How to Fight an SEC Enforcement Action.

An SEC matter can begin as an informal inquiry or a formal investigation. Either way, it should be taken seriously. With an informal inquiry, the SEC staff will send you (or your counsel) a request for information. This process can be more protracted if the staff opens a formal investigation. During a formal investigation, the staff has subpoena power. Even if the SEC staff declines to file any charges against you, you may still need to spend the time and expense of litigating.

Examinations can also escalate into referrals to the Division of Enforcement. If you receive a subpoena, request for information, or any other communication from the SEC, you should contact a securities enforcement defense attorney immediately.

The primary goal of avoiding enforcement proceedings will be to avoid a recommendation of enforcement action by the SEC staff. While the SEC staff can end an investigation without filing charges, any charges that are filed can bring licensing, debarment, insurance, commercial, and reputational consequences. A related risk is that government enforcement activity can trigger a private securities class action, which can bring additional costs and exposure.

SEC enforcement proceedings aren’t limited to public issuers, although these issuers certainly make up a significant portion of the agency’s enforcement activity. The SEC also investigates private companies. Similarly, not only can companies be the target of the SEC’s enforcement activity, but officers, directors, employees, auditors, accountants, and lawyers can all face scrutiny as well. For those lawyers, accountants, and other professionals who may be the subject of Rule 102(e) proceedings, the stakes can be especially high.

All of the above apply whether you are targeted for alleged violations of the Securities Act, Securities Exchange Act, Investment Company Act, Investment Advisers Act, or any of the myriad of others governing the U.S. securities industry.

What Should I Do Immediately After SEC Contact?

1. Preserve All Documents and Other Relevant Information

Once litigation or an SEC enforcement proceeding is reasonably anticipated, there is a duty to preserve all relevant documents and other electronically stored information. As a result, one of the most important first steps in any SEC matter is implementing the appropriate preservation protocol. As we have explained in greater detail on our SEC document preservation page, this requires a targeted approach in order to avoid the risk of unnecessary disclosure to the SEC.

2. Respond in Compliance with the SEC’s Rule 21F-17

The SEC has promulgated a special rule regarding “impeding” direct communications with the SEC staff. This is Exchange Act Rule 21F-17, and it is one of the most important rules in the agency’s regulatory framework. It is also one of the most-cited rules for purposes of administrative proceedings.

The SEC has recently asserted that this rule prohibits companies from requiring employees to report securities law violations internally first. As the SEC staff makes clear on its Securities and Exchange Commission Bulletin page, “We have recently brought several administrative proceedings against companies for impeding the ability of whistleblowers to directly communicate with the SEC.”

3. Immediately Address Conflicts and Other Representation Issues

When faced with an SEC enforcement proceeding, it is important to make sure that you are represented by qualified and experienced SEC defense counsel, and that your counsel is not subject to any conflicts of interest that prevent it from providing zealously defended representation.

The American Bar Association Model Rules of Professional Conduct (ABA Model Rules) are particularly important in this regard. See, for example, ABA Model Rule 1.7, which governs concurrent conflicts between the organization’s counsel and those seeking representation in an SEC matter. If your company has recently implemented an internal investigation, the protections afforded by the “Upjohn Warning” become an issue. If you have recently come into possession of documents in response to an SEC subpoena, this is even more true.

4. Consider Advancement of Fees and Insurance Coverage

If you are an officer, director, or employee facing scrutiny in an SEC enforcement proceeding, it is important to address advancement of your legal fees promptly. Advancement rights are generally governed by applicable corporate law, organizational documents, and other applicable agreements. Similarly, if your organization provides coverage under a directors and officers (D&O) liability policy, timely notice is important, as many policies require advance notice before coverage becomes available.

5. Consider the SEC’s Assertion of Privilege Waiver

One of the SEC’s most-cited arguments is that companies are required to disclose privileged material in response to a subpoena, and that failure to do so should be interpreted as a waiver of privilege. It is also true that the voluntary disclosure of privileged material to the SEC can potentially waive the attorney-client privilege (or any other privilege) in later private litigation. However, this is a highly complex area of the law, and these are issues that require careful analysis of the facts at hand.

