Surviving Parallel Proceedings

June 19, 2018


judge-with-gavel-on-table-picture-id639884564.jpgBy Dan Portnov

Late last week the other shoe finally dropped for Theranos founder and ex-CEO Elizabeth Holmes, as she and fellow executive Ramesh “Sunny” Balwani were indicted on charges of wire fraud and conspiracy to commit wire fraud. Following allegations made in the Theranos investor lawsuit, the SEC charges against Balwani and settlement with Holmes, this latest and most serious development came as no surprise.

Theranos, with Holmes at the helm, had been the darling of Silicon Valley: once valued at $9 billion, touting a product that would have revolutionized blood testing technology and with investors that included well known private equity firms, media moguls, the family of the Secretary of Education. The deception and fall were also epic.

But this post is not really about Theranos, or Holmes. That story deserves much more time and space, and will soon be retold in film, starring national treasure Jennifer Lawrence.

Instead, the indictment of Holmes and Balwani provides an opportunity to discuss parallel proceedings and the strategic decision-making that follows.

What are parallel proceedings?

Parallel proceedings occur when a company or individual is involved in separate criminal and civil proceedings stemming from the same conduct or transactions. The most publicized proceedings typically involve the DOJ and SEC, e.g. Theranos, but other federal and state regulators have joined in the fun with increasing frequency. Notably, the Commodity Futures Trading Commission took the lead in investigating, charging and settling benchmark rate fixing abuses while states attorneys general with expansive anti-fraud enforcement mandates (looking at you, New York), have sued auto manufacturers over emissions defeat devices and banks over Residential Mortgage Backed Securities (RMBS) shenanigans.

How and when do parallel proceedings begin?

Parallel proceedings might begin in all the usual ways that a criminal or regulatory matter might commence: by whistleblower complaint, following routine compliance exams, self-reporting, troubling allegations made in a civil suit, among others. The Theranos investigations were spawned by crack investigative journalism (see above link).

As with most stand-alone cases, by the time DOJ obtains an indictment and the regulator files its action, months or years of investigative work have been done. The subject of these parallel charges will usually have some idea that they are coming, and counsel will have contemplated the key strategic questions.

Which agency takes precedence?

Answers vary, depending on whom you ask, and the size of their ego. In all seriousness, various factors dictate when each regulator opens its investigation, gets first crack at documents and interviews, “surfaces,” files charges and (possibly) settles charges.

Because DOJ has exclusive jurisdiction over criminal penalties and the corresponding Constitutional protections, it usually gets to weigh in on the timing and substantive decisions of other regulators. Where the subject is cooperating and working to settle civil charges and plead guilty to criminal ones, timing is an afterthought. However, when both proceedings are contested, DOJ will likely flex its muscles by intervening in the civil case and moving to stay proceedings until resolution of the criminal case (for reasons discussed below).

In the Theranos matter, the SEC filed charges against Balwani in March, simultaneously settling with Holmes, while DOJ remained quiet. Now that DOJ’s indictment is unsealed, in the same District Court, it is only a matter of time before the latter will intervene in the SEC suit and stay discovery, if not all proceedings. As frustrating as waiting might feel to SEC staff, they will eventually get their crack at Balwani. And when it does, the SEC will have the tactical advantage of the lower burden of proof in its civil case, combined with the preview of the defense.

In some large, high profile enforcement matters, federal and state regulators form a seemingly never-ending line to get a crack at investigating wrongdoing (and lopping off sizable settlements from the subjects). For example, the fallout from the Morgan Stanley’s RMBS abuses drew attention from federal criminal prosecutors, the SEC, the Senate Permanent Subcommittee on Investigations, the New York Attorney General’s Office, and finally DOJ again with a settlement resolving claims under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and its 10 year (!) statute of limitations (settlement press release here – and note the length of the “special thanks” list).

What Are the Key Strategic Considerations for Defendants?

The likelihood of a stay in one of the proceedings is very high. However, should the stay not happen…

With filed parallel proceedings, a defendant can take advantage of the broad discovery afforded to parties in a civil suit to preview the criminal case against them. In a standalone criminal case, depositions are not taken and early discovery of the prosecutor’s files and witnesses is unheard of. Still, this advantage comes with major risk, as the plaintiff would get the same opportunity for discovery and would therefore obtain a preview of the defense for the pending criminal case.

Parallel proceedings can also impact the defendant’s Fifth Amendment rights. Civil interrogatories or deposition questions present the defendant with the dilemma of waiving the Fifth Amendment in future criminal proceedings or invoking it but facing the “adverse inference” instruction, which may harm their chances in the civil case.

Defendants should always expect some level of coordination and information sharing by criminal and civil regulators. Certain information, however, cannot be shared, such as “matters occurring before the grand jury.” (Fed. R. Crim. P. 6(e).)

Further, defendants facing regulatory investigation should always anticipate and prepare for the potential of a parallel criminal investigation, especially if the criminal authorities have not yet surfaced. Civil and state regulators are, for instance, are under no obligation to tell a defendant of the existence of a federal investigation.

Several recent court decisions have addressed the question of what happens when “bad faith” is alleged, that is, when a civil regulator uses civil means to conduct a de facto criminal investigation. Unfortunately, absent extreme circumstances, documents and testimony obtained by civil regulators and later used in criminal proceedings is rarely suppressed. Compare United Sates v. Stringer, 535 F.3d 929, 940-41 (9th Cir. 2008) and United States v. Luce, 2006 U.S. Dist. LEXIS 76052 (S.D. Ill. Sept. 29, 2006) with United States v. Scrushy, 366 F. Supp. 2d 1134, 1135-36 (N.D. Ala. 2005) and United States v. Healthsouth Corp., 261 F. Supp. 2d 1298, 1339 (N.D. Ala. 2003). Indeed, the Ninth Circuit specifically admonished defendants that “the possibility of criminal investigation should have been well known to both the defendants and their counsel.” Stringer, 535 F.3d at 941.

In some situations, evidence obtained by criminal investigators that is otherwise not available to other regulators can become discoverable in a civil suit by virtue of it being turned over to the defendant during pre-trial discovery. Wiretaps, a staple of white-collar criminal investigations, are a prime example. Once produced to a defendant, regulators such as the SEC and even non-government civil plaintiffs (like shareholders or victims) can make discovery requests for these recordings. The Second Circuit did provide a major caveat: the recordings must have been legally obtained; thus, if the defendant can successfully suppress wire tap evidence during the criminal proceeding, they may not be required to produce these recordings as part of the civil discovery process. See SEC v. Rajaratnam, 622 F.3d 159, 169 (2d. Cir. 2010).

This All Sounds So Terrible!

There’s no sugarcoating it, any criminal or civil proceeding that threatens your liberty and substantial decimation of resources is terrible. Facing two at once is extremely difficult. Fortunately, some types of crimes rarely result in parallel proceedings. Per Chair Mary Jo White’s 2014 speech, only 20% of insider trading cases brought by the SEC since 2009 resulted in a parallel criminal prosecution.

Deputy Attorney General Rod Rosenstein also announced last month that DOJ will cease “piling on,” or coordinating with other domestic and foreign agencies to avoid multiple and disproportionate penalties for the same conduct. Legal pundits have assumed that this will result in fewer parallel proceedings, or at least a gentler path for defendants to reach settlement with multiple regulators.



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