SEC Target Letters: Signals of Securities Fraud Investigations

SEC Target Letters: Signals of Securities Fraud Investigations

Getting a target letter from the SEC can be scary. It means the SEC thinks you may have broken securities laws. But don’t panic! There are things you can do to protect yourself. This article will explain what target letters are, what they mean, and how to respond. We’ll also look at some real cases of securities fraud so you can see how it happens. Our goal is to help you understand target letters and your options if you get one.

What is a target letter?

A target letter is a letter sent by the SEC to someone they think may have violated securities laws. It lets the person know they are under investigation and could face civil or criminal charges. Target letters don’t always lead to enforcement actions. But they signal increased SEC scrutiny.

Target letters typically ask for a “Wells submission.” This is a written statement explaining why the SEC shouldn’t bring an enforcement action. The SEC must consider the Wells submission before deciding whether to file charges. This gives the target a chance to persuade the SEC not to sue them.

What prompts a target letter?

The SEC sends target letters based on evidence of possible securities violations. This evidence often comes from:

• Tips from whistleblowers
• Complaints by investors
• Referrals from other agencies like FINRA
• The SEC’s own surveillance and investigation

For example, if the SEC gets multiple complaints about a brokerage firm’s sales practices, they may start an investigation. If they find red flags like unauthorized trading or misrepresentations, they may send target letters to the firm’s principals.

What are common securities violations?

Here are some typical activities that lead to target letters and SEC enforcement actions:

• Insider trading – Buying or selling securities based on material, non-public information. Example.
• Accounting fraud – Falsifying financial statements and filings. Example.
• Misrepresentations – Lying to investors about products, performance, risks, etc. Example.
• Unregistered offerings – Selling securities without properly registering with the SEC. Example.
• Pump-and-dump schemes – Touting stocks to inflate prices and then sell shares. Example.

As you can see, securities fraud takes many forms. The common thread is deceiving investors for illicit gain.

Real-life target letter cases

Looking at actual cases can help illustrate how target letters work. Let’s examine two high-profile matters:

Mark Cuban – Insider trading allegations

Billionaire investor Mark Cuban was sent an SEC target letter in 2011. It alleged he engaged in insider trading of Mamma.com stock. According to the SEC, Cuban sold his holdings after learning the company planned a private investment in public equity (PIPE) offering. This confidential information allegedly let him avoid over $750,000 in losses when the stock price dropped after the offering was announced.

Cuban disputed the allegations. He did not make a Wells submission. Instead, he sued the SEC. Cuban argued there was no binding agreement restricting his ability to trade the shares. He also said he did not engage in insider trading even if the information was confidential.

The SEC ultimately decided not to pursue enforcement action against Cuban. But the target letter process illustrated how insider trading investigations often begin. The SEC saw suspicious trading around a major corporate event and sent a target letter to investigate further.

Elon Musk – Misleading tweets

In 2018, the SEC sent Tesla CEO Elon Musk a target letter over misleading tweets. Specifically, Musk tweeted that he had “funding secured” to take Tesla private at $420 per share. But the SEC found this statement was false. Tesla had not actually secured funding for a going-private transaction.

Musk submitted a Wells response arguing he believed the tweets were true. But the SEC pushed ahead with an enforcement action for securities fraud. Musk settled the charges, stepping down as Tesla Chairman and paying $20 million in fines. The SEC said Musk’s “false and misleading” tweets harmed investors.

This case shows how public statements by executives can trigger target letters if they prove inaccurate or omit key facts. The SEC expects corporate leaders to exercise care when communicating with the markets.

What to do if you get a target letter

Receiving an SEC target letter can be unsettling. But it’s important to remain calm and know your options. Here are some steps to consider if you get a target letter:

1. Consult an attorney – Get legal counsel from a securities lawyer before responding. They can guide you through the Wells process or negotiating a settlement.
2. Preserve documents – Save all files, emails, texts, etc. related to the allegations. These may help rebut the charges.
3. Consider making a Wells submission – Weigh the pros and cons of making a formal written defense before deciding.
4. Explore settlement – The SEC settles most cases. A quick settlement may limit penalties and negative publicity.
5. Don’t panic – Target letters don’t mean you’ll necessarily be sued or found liable. Take a breath and proceed carefully.

The most important step is getting experienced legal counsel. Securities laws are complex. An SEC investigation can turn into a long, stressful process without the right guidance.

Takeaways

Dealing with an SEC target letter is no fun. But understanding the process and getting skilled legal help can improve the outcome. Key points to remember include:

• Target letters signal increased SEC scrutiny but don’t guarantee enforcement actions.
• Making false statements and omitting key facts are common triggers for target letters.
• Getting experienced counsel is critical when responding to a target letter.
• Wells submissions allow targets to present defenses before charges are filed.
• Settlement is possible in many cases and may limit penalties.

With the right preparation, targets can emerge from SEC investigations without long-lasting harm. But ignoring a target letter is never wise. This just raises the odds of ending up in a protracted legal battle.

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