6. Determine What the SEC Already Knows

While responding to the SEC, it is also important to keep your investigative and defensive efforts focused by determining what the SEC already knows. The SEC staff has a wealth of information at its disposal in many cases, including information derived from whistleblowers and information obtained through cooperation agreements. With that said, companies may also have conducted their own investigations when faced with an SEC enforcement proceeding. If so, then an unassisted (and well-planned) investigation can help determine the scope and focus of the SEC’s investigation.

How Should I Respond to an SEC Subpoena?

1. Understand Your Obligations and Options Under the SEC’s Subpoena Authority

As a result of its formal investigation order, the SEC has the authority to seek information and testimony under 15 U.S.C. § 78u(b). When responding to an SEC subpoena, the most important questions to address include:

• What is the SEC’s subpoena authority?
• What are the SEC’s production or appearance requirements?
• What can (and must) I do to respond to the subpoena in order to preserve the privilege?
• What are the SEC’s means of enforcing the subpoena?
• What are the SEC’s requirements for refusing the subpoena (or for asserting the privilege)?

2. Respond to the SEC Subpoena Accordingly

As a result, responding to an SEC subpoena requires responding to the SEC’s specific requirements as well as complying with the legal and ethical obligations that are on the table. The requirements for responding to an SEC subpoena are not uniform. For example, while the SEC’s subpoenas will specify a production or appearance date, the SEC hasn’t imposed any universal response period (similar to the 30-day response periods in federal court). The SEC can, however, seek enforcement of its subpoenas under 15 U.S.C. § 78u(c).

3. Preserve All Relevant Documents

Once litigation or an SEC enforcement proceeding is reasonably anticipated, there is a duty to preserve all relevant documents. In order to respond to this duty, companies and other entities must implement the appropriate document preservation protocol. As we have discussed on our SEC document preservation page, this includes taking targeted steps toward ensuring that evidence is not inadvertently destroyed. These steps are especially important in light of the rules adopted in the 2015 amendments to Rule 37(e) of the Federal Rules of Civil Procedure. Under the current version of Rule 37(e), federal district courts have the authority to impose sanctions for the loss of electronically stored information in circumstances where it should have been preserved.

How Can a Wells Submission Prevent SEC Charges?

1. Advocate Before the SEC Makes Its Charging Decision

A Wells submission is a written response to a Wells notice. The primary function of a Wells submission is to provide individuals and companies the opportunity to advocate before the SEC decides whether to bring any charges. By this means, the Wells submission (or multiple submissions) will, in many cases, play a key role in preventing an SEC enforcement action from starting.

In fact, this also includes self-reporting. If a company is aware of a potential violation, the most effective way of providing information to the SEC may be the strategic decision to self-report before the government gets in contact with its senior management (or its legal counsel).

2. Understand Your (Limited) Rights and Duties When Facing an SEC Enforcement Action

When facing an SEC enforcement action, individuals and companies can expect much more of a challenge than they would in private litigation. This is the case, in part, because of the SEC’s enforcement manual, which imposes the following requirements (among others):

• The SEC Enforcement Manual generally gives individuals and companies four weeks to file their Wells submission.
• Recipients of a Wells notice do not have a general precharge right to seek discovery of the evidence the SEC has in its possession.
• Statements in a Wells submission may be used in later SEC proceedings.

3. Strategically Pursue “Cooperation Credit” from the SEC

Along with responding to the SEC’s subpoena (or other precharge request), individuals and companies can pursue cooperation credit from the SEC. To earn “cooperation credit,” parties must provide “extraordinary cooperation” to the government. The SEC’s SEC Cooperation Policy (or the “Cooperation Framework”) establishes the government’s approach to assessing the extent of a company’s or individual’s cooperation, and it recognizes a variety of factors.

4. Respond to the SEC Enforcement Staff’s Request for Information and Documents

Ultimately, if the SEC reaches the end of its investigation without any enforcement charges being filed against you, you (or your company) can walk away without any liability. To ensure this result, you will need to deal with the SEC enforcement staff’s various requests for information and documents, and you will need to pursue a strategy focused on doing this within the boundaries of the SEC’s authority.

With that said, responding to an SEC enforcement proceeding can be a complex and time-consuming process. In order to protect your organization and your interests, it is important to work closely with your outside counsel to determine the best course of action going forward.

Todd Spodek is the managing partner of Spodek Law Group, a second generation criminal defense firm that has been practicing since 1976.

Should I Testify When Criminal Charges are also Possible?

