Multi-Regulator Investigations: SEC, FINRA, and State AGs.

Multi-Regulator Investigations: SEC, FINRA, and State AGs

A single transaction, representation, or omission (or a series of such acts) can trigger a multi-front battle. The same conduct can be the impetus for civil enforcement action by the SEC or state authorities, criminal investigation by state or federal prosecutors, self-regulatory inquiry by FINRA or other SROs, and private securities litigation by customers and investors. As a result, parallel agencies can obtain identical records through separate (but overlapping) subpoenas, demands, or other means of compelling a response. These agencies also compare independently obtained documents, emails, and testimony in order to identify inconsistencies and contradictions between what the individual or company says to one agency and what the individual or company says to another agency. For example, the SEC and FINRA have recently pursued successive sales-practice inquiries involving the same (and related) broker-dealers. The SEC and New York Attorney General’s Office have both pursued investigations into dark-pool trading in related (albeit separate) investigations. Market-timing practices, with allegations ranging from securities fraud to market manipulation, have prompted parallel SEC and New York Attorney General investigations in several cases. Pay-to-play allegations have also recently attracted scrutiny by the SEC, state authorities, and federal prosecutors. We recommend taking a holistic approach to dealing with multiple investigations and enforcement proceedings. By aggressively challenging the inquiry or proceeding at its earliest stages, we can help our clients make informed decisions about their next steps while minimizing the risks to the greatest extent possible. This approach is especially important when multiple investigations are underway, as decisions made in one investigation can (and will) have implications for every other inquiry that is underway, and for any that may be on the horizon.

Which regulator has authority over the same conduct?

At first glance, many regulators’ authority may seem to be overlapping. However, their scope of authority and the nature of their investigations differ fundamentally. For example:

FINRA (Self-Regulatory vs. Civil Enforcement) FINRA

is a self-regulatory organization (SRO) rather than a government agency. FINRA’s disciplinary matters are self-regulatory proceedings, as opposed to civil enforcement proceedings like those conducted by the SEC. Similarly, FINRA customer arbitrations are a form of alternative dispute resolution and differ in nature from FINRA’s disciplinary proceedings.

State Attorneys General vs. State Securities Regulators State

attorneys general have the authority to conduct statewide investigations and to enforce securities laws in many states (subject to their states’ enabling statutes). State securities regulators, on the other hand, have the authority to conduct statewide investigations and to enforce their respective states’ blue-sky registration and antifraud provisions. In many cases, state attorneys general and state securities regulators are separate (though complementary) enforcement authorities that may both have authority over the same conduct.

SEC (Regulated Entities vs. Market Participants) The SEC

enforces the federal securities laws against regulated entities, including broker-dealers, investment advisers, and investment companies, and against market participants, including publicly traded companies and individuals who trade securities and derivatives on organized exchanges. The SEC’s enforcement authority includes conducting investigations and pursuing charges against persons who violate any provision of the federal securities laws, including the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Advisers Act of 1940.

FINRA Rule 8210 FINRA Rule 8210 grants the SRO

the authority to seek information and testimony from FINRA member firms and from persons subject to FINRA jurisdiction. Rule 8210 applies to both member firms and persons, and it grants FINRA the power to compel information from persons who are associated with member firms and who have registration records.

State Attorneys General (State Enabling Statutes) State

attorneys general have broad authority to protect the public, including in the area of securities fraud. They also have the authority to engage in law enforcement through civil and criminal proceedings, to conduct investigations, and to take other appropriate action. State attorneys general’s authority is granted by state law, and the scope of their authority varies depending on their state’s enabling statute.

State Securities Administrators (Blue-Sky Law) State

securities administrators enforce state securities law, often referred to as blue-sky law. This includes registration and antifraud provisions for securities issuers, broker-dealers, investment advisers, and other registered individuals.

Department of Justice (Criminal Enforcement)

The SEC has authority over civil securities enforcement. When parallel investigations are conducted, the U.S. Department of Justice is typically the agency responsible for criminal enforcement. The Department of Justice can initiate criminal charges based on the same conduct that might warrant civil charges by the SEC.

