SEC Enforcement: How Investigations Unfold and Cases Get Built

SEC Enforcement: How Investigations Unfold and Cases Get Built

Dealing with an SEC investigation can be scary. The SEC has a lot of power to dig into your affairs and charge you with violations. But don’t panic! With some knowledge of how the process works, you can get through it.

How Investigations Get Started

There are a few ways an SEC investigation can begin:

• Tips – The SEC gets thousands of tips a year from whistleblowers, investors, and other sources. If the tip seems credible, they may open an investigation.
• Surveillance – The SEC monitors trading activity to spot suspicious patterns like insider trading or accounting fraud. Unusual trading or financial ratios can trigger an investigation.
• Exams – Routine exams of brokerages and investment advisors sometimes turn up potential wrongdoing that leads to an enforcement action.
• Cooperation – Information from other investigations, like criminal probes by the DOJ, can prompt the SEC to open a new civil investigation.

The SEC has to obtain a formal order of investigation to use subpoenas and compel testimony. But they can start informally gathering facts and talking to witnesses first.

The Investigation Phase

SEC investigations are not public. This phase is all about the SEC developing the facts behind closed doors.

Some techniques SEC attorneys use:

• Informal interviews of witnesses
• Reviewing trading data and financial records
• Examining brokerage records
• Using subpoenas to obtain documents and compel testimony

This can take months or even years. The SEC gathers facts until they determine whether securities laws were broken.

Potential SEC Actions

If the SEC Enforcement Division finds violations, here are some things they may do:

• File an administrative proceeding before an SEC judge seeking fines or bars from the industry.
• File a civil complaint in federal court seeking monetary penalties and injunctions.
• Refer the case to the DOJ for criminal prosecution.
• Issue a Wells notice giving a chance to argue why charges shouldn’t be filed.
• Reach a settlement requiring certain undertakings without filing charges.

The most serious charges like insider trading or accounting fraud will typically lead to federal court actions. Minor infractions may lead to administrative proceedings.

Typical SEC Violations

Some of the most common allegations in SEC enforcement actions include:

• Accounting fraud – Overstating revenue or assets to mislead investors.
• Insider trading – Trading on material nonpublic information in breach of a duty.
• Misrepresentations – False or misleading statements about securities.
• Registration violations – Not properly registering securities or disclosing information.
• Compliance failures – Not maintaining required policies and procedures.

Public companies and financial firms tend to get charged with accounting, disclosure, and reporting violations. Individuals get charged for trading-related misconduct like insider trading.

Defenses and Mitigating Factors

If you receive a Wells notice or are charged in an SEC action, here are some defenses to consider:

• You had no duty to disclose the information or abstain from trading.
• The information was immaterial or publicly known.
• You did not act with intent – it was an accident or misunderstanding.
• Your conduct did not meet the elements required for the violation.
• You had policies and procedures reasonably designed to prevent the violation.

Even if you don’t have an airtight defense, mitigating factors can help reduce penalties, like:

• You accepted responsibility and cooperated fully.
• You had clean disciplinary history.
• You self-reported the violation promptly.
• You took remedial steps to fix compliance weaknesses.
• You relied on counsel’s advice (sometimes).

How to Respond to an SEC Investigation

Learning you are under SEC investigation can be jarring. But taking swift action can help control the damage:

• Hire experienced SEC defense counsel.
• Preserve documents that may be relevant.
• Determine the scope of the inquiry based on subpoenas.
• Gather facts to evaluate liability risks.
• Consider self-reporting if violations occurred.
• Weigh pros and cons of cooperation vs. fighting.

Having experienced SEC enforcement attorneys on your side early is critical. The decisions made at the beginning can shape the ultimate outcome.

Takeaways

Here are some key points to remember about SEC investigations:

• Act quickly to hire counsel when you learn of an investigation.
• The SEC starts informally but can subpoena documents and testimony.
• Many cases end in settlement, so cooperation can help.
• Explore defenses and mitigating factors with your attorneys.
• Your response at the start can impact the trajectory.

Stay calm, get experienced advisors on your team, and take it one step at a time. With smart decisions, you can get through an SEC investigation intact.