1. Assess the Potential for Parallel Proceedings

In addition to the SEC, parties can face investigations or disciplinary proceedings in various other contexts. These include inquiries from FINRA, the CFTC, the PCAOB, and state regulators. Each of these bodies has the authority to pursue enforcement for suspected violations of the securities laws and other laws regulating the brokerage, consulting, auditing, and investment banking industries.

In some cases, federal criminal prosecutors will also open investigations. Although the SEC generally pursues civil remedies, the Justice Department is responsible for pursuing criminal prosecutions, and the two agencies will occasionally open parallel investigations targeting the same alleged conduct.

The same approach can be taken in cases involving allegations of violations of the Foreign Corrupt Practices Act (FCPA). The SEC and DOJ both have enforcement authority under the FCPA, and parallel investigations are common in these matters. Parallel SEC and DOJ proceedings arise outside the FCPA context as well, as in the criminal prosecution of John DeMarr. In this case, the DOJ alleged that DeMarr participated in an $11 million digital-asset conspiracy between late 2017 and May 2018. DeMarr was charged with one federal crime, a single count of conspiracy to commit securities fraud, to which he later pleaded guilty.

2. Invoking the Fifth Amendment When Facing an SEC Enforcement Action

As individuals facing an SEC enforcement action, you may face a difficult choice. If you are facing the possibility of criminal charges as well, this is especially true. For example, you may want to invoke the Fifth Amendment to avoid providing testimony and evidence for a criminal prosecution. But, if you do not testify, this could hurt your defense at the SEC (or in other civil proceedings).

In fact, while civil courts do not have the authority to compel a party to waive the Fifth Amendment, they are generally allowed to make negative inferences from a party’s refusal to testify. In other words, while the court will not convict you for asserting the Fifth Amendment, it could reach a finding of liability based on your silence. Similarly, while corporate custodians will be protected by the Fifth Amendment, this doesn’t prevent government investigators from seizing the corporate records at issue in the custodian’s possession.

What Defenses Can Defeat or Narrow the SEC’s Claims?

1. Use the SEC’s Burdens to Your Advantage

In civil enforcement proceedings, the SEC bears the preponderance-of-the-evidence burden of proof. If the SEC’s claims cannot be substantiated up to this standard, they will be barred.

Along with this, the SEC will generally need to be prepared to overcome defenses relating to:

• The applicable statute of limitations
• The elements of the SEC’s claim(s)
• The availability of any applicable safe harbor
• Legal defenses that raise defenses to liability or penalty exposure

2. Use the SEC’s Substantive Burdens to Your Advantage

When attempting to prove liability for a securities-law violation, the SEC will need to overcome substantive burdens as well. To these substantive burdens, you should respond with substantive defenses.

For example, while many federal claims, including many of those that are on the table in securities-law litigation, generally require proof of a defendant’s intent, SEC enforcement claims that are brought under Section 10(b) of the Securities Exchange Act and Rule 10b-5 only require proof of the defendant’s scienter. However, while a private plaintiff would be entitled to prove a reasonable reliance on the defendant’s fraudulent statement or a financial loss suffered as a result of the fraudulent statement, the SEC need not prove either in civil enforcement actions.

On the other hand, the SEC can often establish claims under Section 17(a)(2) and Section 17(a)(3) of the Securities Act based upon a defendant’s negligence. In other words, to avoid liability in these cases, defendants must demonstrate that they did not act negligently in respect to the subject matter at hand.

3. Use the SEC’s Procedural Burdens to Your Advantage

The SEC’s procedural burdens also present opportunities for defense. As the SEC enforcement manual explains: “The SEC’s enforcement case must be prepared well-executed. As a result, the SEC staff must conduct thorough investigations. It must determine the scope of its investigation, determine which witnesses are likely to have relevant information, and collect all necessary documents and testimony.”

Some of the SEC’s procedural burdens include the duty to preserve its evidence during its investigation and in order to proceed to trial; and, while the duty to preserve evidence has been heavily litigated in the private litigation context, it is also important to keep this duty in mind when defending against SEC enforcement proceedings. If the SEC fails to preserve its evidence, you should take advantage of this failure when defending against the SEC’s claims.

Some other substantive grounds to defeat an SEC enforcement action include the applicable statute of limitations and the fact that a defendant may have made a mistake. As a result, if you are facing an SEC enforcement action, you should take advantage of the SEC’s procedural and substantive burdens in order to shield your organization and interests.

