ABA Section of Business Law

Volume 13, Number 6 - July/August2004

Should the 1st choice involve taking the 5th?
Some possibilities and consequences in SEC probes
    By Jay A. Dubow, Michael F. Gerber and Lauren M. Mazur

It is better to keep your mouth closed and let people think you are a fool than to open it and remove all doubt. — Mark Twain

Mark Twain certainly was not thinking of today's Wall Street world and the people who play in it when he uttered those words, but for some modern-day mavericks, the words should be heeded.

The Securities and Exchange Commission has increased its pressure on corporate and securities wrongdoers while Congress has passed new laws and enacted harsher penalties.

The Sarbanes-Oxley Act of 2002 (SOX) created new federal criminal offenses aimed at placing criminal liability on corporate executives, enhanced penalties for existing offenses, and mandated review and amendment of the Federal Sentencing Guidelines to reflect the SOX's purpose of deterring securities law violations.

The new provisions create offenses that can result in fines ranging from $1 million to $5 million and prison terms spanning 10 to 25 years. Fines and prison terms for existing offenses have been substantially increased. For example, under the new guidelines, a defendant causing a loss greater than $400 million faces a possible sentence of approximately 15 to 20 years compared to the previous sentence of about 10 to 12 years.

The confluence of more aggressive SEC investigating and new and harsher laws has forced individuals involved in SEC investigations to think deeply about their own potential criminal liability and about whether they should invoke the Fifth Amendment right against self-incrimination during SEC investigations. Of course, in determining whether or not to advise a client to assert his or her rights against self- incrimination, counsel must weigh the consequences of invoking the Fifth Amendment against any potential strategic benefits.

In civil proceedings, since the Supreme Court's 1976 ruling in Baxter v. Palmigiano, it has been well established that an adverse inference may be drawn from a witness' invocation of the Fifth Amendment in the face of probative evidence. Courts have recognized that invoking one's Fifth Amendment rights alone does not create an adverse inference, but that there must be independent evidence to support an adverse inference — in addition to the assertion of the privilege. Given the possibility of a negative inference, clients often face a dilemma in deciding whether to exercise the Fifth Amendment privilege against self-incrimination.

This is most difficult when there are parallel civil and criminal proceedings. While the criminal case or investigation is of paramount importance, consideration should be given to seeking a stay of the civil proceeding pending the conclusion of the criminal proceeding. This may allow the client to avoid having to invoke the Fifth Amendment in the civil action. This approach was taken in the SEC's recent case against Healthsouth Corp. where the court agreed to a stay of civil proceedings until related criminal proceedings were resolved.

Typically, courts have made an adverse inference when the client asserts the Fifth Amendment during both the SEC investigation and the subsequent civil enforcement action. Although some courts have found an adverse inference based solely on one's assertion of the Fifth Amendment in an SEC investigation, such assertion during an SEC investigation and not during a subsequent civil enforcement action may not be enough to draw an adverse inference because of the nature of the SEC proceedings.

Procedurally, SEC investigations are a one-way street, which only the SEC gets to drive down. The SEC has control over its investigative process, and the parties being investigated do not get access to information gathered as they do in civil litigation.

Thus, the timing of the assertion is important. It may be appropriate for a client to assert his or her Fifth Amendment rights during an SEC investigation, but then revisit this decision if and when the SEC institutes a civil enforcement action. The initial assertion may prevent the SEC staff from obtaining sufficient facts on which to institute an enforcement action. Moreover, if an action is brought, the client will then be able to learn more facts through discovery to be better prepared to testify in a deposition or at trial if a decision is made to then waive the client's Fifth Amendment rights.

A few recent cases show the effect of the assertion of the Fifth Amendment during SEC civil proceedings.

For example, in 1998 in SEC v. Colello, the SEC alleged a scheme in which a company called Cross Financial Services Inc. (CFS) and a number of individuals defrauded more than 700 public investors out of more than $21 million. According to the SEC, Michael Colello, who provided financial services to CFS, received about $2.9 million of the $21 million. The SEC sought to recover this money from Colello after he was dismissed as a party to the fraud allegations. Colello repeatedly asserted his Fifth Amendment privilege not to testify in the face of the SEC's evidence that he received the funds.

The Ninth Circuit determined that the combination of the SEC's proof with an adverse inference drawn from Colello's silence was sufficient to find that Colello received the funds and had no legitimate claim to them.

Similarly, in SEC v. Martino, the SEC charged Carol Martino with various securities law transgressions, including:

• violating an SEC order barring her from associating with a broker or dealer;
• acting as an unregistered broker; and
• manipulating clients' stock prices.