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News July 26, 2004 Issue

Existence of OCIE’s So-Called 'Examination Privilege' In Doubt

In trouble with the SEC or private litigants? Wouldnít it be nice to show that SEC examiners had never raised concerns about the conduct at issue with your competitors?

If that sounds too good to be true, consider this: Earlier this spring, Putnam successfully subpoenaed the SEC for deficiency letters issued to other firms. In preparation for settling with the SEC over the amount of sanctions it should pay relating to its alleged market timing activities, Putnam wanted to shed light on what regulatory requirements, if any, the SEC staff understood to have existed relating to market timing. Putnam requested letters issued by OCIE to advisers, funds, and brokers between February 2003 and March 2004.

OCIE opposed Putnamís request, arguing that deficiency letters and other documents related to SEC examinations are protected by a so-called "examination privilege." OCIE conceded that it was the first time the SEC had considered whether or not such a privilege existed.

In two orders, issued March 26 and April 7, James Kelley, an SEC administrative law judge, declined to recognize the privilege. "I do not question the sincerity of OCIEís belief that the new privilege would serve a worthy public purpose," said the judge. "However, the boundaries of the proposed privilege are poorly defined. OCIE does not even pay lip service to the Supreme Courtís admonition that privileges are not to be lightly created or expansively construed." If OCIE wanted to assert such a privilege, he added, "it must persuade the Commission to announce that the privilege exists and define its limits."

Kelley redacted the 14 deficiency letters at issue to hide the identity of the firms and to reveal only the market-timing-related deficiencies. The letters were handed over to Putnam. On April 7, Putnam settled with the SEC and Secretary of the Commonwealth William Galvin for $110 million.

Hereís the twist: OCIE didnít like Kelleyís orders hanging out there, suggesting that there was no such thing as an examination privilege. So, on April 21, OCIE asked the Commission to vacate the two orders, arguing that leaving them on the books "could adversely affect the Commissionís examination program, because regulated entities may not be as open and forthcoming during the examination process if they believe examination documents are subject to production in administrative proceedings."

Last week, the SEC Commissioners, citing procedural rules and noting that the underlying matter had been settled, declined to vacate the orders.

But in an apparent effort to throw cold water on the lawyers sharpening their pencils to draft subpoena requests, the Commission added that its decision "should not be construed as taking a position" about whether an examination privilege exists. It pointed out that the two ALJ orders were "unreviewed actions" in a settled proceeding, and said that it did not view them as having significant precedential weight. The Commission suggested that the examination privilege question "should be reviewed in a litigated context in which two parties offer competing views." A full and evidentiary record, it added, "is necessary to reach a correct legal conclusion."