Can Officers Go to Jail for SEC Violations??

An SEC violation is not automatically a felony or criminal offense. While the SEC can impose heavy civil penalties on corporate officers, the U.S. Department of Justice is the government agency responsible for criminally prosecuting federal securities fraud and other securities-related crimes. This distinguishes civil enforcement actions from criminal prosecutions.

The SEC is incapable of indicting defendants on its own. No federal statute or Supreme Court precedent has granted the SEC this authority. Similarly, the SEC is incapable of obtaining any form of criminal punishment, and it cannot obtain a prison sentence as a result of a case filed in federal court. Instead, the SEC has the authority to seek financial restitution, including fines, disgorgements, and injunctions. While the SEC can initiate an investigation, the DOJ is the only federal agency that can seek to have corporate officers imprisoned for securities fraud.

Is a corporate officer criminally liable if they personally participated in violations that triggered an SEC investigation? Yes, they are criminally liable. But a corporate officer cannot go to jail as a result of an SEC investigation. As with the DOJ’s criminal prosecutions, federal judges, not the SEC, determine criminal defendants’ sentences after a conviction.

In a press release from August 2021, the DOJ disclosed that among all sentenced securities fraud offenders in fiscal year 2020, 86.6% of those individuals were sentenced to some length of incarceration in federal prison. The average sentence was 46 months. Other recent securities fraud cases have resulted in much longer prison sentences. For instance, Bernard Madoff received 150 years, Allen Stanford received 110 years, and Sam Bankman-Fried recently received 25 years.

When Does an SEC Violation Become a Federal Crime?

Securities Act Section 24 makes any “willful” violation of any provision of the Act or of the rules and regulations promulgated by the Commission thereunder, as well as willfully making an untrue statement of a material fact in a registration statement, a criminal offense punishable by up to five years in prison. Exchange Act Section 32(a) makes any “willful violation” of any provision of the Exchange Act (or any rule promulgated thereunder) a criminal offense. A violation of federal securities fraud laws can also lead to criminal prosecution under 18 U.S.C. § 1348, which authorizes prison sentences of up to 25 years. In general, federal securities fraud is treated as a felony offense, though some of the securities laws make certain violations misdemeanors. Felony offenses are generally defined as federal offenses that carry statutory maximum prison sentences of more than one year.

Are the Standards Different Between Criminal and Civil Securities Cases?

In a civil enforcement case brought under the SEC’s authority, it may only prove a statutory violation by a preponderance of the evidence. In a criminal securities case prosecuted by the DOJ, federal prosecutors must prove every element of the statutory violation (including criminal intent) beyond a reasonable doubt. While a federal court is able to find a defendant civilly liable for a securities violation based on the preponderance of the evidence standard, it cannot convict a defendant of a securities crime unless the evidence supports a guilty verdict to a near certainty.

What Types of Intent Are Required for Criminal Liability for Securities Fraud?

The various federal securities fraud laws that allow for criminal prosecution under U.S. Code Sections 1348 and 1343 all impose varying requirements for the state of mind necessary to support a conviction. For example, Section 1348 requires the government to prove that a defendant knowingly executed or attempted to execute a “scheme or artifice . .. to defraud any other person . .. or to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with any . .. security.” Section 32 of the Exchange Act allows for criminal penalties when the violation is “willful.” While most securities-fraud statutes establish a “knowingly” standard, the federal obstruction of justice statute and the federal wire fraud statute, 18 U.S.C. § 1343, impose a “specific intent” standard. Specific intent generally requires prosecutors to prove that a defendant not only had knowledge of what they were doing but intended to produce a specific criminal result.

What Types of Intent Are Required for Criminal Liability Under the Exchange Act?

The criminal enforcement provisions of the Exchange Act impose “willful” standards of liability that have several noteworthy exceptions. Among them, Section 32(a) of the Exchange Act explicitly states that a “willful violation of this chapter or a rule promulgated under this chapter shall be punishable . .. unless it can be proven that the defendant had no knowledge of the particular provision of the Act or rule violated.”

Does Holding a Corporate Officer Position Make a Defendant Liable for Federal Securities Violations?

No, merely occupying the role of a corporate officer does not establish a defendant’s participation, intent, or guilt. While corporate officers can have particular statutory duties, their failure to meet these duties does not automatically result in liability, especially if a corporate entity is the one responsible for filing a fraudulent or inaccurate statutory document. That said, corporate officers and their respective companies can both face proceedings that stem from the same underlying conduct. If a corporation commits securities fraud, corporate officers who had knowledge of, or played a role in, the misconduct can face criminal prosecution and civil enforcement action alongside the company. With this in mind, corporate officers should be mindful of the fact that they can be held liable under several different theories when defending their positions in SEC matters.