How do we coordinate evidence requests and competing deadlines?

When multiple regulators are involved in investigations, the request for evidence can be overwhelming. Our lawyers are highly adept at helping our clients deal with evidence requests. We are also highly adept at helping our clients deal with competing deadlines. Here are some of the reasons why our experience is essential to a successful outcome.

The Nature of Evidence Requests An SEC Form 1662, “Supplemental Information for Persons Requested to Supply Information Voluntarily or Directed

to Supply Information Pursuant to a Commission Subpoena,” states in the first page of instructions that, “information obtained may be shared with other agencies of the government or foreign governments.” However, delivering a production to the SEC will not satisfy another regulator’s demand for information, although it can substantially lessen the burden of the production request. When facing requests from multiple regulators at once, it is crucial to remember that: - Information produced to one regulator will not necessarily be used (or even considered) in connection with an investigation conducted by another regulator.

• A production to one regulator does not necessarily mean that the same production will be acceptable to another regulator.
• A production to one regulator can inform another regulator’s inquiry if the other regulator obtains the production by means other than through the first regulator.
• Different regulators will have different custodians, periods, and formats, and may require different certifications and other documentation.

As a result, it is important to coordinate the production process between different regulators. Our lawyers can work to meet individual regulators’ requests while simultaneously ensuring that all productions are uniform and consistent.

The Nature of Deadlines

There is no rule that states the SEC, FINRA, or a state authority must proceed first, last, or in any other order. Therefore, when facing an SEC inquiry, FINRA disciplinary proceeding, or a state attorney general investigation, any order of proceedings can be to the extent possible to the benefit (or detriment) of a party. For example, delays in proceeding with the SEC will have repercussions in the FINRA, DOJ, and state proceedings. As a result, it is important to have a high-level perspective on all proceedings that could potentially affect a matter. All production requests, letters, notices, and other demands will have the same implications on one’s response deadline.

The Nature of Evidence/Testimony/Disclosure/Deadlines

When facing SEC or state regulatory scrutiny, individual decisions often have the potential to effect others.

The Nature of Parallel Investigations

Parallel investigations also raise unique issues. We work with our clients to make critical decisions that affect the outcome of all investigations. By keeping the evidence, testimony, disclosures, and deadlines in mind, our lawyers can ensure that all decisions are made in coordination with one another.

• SEC Subpoenas
• FINRA Rule 8210 requests
• SEC Wells Submissions
• State Investigative Demands

  How can we protect privilege and manage employee conflicts?

  Voluntary Disclosure A voluntary disclosure of privileged material to a regulator may waive attorney-client privilege to third parties. As a result, if the voluntary disclosure is permitted, the materiality produced to regulators may be obtained through discovery and used against the company in private litigation. Third parties such as private plaintiffs seeking damages in private class action lawsuits can often obtain materials produced to regulators.

As a result, in many circumstances, companies cannot protect attorney-client privilege by voluntarily producing privileged information to the government. When companies voluntarily produce privileged material to federal government authorities, they must do so with the knowledge that the third party may be able to obtain this information.

One argument against this conclusion is that some federal courts have recognized a so-called selective waiver, which permits a party to voluntarily disclose privileged material to a government regulator without waiving the attorney-client privilege with respect to third parties. The federal circuits are, however, divided over whether a selective waiver is available. The Eighth Circuit is the only circuit to have adopted selective waiver, in Diversified Industries, Inc. v. Meredith, 572 F.2d 596 (8th Cir. 1977) (en banc). The Third, Fourth, Sixth, Ninth, Tenth, and D.C. Circuits have rejected selective waiver, and the Second Circuit has declined to adopt a per se rule either way while refusing to apply selective waiver on the facts before it.

If a company decides to voluntarily produce privileged information to the government, it must prepare for the potential consequences of waiving the attorney-client privilege to third parties in the courts.

Issues with Representation and Conflicts Privilege

is not the only issue that must be considered when executing an internal investigation. When multiple individuals are facing an inquiry or investigation, there are also issues of representation and potential conflicts. As with attorney-client privilege, the company generally owns the attorney-client privilege in investigations that are conducted under the direction of the company’s outside counsel.

