who may be called or have officers or former officers or directors called to participate in proceedings by giving testimony or issuing documents need to be thinking ahead about how they’re going to handle that,” Olson said.

That “has real risk” in terms of both civil and criminal liability, he said, because the information may be put forward, at least in summary form, in public hearings and also may be reachable by prosecutors and civil litigants through subpoenas.

“Ultimately, there will be a report by the commission … and it sounds as though it’s going to name names,” Olson said.

In response to the question of whether the receipt of inquiry or request to cooperate from the Commission creates a disclosable event, Olson said it depends.

While a request for information itself may not be disclosable, he said, “If you’re going to have somebody testifying, or you’re producing documents, particularly pursuant to a subpoena, the chances of that information becoming public are very great.”

“That’s going to be something that’s going to be of significant interest to investors if that happens,” Olson told Compliance Week. “I think you have to think seriously about making public disclosure and getting ahead of that news.”

The Commission’s report is due in December of 2010. Meanwhile, congressional leaders in both chambers say they hope to have a regulatory reform bill on the president’s desk by the end of this year.

However, Oesterle noted that there’s still a “question on the timing of when the reform legislation will be finalized … I’m not sure its going to happen as quickly as some think.”