SEC Probes of Public Company Disclosures: Strategies for Defense Lawyers

SEC Probes of Public Company Disclosures: Strategies for Defense Lawyers

When the SEC comes knocking on your client’s door with questions about their public disclosures, it can be daunting for both the company and their legal team. However, with some preparation and strategic thinking, defense lawyers can effectively guide their clients through an SEC investigation. This article examines some of the key considerations and strategies for lawyers defending public companies against SEC disclosure probes.

Understanding the SEC’s Focus

In recent years, the SEC has emphasized the importance of public company disclosure as the “bedrock” of US securities markets [3]. They place a high priority on pursuing companies and individuals who make inaccurate or misleading disclosures in areas like financial reporting, cybersecurity risks, and ESG concerns. Some major areas of focus include:

• Financial reporting – inaccurate revenue recognition, reserve accounting, etc.
• Auditor independence and performance – especially the Big 4 firms
• Executive compensation and insider trading related to inaccurate disclosures
• Cybersecurity policies, risks, and incidents
• Environmental, Social, and Governance (ESG) disclosures

Defense lawyers should have a solid grasp of the SEC’s priorities when beginning to formulate a defense strategy.

Responding to the Initial SEC Inquiry

The SEC often begins an investigation with an informal inquiry letter seeking information or documents related to the company’s disclosures. At this stage, counsel should:

• Carefully review the letter to understand the exact scope of the request
• Consult with the client to gather responsive information in an organized fashion
• Consider seeking a modification or extension if the request seems unreasonable
• Weigh the benefits and risks of voluntary disclosure beyond the letter’s scope

While firms may be tempted to do the bare minimum in response, transparency and cooperation at this stage can build goodwill and potentially resolve issues early. However, counsel should be strategic in determining what is disclosed.

Preparing Witnesses for SEC Interviews

SEC investigations typically involve interviews of key personnel related to the disclosures in question. For interview preparation, defense lawyers may consider:

• Holding a prep session to review relevant documents and refresh recollections
• Reminding clients of the stakes involved – false statements carry criminal liability
• Advising clients to listen carefully to each question and seek clarification if needed before responding
• Discussing the option to pause questioning to consult with counsel
• Developing a coherent narrative of relevant events, with supporting documentation

Thorough witness preparation can help avoid misstatements while promoting the client’s version of events.

Strategic Considerations Around Public Disclosure

A key consideration for counsel is whether and when to recommend that clients publicly disclose the existence of an SEC investigation. Relevant factors include:

• How likely is the investigation to lead to enforcement action?
• What is the potential impact on the company’s reputation and stock price?
• Does securities law require disclosure (e.g. for material events)?
• How might disclosure impact the investigation itself?

There are often good arguments on both sides, and the decision can be challenging. Counsel should present a balanced view of the pros and cons to help clients make an informed decision [4].

Avoiding Missteps as the Investigation Progresses

As an SEC probe continues, defense lawyers should caution clients against common missteps such as:

• Destroying or concealing relevant documents
• Attempting to coordinate stories with other witnesses
• Making public statements that conflict with information provided to investigators
• Retaliating against whistleblowers or other cooperating witnesses

Counsel should remind clients that the cover-up is often worse than the underlying disclosure issue itself. A transparent, cooperative approach is generally advisable.

Exploring Settlement Options

If enforcement action seems likely, counsel may approach SEC staff to discuss settlement options prior to receiving a “Wells notice.” Potential benefits of early settlement include:

• Avoiding a formal investigation process that is resource-intensive
• Controlling the timing of any public disclosures on the matter
• Negotiating reduced charges and/or penalties
• Providing certainty and closure for the client

However, counsel should also consider risks such as the possibility of the SEC staff insisting on admissions of wrongdoing. There are no guarantees in seeking an early settlement.

Building an Effective Defense Strategy

If settlement talks are unproductive and enforcement action proceeds, key elements of an effective defense include:

• Challenging the SEC’s legal interpretations and theories of materiality
• Contesting the evidentiary basis for charges whenever possible
• Seeking to narrow the scope of allegations and proposed remedies
• Presenting counter-narratives to disclosure decisions based on reasonable judgments
• Advocating for reduced penalties and sanctions proportional to the conduct

Counsel should seek opportunities to put the SEC to its burden of proof while pragmatically containing risks for clients.

Avoiding Misguided Approaches

Some ineffective strategies that counsel should generally avoid include:

• Stubbornly resisting any admission of wrongdoing, even on strong SEC evidence
• Making exaggerated claims of attorney-client privilege and work product protection
• Taking an excessively adversarial approach that irks SEC staff
• Simply deferring to SEC demands without critically assessing their validity

While a vigorous defense is warranted, counsel should be careful not to overreach in ways that damage clients’ interests.

Maintaining Perspective Throughout the Process

SEC investigations can be all-consuming, draining company time and resources. While appropriately defending clients, counsel should also:

• Remind clients to stay focused on business operations and strategy
• Caution against overreaction, finger-pointing, or public comments about the probe
• Keep the board updated on a need-to-know basis to avoid surprises
• Monitor employee morale and compliance with company policies during the investigation

By keeping perspective, counsel can help clients navigate SEC probes while mitigating collateral damage and fallout.

The Road Ahead

Defending public company clients against SEC disclosure probes is a high-stakes endeavor requiring strategic thinking and judgment. While each case has unique facts, understanding the SEC’s focus areas, avoiding common missteps, and maintaining perspective are critical to achieving the best possible outcomes. With preparation and prudence, counsel can guide clients through the challenges of an SEC investigation and help position them for future success.