When organization interests may conflict with an employee’s interests, Model Rule 1.13(f) of the Model Rules of Professional Conduct (MRPC) addresses the potential issues involving organizational counsel.

Model Rule 1.13(f) states: “In dealing with an organization’s directors, officers, employees, members, shareholders or other constituents, a lawyer shall explain the identity of the client when the lawyer knows or reasonably should know that the organization’s interests are adverse to those of the constituents with whom the lawyer is dealing.”

Model Rule 1.7(a) of the MRPC defines when a concurrent conflict of interest exists, and Rule 1.7(b) sets out when a lawyer may nonetheless proceed. A lawyer may represent two clients who have a concurrent conflict of interest only if the lawyer “reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client,” the representation is not prohibited by law, it does not involve asserting a claim by one client against the other in the same proceeding, and each affected client gives informed consent, confirmed in writing.

Internal Investigations Internal

investigations can be conducted under the direction of an organization’s board, audit committee, special committee, or other committee. Internal investigations are extremely important as they allow boards and senior management to make informed decisions regarding privilege, disclosure, remediation, and self-reporting. They also provide insight into necessary remedial efforts and will be vital to the outcome of the inquiry or investigation.

Can I refuse testimony or invoke the Fifth Amendment?

Individuals Yes, individuals can refuse to testify when facing SEC, state, or other civil regulatory scrutiny. While an individual may have to give testimony, the individual can refuse to answer specific questions during a testimony by invoking their Fifth Amendment privilege against self-incrimination. However, civil tribunals may draw adverse inferences from an individual’s refusal to testify or answer specific questions during a civil regulatory investigation.

Individuals’ invocations of their Fifth Amendment privilege can also potentially create liability under 18 U.S.C. § 1001. When an individual responds to questions in a civil regulatory investigation, the individual must be truthful. If an individual untruthfully responds to a government investigator, the individual can be charged with a federal crime under 18 U.S.C. § 1001.

While, generally, when an individual invokes the Fifth Amendment privilege, the individual must do so question by question, this is not always the case. For example, if an individual provides a response to a government investigator, the individual may not later refuse to answer a follow-up question to that response on Fifth Amendment grounds. As a result, if there are concerns about the individual’s Fifth Amendment privilege, the individual may choose to invoke the privilege before answering a question that may lead to follow-up questions. Corporations A corporation cannot invoke the Fifth Amendment privilege against self-incrimination. Even though the corporation’s records may contain incriminating evidence against individuals in the corporation’s senior management, the corporation cannot refuse to produce documents on Fifth Amendment grounds.

FINRA When facing a FINRA

inquiry or disciplinary proceeding, individuals and member firms are generally not able to invoke the Fifth Amendment privilege. The Fifth Amendment privilege protects individuals from being compelled to be witnesses against themselves by a state actor. Courts generally do not view FINRA as a state actor, and courts generally hold that the Fifth Amendment does not apply in FINRA proceedings. Additionally, FINRA Rule 8210 contains no Fifth Amendment exception. As a result, individuals and member firms cannot refuse to testify on Fifth Amendment grounds. If an individual associated with a FINRA member firm refuses to testify, FINRA may punish the individual for his or her failure to testify. However, if there is a criminal inquiry alongside FINRA’s investigation, it will be possible to refuse to testify.

Can one regulator’s settlement affect the other investigations?

Yes. When multiple regulators are involved, settling with one can trigger a cascade of consequences for the others. For example, in the context of an SEC investigation and a parallel FINRA investigation, an earlier settlement with the SEC can trigger statutory disqualification under the federal securities laws before the FINRA investigation concludes. Settlement Releases A settlement release is another important issue. Settlement releases bind only the parties identified in the settlement agreement and release only the claims within its stated scope. As a result, an early settlement will likely leave a company with multiple unresolved investigations and enforcement proceedings.

Settlement Language Settlement

language also plays a key role. The language used in a settlement instrument governs the scope of admissions and releases, the parties’ future cooperation obligations, the parties’ rights to penalty credits, and other critical aspects of the settlement.

