SEC Enforcement Against Registered Representatives.

SEC enforcement action against registered representatives is complex. A registered representative who is facing SEC scrutiny could also be facing civil, criminal, FINRA, and state investigations, all of which can proceed concurrently.

Voluntarily supplied information can have a direct impact on the Commission’s later enforcement decisions when facing SEC scrutiny. In this context, choosing whether to cooperatively disclose, which can sometimes expose a registered representative to state, criminal, or FINRA liability, is a crucial first decision. If a registered representative’s defenses and those of their firm diverge materially, it will also be necessary to seek separate counsel.

SEC investigations can arise from a variety of sources, including complaints, tips, electronic trading surveillance, and referrals from other regulatory agencies, as well as other sources that are often not disclosed. While most adviser examinations end with no further action, any issues identified during an examination can escalate to an investigation when the Division of Examinations staff believes a violation of federal securities laws may have been committed.

The SEC’s annual enforcement reports are general in nature and are not broken down by registered representatives or other specific groups. Similarly, while EDGAR is the Commission’s public filing system, its role in triggering enforcement is limited to enforcement targeting a failure to file.

When the Division of Examinations releases its examination priorities each year, this signals to registered representatives and their firms where the Commission’s staff is focusing its efforts. However, these publications cannot be viewed as guarantees of Enforcement charging decisions; they simply reflect the priorities of the staff at a particular time.

Which Regulators Can Act Against a Registered Representative?

SEC enforcement actions are civil or administrative proceedings. The U.S. Department of Justice (DOJ), through federal prosecutors, is responsible for bringing criminal securities charges. Registered representatives must, therefore, be mindful of the distinct sources of authority for SEC and DOJ enforcement actions.

While FINRA is a well-known enforcement authority for registered representatives, it is important to understand the sources of its authority as well. FINRA is a self-regulatory organization, not a federal enforcement agency, and is delegated the responsibility of regulating registered representatives and brokerage firms by the SEC. Registered representatives face an additional source of enforcement authority because of their association with (and FINRA’s jurisdiction over) their brokerage firms.

Within FINRA’s jurisdictional scope, FINRA Rule 8210 is one of the key provisions authorizing FINRA’s ability to impose requirements on its members and associated persons. When pursuing an inquiry, inspection, or examination, or when conducting or facilitating investigations into potential violations of the Securities Exchange Act, FINRA Rule 8210 permits FINRA to require that its members and associated persons provide information, supply records, furnish testimony under oath, and allow access to accounts and documents. The information and documents compelled under FINRA Rule 8210 can be used in subsequent enforcement proceedings and may, in certain cases, be referred to the SEC for enforcement.

State securities regulators also have the authority to conduct enforcement action against registered representatives within their jurisdictions. State securities regulators generally have a variety of sources of authority, and state enforcement actions often follow separate procedures from those of the SEC and FINRA. State enforcement proceedings can, however, be brought at the same time as SEC and FINRA enforcement proceedings, and registered representatives should be prepared to face multiple sources of regulatory scrutiny.

Registered representatives can also be referred to the DOJ for criminal prosecution. Both SEC and FINRA may refer cases to the DOJ when investigations uncover what appears to be criminal conduct. However, while the SEC and FINRA are responsible for enforcement under various administrative, civil, and regulatory authorities, the DOJ has jurisdiction over the enforcement of federal criminal statutes. Registration and affiliation with a brokerage firm does not carve out an exception for criminal liability under federal law; and, like all securities professionals, registered representatives can be subject to criminal prosecution for violations of the Securities Exchange Act and related federal laws.

What Happens After the SEC First Contacts Me?

The next steps in an SEC investigation will depend upon the source of the inquiry and the type of authority the SEC is exercising when it first reaches out to you.

If the SEC is seeking to uncover violations based on a complaint from a customer or a news story, its first inquiry will typically be an “informal” one. For unregistered broker-dealers, an “informal” inquiry means that the SEC is not exercising its compulsory subpoena power. Participation is, therefore, generally voluntary. However, in these inquiries, registered representatives can-and often will-voluntarily supply information, and this information can then have a direct impact on SEC enforcement decisions down the road.