What Are Some Examples of Direct Criminal and Civil Liability for Securities Fraud?

Corporate officers can potentially be held either criminally or civilly liable for federal securities fraud. For criminal liability under the various federal fraud and racketeering statutes, federal prosecutors must prove their case against a corporate officer beyond a reasonable doubt. With respect to civil liability, the SEC must establish a preponderance of evidence in order to prevail. Some of the civil provisions of the Exchange Act and related federal securities laws and regulations require a showing of scienter, while others allow for liability in cases of negligence.

Among the substantive provisions of the Sarbanes-Oxley Act (S-O), the following impose compliance requirements and liability for corporate officers who have a statutory duty to ensure accurate financial disclosures for their respective companies:

• Section 302 of S-O, for example, requires CEOs and CFOs of publicly traded companies to personally certify that their employers’ periodic financial reports are accurate and are not misleading. They certify that no part of the reporting documents contains any false or misleading statements and no omissions. If the certifications are found to be false, CEOs and CFOs can face penalties under S-O’s provision, the U.S. federal securities fraud statute, or the DOJ’s federal wire fraud or bank fraud statutes.
• Section 303 of S-O also prohibits officers and directors from improperly influencing or coercing an issuer’s auditor in its performance of an audit.

Can Corporate Officers Be Liable When They Facilitate Another’s Fraud or Violate SEC Rules in Another’s Behalf?

Corporate officers can become liable in criminal fraud cases when they assist with or cause others’ misconduct. Under 18 U.S.C. § 2, criminal aiding, abetting, and counseling of another are punished as the offense the parties participated in, even if the aider or abettor did not execute or attempt to execute the fraud himself. Similarly, Section 371 makes federal prosecutors able to bring conspiracy charges if they have evidence showing that two or more parties conspired to defraud the federal government by committing one or more federal crimes.

Similarly, federal judges can hold corporate officers liable in civil proceedings when they facilitate violations of federal securities laws. Under Section 20(e) of the Exchange Act, “For purposes of any action brought by the Commission under paragraph (1) or (3) of section 78u(d) of this title, any person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this chapter, or of any rule or regulation issued under this chapter, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided.” The federal securities laws also contain a “control person” provision (Section 20(a) of the Exchange Act), which is another common basis for liability in civil enforcement actions. Section 20(a) is a form of joint and several liability under which every person who, directly or indirectly, controls any person liable under the federal securities laws can also be held liable jointly and severally with and to the same extent as the controlled person. This form of liability is presumed under the Exchange Act; and it is up to the accused control person to prove that they acted in good faith and did not directly or indirectly induce the acts constituting the violation.

If you are facing this situation, Spodek Law Group handles federal criminal defense matters nationwide, from offices in New York and Los Angeles.

How Can an SEC Investigation Create Criminal Exposure?

While it is possible to face a criminal prosecution based on an SEC investigation that has been referred to the U.S. Department of Justice (DOJ), a formal referral from the SEC is not required in order for the DOJ to initiate a criminal investigation. The SEC’s Division of Enforcement investigates cases suspected of involving violations of federal securities laws and rules. If the SEC or a whistleblower tips off the DOJ, prosecutors can then initiate a criminal investigation regardless of whether the SEC decides to refer the case. In some cases, the SEC and the DOJ will investigate federal securities fraud or other alleged securities-related crimes concurrently. Both agencies can work together to build a case, and the DOJ can use testimony, emails, and other documents from the SEC’s civil investigation to support a criminal prosecution.

• What is the difference between an SEC subpoena and a DOJ indictment? An SEC subpoena is not a criminal document and is not equivalent to an indictment. An SEC subpoena asks a party to provide certain records, such as documents, emails, and information. If the target of a subpoena, whether an individual or a corporation, is reluctant to produce these records, it can invoke its Fifth Amendment privilege against self-incrimination. The Fifth Amendment provides that no person shall be compelled in any criminal case to be a witness against himself. This right to silence is also available in civil cases, such as SEC civil proceedings. A corporate officer, for example, can refuse to testify at a deposition or before a grand jury by invoking his right to remain silent. However, while constitutional protections and court rules bar federal judges from allowing a prosecutor to pursue the “Fifth Amendment right to remain silent” in criminal prosecutions, the opposite standard applies in civil proceedings. In cases decided in civil bench trials, federal judges may be permitted to draw adverse inferences from silence in civil matters.
• Can corporate officers rely on their corporations’ legal teams during SEC and DOJ investigations?