The language used in a settlement instrument can also have significant implications in other parallel proceedings. For example, a settlement in an SEC enforcement action may require a company or individual to admit to certain facts or conduct. These admissions may be used against the company or individual in a FINRA inquiry or disciplinary proceeding, and the company or individual may be unable to contest their accuracy in its response to the other regulators. Settlement Implications As with settlements, resolving one regulator’s claims is not the same as resolving all regulators’ claims.

Similarly, if a company or individual pays a penalty to one regulator, the payment does not automatically offset the penalty that the company or individual may owe to another regulator.

As a result, it is important to consider the potential consequences of a settlement across all relevant proceedings. Our lawyers handle matters negotiating settlements on behalf of companies and individuals in SEC, FINRA, DOJ, and state enforcement proceedings.

In order to coordinate resolutions with multiple regulators, a company or individual will have to negotiate multiple settlement instruments. Each participating authority will have to approve its settlement instrument before the company or individual can conclude all of its investigations.

Other Considerations When facing a FINRA

inquiry or disciplinary proceeding, it is also important to consider the sanctions that other regulators have imposed for the same misconduct. FINRA’s Sanction Guidelines include a Section on “Aggravating Factors” and a Section on “Mitigating Factors.” In cases where other regulators have imposed sanctions for the same conduct, FINRA may consider this as an aggravating or mitigating factor when determining an appropriate sanction.

Parallel state investigations may also play a role. In some cases, state attorneys general may coordinate their investigations. As a result, a state attorney general may resolve his or her state’s claims based on a settlement negotiated with the federal government on behalf of a group of states.

What must happen after the first regulatory contact?

SEC Disclosure Obligations Receiving

an investigative subpoena from the SEC (or any other regulator) does not, of itself, automatically create an obligation to issue an SEC disclosure. However, it can create an obligation for the company (or individuals) to issue public disclosures. Item 103 of Regulation S-K provides:

“A company must generally disclose material pending legal proceedings, including those that do not involve any party other than the company. An SEC investigation may not trigger a disclosure obligation under Item 103 if it does not give rise to a legal proceeding.”

As a result, it is important for the company or individual to consult with SEC disclosure counsel promptly after receiving a subpoena or other investigative demand.

Preservation of Documents and Records

When a company reasonably anticipates litigation, it must preserve all potentially relevant documents, emails, and other records that could be used by the opposing party in the proceedings. This obligation applies in civil litigation and in regulatory investigations (civil and criminal). To fulfill its preservation obligation, the company should promptly issue an “evidence preservation hold,” or a “litigation hold.”

A preservation hold should instruct all relevant employees, officers, and directors to:

• Preserve and not destroy or modify any documents, electronic records, or other materials potentially responsive to the regulator’s inquiry or demand
• Suspend any and all routine or automatic data deletion or destruction practices; and
• Provide a copy of the preservation hold to outside counsel.

Preservation obligations also encompass the obligation to preserve business-related communications sent through employees’ personal devices and through ephemeral-messaging platforms.

If a company or individual has been subject to a subpoena, the destruction of any material that was responsive to the subpoena could expose the company or individual to criminal prosecution under 18 U.S.C. § 1519.

Early-Stage Regulatory Matters Regulatory

investigations often do not begin with an investigative subpoena. Instead, they often begin as:

• A routine examination;
• An informal request for information (e.g., an SEC “request for information” or a FINRA “Rule 8210 request”); or
• A complaint filed by a customer or a competitor.

Examinations can be referred to an agency’s enforcement staff if the examiners find evidence of violations of the law. Informal requests and complaints can trigger full-blown investigations as well. As a result, companies must take all early-stage regulatory matters seriously and treat them as the potential beginning of an inquiry or investigation.

Talk to Spodek Law Group

Every case turns on its own facts, and general information is no substitute for advice about yours. Todd Spodek, managing partner of Spodek Law Group, and the firm& #x27;s attorneys defend federal criminal and white collar matters nationwide. Reach the firm at 212-300-5196.