Q: Has the current economic crisis altered the regulatory environment? If so, how?
A: The current economic crisis has altered the regulatory environment in two important and related respects.
First, the law has changed. Congress enacted the Emergency Economic Stabilization Act of 2008 ("EESA"), which requires all federal financial regulatory agencies to cooperate with the Federal Bureau of Investigation ("FBI") and all "other law enforcement agencies," including state regulatory agencies, that are "investigating fraud, misrepresentation, and malfeasance with respect to development, advertising, and sale of financial products." As a practical matter, this requires financial regulatory agencies, such as the Securities and Exchange Commission ("SEC") and Financial Industry Regulatory Authority ("FINRA," formerly the NYSE), to provide support to the FBI's and state law enforcement's criminal investigations of financial fraud. As a result of this broad mandate, more criminal investigations concerning the current economic crisis should be expected. The EESA also creates new civil liabilities (e.g., for misrepresenting or falsely advertising the insured status of bank deposits) and new disclosure obligations (e.g., for those financial institutions participating in the Troubled Asset Relief Program ("TARP")).
Second, the climate has also changed. The public desire to assign blame for the financial crisis and the attendant political pressure to prosecute entities or individuals who may be responsible will likely lead to more vigorous enforcement of familiar criminal laws and financial regulations, such as prohibitions on securities fraud and insider trading as well as wire, mail, bank and bankruptcy fraud. In addition, pending investigations may lead to high-profile prosecutions that press novel theories under more general laws, such as New York's Martin Act. For example, New York Attorney General Andrew Cuomo is currently investigating executive compensation and corporate spending at major financial institutions that have received federal bailout funds, and he has threatened to "seek appropriate sanctions and remedies" against any company that "wastes" taxpayer funds—for example, by deeming employee bonuses to be fraudulent conveyances in violation of New York law. Massachusetts Secretary of State William Galvin has already charged investment banks with violating state securities laws by defrauding investors who purchased collateralized debt obligations and auction rate securities.
Q: Which government agencies are investigating activities relevant to the current economic crisis? And who is under investigation?
A: A wide range of government agencies have launched investigations related to the current financial crisis. These agencies include various U.S. Attorneys' Offices, the FBI, the SEC, the Internal Revenue Service, the United States Postal Inspection Service, the Federal Deposit Insurance Corporation, as well as various state attorneys general, state securities regulators, and congressional committees, such as the House Oversight & Government Reform Committee. Given the EESA's broad mandate that all federal financial regulatory agencies must cooperate with the FBI and state investigators, additional federal agencies are apt to become involved as these investigations proceed.
A similarly wide range of institutions and individuals face government scrutiny. Those already under investigation include some financial institutions that have received federal bailout funds and other failed financial institutions, hedge funds, institutional investors, mortgage lenders, broker-dealers, stock exchanges, clearing houses, credit rating agencies, insurance companies, auditors, real estate brokers, and even individual home owners. According to public reports, the FBI has launched as many as 1,500 "mortgage-related" investigations.
Q: What types of activities will investigators be looking at? Can you give some examples?
A: We anticipate that investigations will approach the current economic crisis from, at least, two different perspectives: What caused the financial crisis? And what must change, going forward?
Looking back to assign blame, investigations will focus on a broad range of issues, including the valuation of and accounting for mortgage-related assets and securities, especially in the subprime markets; market manipulation and short selling, particularly with respect to the securities of financial institutions; securities fraud and insider trading; the marketing and sale of collateralized debt obligations and auction rate securities; and trading of derivative products developed from mortgages, such as credit-default swaps.
Meanwhile, looking ahead to prevent perceived abuses in the future, investigations are apt to focus on more hot-button political issues, such as executive compensation, corporate governance, risk management and related financial disclosures. Even further down the road, additional investigations may consider compliance with the provisions of TARP, which include new disclosure rules.
One thing is certain: investigations concerning the current financial crisis will be wide-ranging and long-lasting. Recall that indictments issued against Enron executives as many as two and three years after the company's precipitous collapse.
Q: What steps should we take if our company receives the proverbial "knock on the door"?
A: If your company receives notice of a government investigation, or a subpoena from a government agency, the assistance and advice of experienced counsel will be critical.
Experienced counsel who have successfully handled similar criminal and regulatory investigations, can provide important guidance to your company and serve as an advocate in dealing with government investigators. At the outset, counsel can assess where your company falls in the spectrum from a mere "witness" to the actual "target" of a government investigation. Thereafter, counsel can effectively negotiate with investigators to define—and even limit—the scope of an investigation. If a subpoena has been issued, counsel can work to narrow document requests, reducing both potential legal liability and the practical burdens associated with producing documents. Counsel can also meet with key employees and, if necessary, prepare them to meet with investigators. When appropriate, counsel can also make a presentation intended to persuade investigators to conclude, or simply drop, an investigation.
Through consultations with experienced counsel, your company can work through the myriad of issues presented by the "knock on the door."
Q: Our best client/joint venture partner is under investigation. What steps should our company take?
A: If your company is not under investigation and has not received a subpoena, the goal is, of course, to stay out of the investigatory spotlight. To that end, your company should avoid attracting unwanted attention from government investigators. One common mistake is to allow, or even encourage, employees to contact clients or partners, who are under investigation, in an effort to gather information or influence an investigation. Instead, your company should steer clear of any pending investigation.
At the same time, your company should take important precautionary steps to prepare for a possible "knock on the door." Retention of experienced counsel, at this early stage, is beneficial. With the assistance of experienced counsel, your company may ensure that potentially relevant documents are preserved, rather than destroyed. Similarly, your company may review critical internal controls, policies and procedures, and business practices. Taking a proactive approach to issues of concern in the current economic crisis may help to make a favorable impression on investigators. In certain circumstances and with the advice of counsel, even before any government investigation, your company may consider conducting its own internal investigation. Counsel can help your company to understand any potential criminal or civil liability and be prepared for any eventuality in this new regulatory environment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