An “informal” inquiry may give way to a formal investigation if the SEC staff believes there is substantial evidence that registered representatives may have violated the federal securities laws. To open a formal investigation, the staff must obtain a Formal Order of Investigation (or Formal Order). Once the SEC staff has a Formal Order, it has the authority to compel registered representatives and their brokerage firms to comply with the SEC’s requests under Section 21(b) of the Securities Exchange Act.

With a Formal Order in hand, the SEC can use a subpoena to compel compliance in order to produce documents or furnish testimony under oath. The issuance of a Formal Order is the first step in opening a compulsory investigation; and, with that, it triggers the SEC’s ability to compel the production of documents and testimony. However, a Formal Order does not constitute charges, and a registered representative who receives a subpoena should not mistake the latter for proof that criminal or civil charges will follow.

Many SEC cases are ultimately filed without a Wells notice. As noted, the Wells process is the SEC staff’s decision to contact you in advance of filing charges. However, even when the SEC gives notice that it will file enforcement charges, registered representatives cannot assume the process will play out predictably. For instance, while some sources suggest the SEC sets a 30-day deadline for submitting a response, this deadline is at the discretion of the SEC staff.

An SEC staff member can subpoena a witness, and this means a witness will be required to cooperate. If a registered representative is unwilling to do so, the SEC may request that a federal court compel compliance. However, the SEC cannot enforce its own subpoenas; and, it must go to court to request that a federal judge formally order a witness to comply.

How Do I Protect Myself During an SEC Investigation?

Registered representatives facing SEC scrutiny must be mindful of any other investigations as well. Because civil, criminal, FINRA, and state inquiries can overlap and run concurrently, statements made in one proceeding can have significant implications in others. As a result, we advise our clients to carefully coordinate their defenses in all relevant regulatory proceedings.

When compelled to testify during an SEC investigation, witnesses must make important decisions regarding when to invoke their right to remain silent. At Spodek Law Group, we rely on the Fifth Amendment to protect our clients from self-incrimination during SEC investigations. However, unlike criminal prosecutions, SEC investigations are civil or administrative matters. As a result, while the Fifth Amendment can still be used to stop testimony, civil factfinders can draw adverse inferences from its use.

Registered representatives can protect themselves during SEC investigations in a variety of other ways as well. Among the most important is the attorney-client privilege. We rely on the attorney-client privilege in SEC enforcement cases, as this privilege protects communications between a lawyer and their client made in confidence for the purpose of legal advice. This protection applies to communications that would be otherwise subject to disclosure during an investigation, and, in most cases, a lawyer can protect information under the attorney-client privilege even if the underlying facts or preexisting documents are not protected. However, sharing information that is protected by the attorney-client privilege with third parties will, in many cases, trigger a waiver of the privilege.

Another important step is to preserve all potentially relevant documents. Our lawyers can work with your brokerage firm to ensure that all relevant records and communications are preserved during its SEC investigation. While a duty to preserve documents is not immediately triggered, it becomes binding as soon as the registration and litigation or enforcement proceedings become reasonably foreseeable. Failure to preserve all relevant documents, whether intentional or not, can lead to additional liability, and it can also make it impossible to build a complete and comprehensive defense strategy.

Registered representatives also have a variety of other rights during the SEC’s investigative process. For example, witnesses have the right to legal representation during SEC investigations under 17 C.F.R. § 203.7, and investigated persons have the right to submit written positions in response to the SEC’s allegations under 17 C.F.R. § 202.5(c). However, as with other rights, the right to representation, the right to testify, and the right to submit written positions can all be easily waived or lost if not carefully maintained.

If any of this describes your situation, it is worth talking it through with counsel. Spodek Law Group can be reached at 212-300-5196.

What Can the SEC Charge and What Must it Prove?