Corporate officers and other targets of SEC and DOJ investigations should be aware that corporate counsel ordinarily represents the interests of the corporation, not those of the individual officers. While corporate officers are entitled to rely on their representation by corporate counsel in most cases, they should be mindful of the potential conflict of interest that exists between them and their companies. Absent a specific representation agreement to the contrary, corporate counsel’s primary duty is to protect the company’s interests. This creates several issues that corporate officers must understand. First, voluntary testimony during an SEC interview can be used as evidence in a criminal case. For example, if a corporate officer gives deposition testimony at a SEC proceeding that allows for a criminal prosecution, the corporate officer can face criminal sanctions in the DOJ’s securities fraud prosecution. Second, corporate counsel will do all he can to protect his client, the corporation, even if this means doing nothing to support the corporate officer during an SEC investigation. Third, the corporation controls the attorney-client privilege. When corporate counsel represents both a corporation and one of its officers, it is usually the corporation that is entitled to use the privilege in its defense and, as a result, the corporation can waive the privilege over the officer’s objection. As a result, it is not uncommon for corporate officers to face civil or criminal liability due to a statement made during the representation of their employer.

What Can the SEC Impose Instead of a Prison Sentence?

The SEC Enforcement Staff does not personally impose penalties or sanctions in civil enforcement matters. Instead, the Enforcement staff’s role is to conduct investigations and build civil cases against individuals and entities that they believe have violated federal laws and regulations. In most SEC civil enforcement cases, either a federal judge in U.S. District Court imposes sanctions, or the Commission formally imposes the sanctions following administrative proceedings.

While the Enforcement staff can only request sanctions in their cases, they can request any number of remedies from federal judges and the Commission. These are just some of the sanctions that can be imposed in SEC enforcement matters:

• Civil monetary penalties;
• Permanent or preliminary injunctions against violating the Exchange Act or Investment Advisers Act;
• Disgorgement of “unjust enrichment”;
• Cease-and-desist orders; and
• Bars against serving as directors, officers, or investment advisers.

Civil Monetary Penalties

Civil penalties are a frequent sanction in SEC enforcement proceedings. The SEC’s ability to seek civil penalties is subject to statutory caps, though there is often some room for negotiation. Generally, statutory penalty caps will fall into one of three tiers, and the tier that applies will depend on a variety of factors, including whether the violation was the result of fraud, deceit, or manipulation. Many of the statutory caps under the Exchange Act and the Investment Advisers Act receive annual inflation adjustments.

Disgorgement

Another sanction that can be imposed in SEC enforcement matters is disgorgement. In Securities and Exchange Commission v. Liu, the Supreme Court upheld the SEC’s ability to seek disgorgement under some circumstances. This sanction generally limits the recovery to the “net profits” that defendants received in exchange for committing the violations, and it may allow the SEC to remit these profits to the victims. In SEC matters, federal judges and the Commission will also rely on the other remedy provisions of the federal securities laws.

Time Limits

For civil penalties, the five-year statute of limitations for asserting a claim under 28 U.S.C. § 2462 is generally the limiting factor. If the civil penalty sought is based on fraud or a different type of “scienter-based” claim, then the SEC may be able to pursue disgorgement for up to ten years after the subject violations.

Jury Rights in SEC Matters

• Can the SEC initiate civil enforcement proceedings in federal district court without a jury? While most federal civil suits are tried by a jury, this is not always the case in the SEC’s cases. In SEC & Exchange v. Jarkesy, the Supreme Court recognized that an investor has the right to a jury trial in federal district court when the SEC is seeking a penalty under federal securities fraud laws. The Supreme Court also noted that certain types of SEC cases require a “clearer distinction” between their substantive claims (e.g., violation of the Exchange Act), procedural enforcement, and sanctions sought.

Factors That Impact Civil Penalties

When determining what penalties to impose against defendants in civil securities fraud cases, federal judges and the SEC Commission will consider several factors, including:

• The harm suffered by victims;
• The amount of unjust enrichment;
• The respondent’s prior violations of federal securities laws;
• Deterrence, specifically the need to deter others from future violations; and
• The respondent’s conduct (or lack thereof) during the investigation and any subsequent proceedings.

Talk to Spodek Law Group

Every case turns on its own facts, and general information is no substitute for advice about yours. Todd Spodek, managing partner of Spodek Law Group, and the firm's attorneys defend federal criminal and white collar matters nationwide. Reach the firm at 212-300-5196.