The Securities and Exchange Commission closed out the year with its first non-prosecution agreement under the Enforcement Cooperation Initiative launched earlier this year.
The honor goes to Atlanta-based children's clothing marketer Carter's Inc., which won't be charged with any violations of the federal securities laws relating to SEC allegations of fraud and insider trading by its former Executive Vice President Joseph Elles.
Non-prosecution agreements are one of the tools the SEC added to its enforcement arsenal in January as part of a broader effort to encourage greater cooperation from individuals and companies in investigations and enforcement actions.
In announcing the NPA, the Commission said the agreement reflects the “relatively isolated nature of the unlawful conduct, Carter's prompt and complete self-reporting of the misconduct to the SEC, its exemplary and extensive cooperation in the investigation, including undertaking a thorough and comprehensive internal investigation, and Carter's extensive and substantial remedial actions.”
The SEC charged Elles with financial fraud and insider trading, which it said caused Carter's to understate expenses and overstate net income for several reporting periods, leading the company to restate its financial results for fiscal years 2004 through 2008, and the fiscal quarters from Sept.29, 2007 through July 4, 2009.
The SEC alleges that, from 2004 to 2009, Elles inflated the company's earnings by giving Kohl's, its largest wholesale customer, huge discounts to buy more clothing and hid it by getting the Kohl's to defer subtracting the discounts from payments. He also created and signed false documents that misrepresented the timing and amount of those discounts, and pocketed $4.7 million in profit from insider trading in shares of Carter's common stock between May 2005 and March 2009, according to the Dec. 20 SEC complaint. Elles was terminated from the Company in March 2009.
“The SEC is clearly sending the message that they intend to wield a very big stick, but for those companies that, in an effective and sincere way, step up and voluntarily self-report, effectively cooperate and remediate the situation that gave rise to the underlying conduct, there are also carrots,” says Randall Bodner, a partner in the law firm Ropes & Gray who co-led the team representing Carter's.
Under the terms of the non-prosecution agreement, Carter's agreed to cooperate fully in any further SEC investigation and in the enforcement action filed against Elles, including producing non-privileged documents and other materials requested by the staff.
"Carter's did the right thing by promptly self-reporting the misconduct, taking thorough remedial action, and extensively cooperating with our investigation, for which it received the benefits of a non-prosecution agreement,” SEC Enforcement Division director Robert Khuzami, said. “In such circumstances, incentivizing appropriate corporate response to misconduct through the use of non-prosecution agreements is in the best interest of companies, shareholders and the SEC alike."
The SEC is seeking permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, financial penalties, and an officer and director bar against Elles. Its investigation is continuing.
“The fact that the SEC's first non-prosecution agreement is with a public company shows that the Commission wanted this case to get the attention of markets and public companies,” says Rick Firestone, a partner in the law firm McDermott Will & Emery, formerly an associate director in the SEC's Enforcement Division.
It remains be seen whether the Commission will give companies that cooperate a full pass in the form of a NPA on more regular basis or not, says Firestone. “In this case, the conduct was isolated,” he says. “It's an open question in cases of broader misconduct where a company provides extraordinary cooperation whether they'll be the beneficiaries of a non-prosecution agreement.”