The SEC can pursue enforcement action against registered representatives either administratively or by filing a civil lawsuit in federal district court. The former involves filing a complaint in an administrative proceeding, which will proceed until settled or brought to trial. The latter involves filing a complaint in federal district court, which can also be resolved with settlement or litigation. The SEC’s allegations under either procedure can be pursued on one or more of the following grounds:

The following sections of the federal securities laws focus on fraud by sellers and issuers of securities. The following laws apply to registered representatives when they are selling (or attempting to sell) securities to members of the public:

Securities Act § 17(a)(1) makes it unlawful to “employ any device, scheme, or artifice to defraud” in the offer or sale of a security. This prohibits registered representatives from misrepresenting material facts about securities in their offerings.

Under Securities Act § 17(a)(2), it is unlawful to “obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” This section applies as a broad anti-fraud provision.

Section 17(a)(3) makes it unlawful to “engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.” This section makes it unlawful to sell securities fraudulently, whether through use of misleading documentation, failure to disclose material facts, or other means.

The following law also applies to registered representatives when selling, attempting to sell, or promising to sell securities to members of the public, but with the added effect that it applies only in cases of intentional misconduct:

Section 10(b) of the Securities Exchange Act imposes liability in private lawsuits and SEC enforcement action for fraud committed in connection with the purchase or sale of any security. Section 10(b) includes SEC Rule 10b-5, and a violation of Rule 10b-5 is prohibited under Section 10(b).

The following section imposes fraud liability on registered representatives when they act in the capacity of a broker or dealer:

Section 15(c)(1) makes it unlawful for a broker or dealer to use the mails or interstate commerce to effect, or to induce or attempt to induce the purchase or sale of, any security by means of a manipulative, deceptive, or other fraudulent device or contrivance.

Generally, when seeking civil sanctions in district court, the SEC will have the burden of proving by a preponderance of the evidence that a registered representative violated a substantive provision of the federal securities laws. The amount of proof required is sometimes less in other cases, as well, and in some cases, the amount of proof may be higher.

While Section 10(b) requires a showing of scienter (i.e., intentional misconduct) to sustain a violation, a violation of Section 17(a)(2) or 17(a)(3) can be established through evidence of negligence. However, for fines or penalties, the SEC must show willful or reckless misconduct.

Recently, in SEC v. Jarkesy, the U.S. Supreme Court held that the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties against that defendant for securities fraud, which means the SEC must bring such an action in federal court rather than in an in-house administrative proceeding. This decision significantly impacts the types of enforcement cases that the SEC can pursue and may change the procedural requirements in the coming years.

What Penalties and Settlement Terms Could the SEC Seek?

The penalties and sanctions available to the SEC under the federal securities laws are broad. While the specific remedies available in any particular case will depend on the facts involved, potential remedies are:

Injunctions

Under the federal securities laws, injunctions can bar registered representatives and brokerage firms from violating specific provisions of the laws. While injunctions are often one of the more serious forms of federal enforcement, they do not necessarily come with a fine. Instead, injunctions apply when a registered representative or brokerage firm has been alleged to have knowingly committed fraud or violated any other specific provision of the federal securities laws.

Administrative Sanctions

Registered representatives can also face administrative sanctions during SEC enforcement actions. This is true even if their violations are not based on fraud or scienter. The sanctions available to the SEC in administrative proceedings include:

Loss of license to serve as a broker-dealer, investment adviser, or other regulated entity

Fines for violations of various federal securities regulations

Disbarment from appearing or acting before the SEC

Civil Monetary Penalties

The SEC can impose civil monetary penalties under the federal securities laws in several circumstances. The U.S. government generally only has the authority to seek civil monetary penalties under U.S.C. § 2462, which establishes five years for civil monetary penalties. However, Section 21(d)(8) of the Exchange Act allows a ten-year statute of limitations for disgorgement in cases involving scienter-based violations. While disgorgement is an available remedy under Exchange Act § 21, the U.S. Supreme Court has recently limited the application of disgorgement. In Liu v. SEC, the U.S. Supreme Court held that disgorgement should be limited to the “net profits” obtained by defendants and awarded to victims of their conduct, unless a monetary penalty is imposed separately.