How Can I Challenge an Asset Freeze or Receivership?

1. Avoid Asset Freezes and Court-Appointed Receiverships

If you are an individual or business, you may also face issues involving asset freezes and court-appointed receiverships. As a result of these issues, it is important to consider all available defenses, especially when facing the risk of disgorgement of illicit proceeds. The SEC can seek an asset freeze and receivership before, during, and after litigation in federal civil enforcement actions. In fact, although the SEC must meet a relatively high standard to prevail in its request for a receivership, the fact is that federal courts have frequently granted these requests at the SEC’s request.

At the same time, relief defendants can also be subject to asset freezes. An SEC enforcement action may trigger a court order freezing a relief defendant’s assets even if the relief defendant did not violate any rule, regulation, or statute under the SEC’s enforcement authority.

2. Defend Against SEC Requests for Asset Freezes and Court-Appointed Receiverships

When fighting to preserve your assets, you should prepare to challenge any requested asset freeze or court-appointed receivership. This includes asserting defenses against the SEC’s substantive assertions and ensuring that the SEC’s procedures comply with all applicable legal and ethical obligations.

Here too, there are specific protections available in some circumstances. For example, under Federal Rule of Civil Procedure 65(b), federal district courts are generally precluded from granting ex parte temporary restraining orders.

Furthermore, under 28 U.S.C. § 1292(a)(1), individuals and businesses are entitled to an immediate appeal from any order granting an injunction, and this includes injunctions that freeze assets during the pendency of an SEC enforcement action.

3. Challenge Orders Imposing Asset Freezes and Receiverships (Including the Enforcement of the Orders)

If you do not prevail with your defenses to the SEC’s request for an asset freeze or a court-appointed receivership, you should challenge the enforcement of the resulting order. While an asset freeze may be imposed, you should still ensure that you maintain the ability to pay your bills and other day-to-day expenses. In many cases, it is important to ensure that you do not incur liability for civil contempt of court. For example, in a 2015 ruling, the Seventh Circuit Court of Appeals denied the SEC’s request for civil contempt charges against Martin Armstrong following a seven-year confinement related to the SEC’s case against Armstrong.

Should I Settle the SEC Case or Go to Trial?

1. Take Your Defense to Trial

Although many SEC enforcement cases end with a settlement agreement, defendants have the option to take their case to trial. This includes federal appeals review if necessary. With this in mind, it is important to evaluate all defenses. While not every defense can beat a full SEC case, even partial successes can make settlement more attractive.

For example, in Liu v. SEC, the U.S. Supreme Court limited the SEC’s authority to seek equitable disgorgement of defendants’ ill-gotten profits. The Court explained that a district court may only order disgorgement of a defendant’s net profits and must award the disgorged amount to the corresponding victim.

Similarly, in order to impose a permanent injunction, the SEC must show that there is a reasonable likelihood that the defendant will violate the federal securities laws again.

In some cases, permanent injunctions can be imposed without a finding of liability. Some defendants can, however, prevent the imposition of permanently injunctive relief by establishing a good-faith effort to comply with the SEC’s enforcement proceedings.

When imposing civil remedies, the SEC may also seek an officer-director bar or a penny-stock bar. Depending on the facts at hand, these could be particularly important defenses.

2. Settle the SEC Case

3. Make Informed Decisions About the Settlement

4. Appeal the SEC’s Decision

5. Seek the Appropriate Remedies in Response to the SEC’s Decision

6. Evaluate the Ability to Avoid a Settlement or Judgment

While many SEC enforcement actions and other proceedings end with a settlement agreement, there are many circumstances in which settlements do not offer any perceived advantage. For example, if the terms of the settlement would trigger Rule 506(d) bad-actor disqualification and no waiver is available, taking the case to trial may make more sense.

Similarly, when entering into an SEC settlement agreement, defendants must be prepared to deal with a settlement undertaking. While these undertakings are similar in nature to payments, they create continuing obligations to the SEC. Finally, if you are considering a settlement, you need to be prepared to deal with the implications of any resulting consent judgment. Consent judgments will typically not allow a party to appeal.

Contact a Federal Criminal Defense Attorney

Nothing here is legal advice, and the details of your case matter. Todd Spodek and Spodek Law Group take federal criminal and white collar cases nationwide, from offices in New York, Brooklyn, Queens and Los Angeles. You can reach the firm at 212-300-5196.