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How Receiving a Civil Investigative Demand Impacts a Company’s SEC Reporting Obligations
How Receiving a Civil Investigative Demand Impacts a Company’s SEC Reporting Obligations
When a company receives a civil investigative demand (CID) from a government agency like the Securities and Exchange Commission (SEC), it can have significant implications for the company’s SEC reporting obligations. A CID is essentially an administrative subpoena that compels the production of documents and information related to an investigation. While challenging a CID is difficult, companies should carefully consider their options for responding.
Understanding Civil Investigative Demands
CIDs allow agencies like the SEC to gather large amounts of information, even before formally filing litigation. As explained on the Federal Lawyer site, “civil investigative demands are not subject to court approval. The DOJ, FTC, CFPB, and other agencies can issue civil investigative demands at their discretion.
The grounds for fighting back against a CID are limited. But as the site notes, “companies should not simply assume that they are required to fully comply with a civil investigative demand.” Consulting with legal counsel can help determine if there is any room for negotiating the scope of disclosure.
Weighing the Implications
Receiving a CID from the SEC is not something most companies take lightly. After all, the discovery of wrongdoing can quickly turn a civil investigation criminal. And even in the absence of criminal charges, the SEC can levy hefty financial penalties.
So the stakes are high. As this Reddit comment notes, “100% certain your BIL has been involved in something, it could be something as simple as using a fake currency note.” Carefully reviewing the details of the CID is an important first step.
Key Early Decisions
Among the early decisions a company faces after receiving a CID:
- Should we inform investors and the public? If so, what should SEC disclosures say?
- What data and documents does the SEC want? What is the likely cost and burden of compliance?
- Is there any room to negotiate the scope of disclosure?
- Should we challenge the CID in court?
The Harvard Corporate Governance site examines the tricky question of whether companies need to publicly disclose investigations. Cases and SEC guidance on this issue have been limited. In general, the existence of an investigation does not necessarily mean litigation is “substantially certain” to occur.
Evaluating Reporting Obligations
Public companies have ongoing reporting obligations to the SEC under federal securities laws. Exactly how receiving a formal SEC investigation impacts those duties depends on the specific facts and circumstances at play.
But in general, companies should carefully consider the following reporting issues:
1. Material Information
If the existence of an SEC investigation reaches the threshold of “material information” under securities laws, prompt disclosure is usually legally required. But as noted above, investigations don’t automatically trigger this duty on their own.
In a recent case, a company was not required to disclose an SEC investigation to investors until the eventual settlement, because the penalty fell below a key numerical threshold. But companies should analyze the qualitative and quantitative factors before concluding an investigation is not material.
2. Risk Factors
Public companies must disclose risk factors in SEC filings like 10-Ks and 10-Qs. Receiving a CID may represent a new regulatory risk factor worth disclosing to investors.
Of course, companies should take care not to reveal confidential details or compromise the investigation itself when describing risk factors. But a general statement may be warranted about the existence of an investigation and potential outcomes.
3. Financial Statements
An SEC investigation could impact the way a company reports contingent liabilities in its audited financial statements. Once again, putting specific numbers down is difficult given the uncertain nature of SEC inquiries. But the auditors may insist on disclosing the general possibility of fines or other expenses resulting from the investigation.
4. Insider Trading
Top officials and insiders privy to the existence of an SEC investigation before it becomes public should be extremely careful in terms of their personal trading activities. Otherwise, it risks allegations of illegal insider trading.
Tread carefully here and consult securities counsel for specific guidance. But when in doubt, erring on the side of caution is wise to avoid trouble down the road.
Strategies for Responding
Receiving a CID plunges companies into uncharted waters fraught with risk. Moving forward requires a thoughtful strategy tailored to the unique situation at hand. But in general, sound crisis management calls for:
- Assembling the right team of managers, board members, lawyers, auditors, and communications staff;
- Thoroughly investigating the facts internally before responding externally;
- Carefully drafting required SEC disclosures to inform investors without inflaming the situation;
- Preparing company personnel for the possibility of SEC interviews or depositions;
- Developing a plan for external communications with shareholders, business partners, customers, and the media.
Companies finding themselves in this scenario should know they are not alone. The FTC received enforcement against nearly a dozen CID recipients in recent years alone. Their failures serve as a warning for others to take these investigations seriously from the outset.
While the SEC wields substantial leverage, taking a cooperative posture can pay dividends. Stubborn resistance without a sound legal argument will not serve companies or their investors well over the long haul.
The good news, as explained in this SEC press release, is that “approximately two-thirds of the SEC’s cases involved charges against one or more individuals” rather than companies as a whole. So the focus may quickly shift to certain rogue executives engaged in misconduct without the board’s knowledge.
In any case, SEC inquiries are no small matter, and companies must walk a fine line between defending their interests and avoiding outright confrontation with powerful regulators.