Cooperation Credit

The SEC offers cooperation credit to individual defendants facing enforcement actions in certain circumstances. As a result, registered representatives may be able to mitigate their penalties and sanctions by cooperating with the SEC. However, cooperation is not a guaranteed remedy. Cooperating may avoid charges, but it does not necessarily entitle the defendant to reduced charges or lower sanctions.

Admissions

The SEC has historically imposed admissions as a settlement term for many cases. However, admissions are not required in SEC enforcement actions unless the defendants settle. If a defendant chooses to accept a settlement offer, the terms will be subject to negotiation and can vary widely depending on the registered representative’s cooperation with the SEC.

Penny-Stock Bars

One of the SEC’s most effective ways of protecting the public is to ban individuals from serving in the penny stock industry. Under Exchange Act § 15(b)(6), the SEC can seek a bar against associated persons who have been involved in a fraudulent sale of penny stocks. This bar prevents any involved individual from continuing to engage in trading of penny stocks, as well as acting as a broker or dealer for the penny stock market.

How Can an SEC Case Affect My License and Job?

The impact of an SEC investigation on a registered representative’s license or employment will depend on their broker-dealer’s policy, their job description, and their coverage under the firm’s policies and procedures. Broker-dealer registered representatives will need to make particular amendments to their Form U4 and Form U5 reporting requirements.

If a registered representative’s broker-dealer files a Form U4 amendment in relation to an SEC investigation, then an allegation of wrongdoing against the registered representative can create a “disclosure event” under the FINRA Form U4. Broker-dealer registered representatives need to disclose a wide range of regulatory, criminal, civil, and customer-initiated matters, and the list of events triggering a Form U4 disclosure continues to grow.

When a registered representative is terminated from their position following an SEC investigation, the registered representative’s broker-dealer must also file a Form U5. Both the Form U4 and Form U5 are public disclosures that can have significant repercussions for broker-dealer registered representatives. This is true regardless of whether the registered representative’s conduct was found to be criminal or whether the conduct triggered penalties or sanctions.

Along with being a “disclosure event,” certain allegations and findings during SEC investigations can also lead to “statutory disqualification” under Exchange Act § 3(a)(39). Statutory disqualification is the legal term for a violation that makes a registered representative ineligible to hold a license in the financial industry.

Registered representatives’ and brokerage firms’ ability to access insurance coverage depends on the specific language of their policies and the applicable governing law. Insurance companies often carve out exceptions for fraud, as well as other types of prohibited conduct, and registered representatives and brokerage firms that have been accused of fraud will need to examine their policies closely. Notice requirements also present challenges to insureds, as insurance policies must be submitted in writing, often within a strict deadline.

Advancement of legal fees and reimbursement of fines and costs are other important considerations as well. While the legal authority to advance defense expenses varies depending on applicable law, it differs from the authority to indemnify. While statutory disqualification does not preclude a broker-dealer from accepting or defending an affiliated broker-dealer, indemnification is not generally required or permitted in cases of alleged or adjudicated fraud.

As noted, while brokerage firms will frequently pay for their affiliated brokers to use their counsel and defense counsel in SEC enforcement actions, these lawyers do not automatically serve as lawyers for the individual. Firm-paid counsel are lawyers for the brokerage firms unless another attorney-client relationship exists. This is a significant consideration when brokerage firms face conflicting interests during SEC enforcement proceedings.

The public availability of enforcement records is a concern for broker-dealer registered representatives and brokerage firms as well. The information available on the BrokerCheck website and disclosures filed through Form U4 and Form U5 are generally public records. Registered representatives’ ability to avoid public disclosure depends on the nature of the disclosure and how long after the event in question. FINRA Rule 8312 specifies the time that FINRA records are subject to public disclosure, and the rule lists five types of events that will be permanently subject to disclosure.

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.