SEC Investigations of Proxy Statements.

Proxy statements are among the many public-company disclosures that fall under the SEC’s oversight authority. While the SEC’s enforcement actions are public, and are generally focused on allegations of securities fraud and insider trading, the existence of an ongoing SEC investigation may not necessarily be a matter of public concern. The SEC can initiate, and maintain, confidential investigations prior to any formal public filing of an enforcement action.

Under Rule 14a-9, the SEC has authority to investigate “any solicitation,” “any statement” included within a “solicitation,” and “any solicitation material” that includes a “materially false or misleading” statement or “omits to state a material fact.” In order to avoid potential SEC enforcement, public companies must make efforts to ensure that their proxy statements and other solicitations are compliant with applicable federal securities law provisions.

While the SEC’s authority to investigate under Rule 14a-9 is very broad, it generally applies to proxy statements issued by public companies. This includes statements of the company, and not just statements of the board of directors. Individuals and entities that played a role in the preparation, approval, or transmission of proxy statements (such as company directors, officers, employees, outside accountants, external auditors, and independent committees) can also face SEC scrutiny.

The SEC generally has the authority to investigate proxy disclosures, disclosures that are misleading or incomplete, and other disclosures that violate federal securities law. For example, Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083 (1991), the U.S. Supreme Court held that knowingly false statements of reasons for company actions are actionable under the Exchange Act, even if the actions themselves are authorized under the company’s articles of incorporation and by-laws.

Which Federal Rules Govern Public-Company Proxy Statements?

Exchange Act Section 14(a) has been cited as the primary authority for many of the federal rules and provisions that govern public-company proxy statements. Section 14(a) covers proxy solicitations involving securities that are registered under Section 12 of the Exchange Act. The provision prohibits soliciting shareholder votes through the use of “misleading” or “materially false or misleading” statements or omissions.

Under the Exchange Act, Regulation 14A is among the federal rules and provisions that contain federal proxy-disclosure and solicitation requirements. Included within Regulation 14A is Rule 14a-9, which is one of the provisions that the SEC enforces during public-company investigations. The “materiality” test that applies in Rule 14a-9 comes from TSC Industries, Inc. v. Northway, Inc. (1976). In TSC Industries, the U.S. Supreme Court established the “substantial-likelihood” standard: “An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”

As another provision of Regulation 14A, Schedule 14A specifies the content of several items of information that must be contained within many proxy statements. Schedule 14A has broad application, although the amount of information required varies depending on the specific purpose of the solicitation.

Rule 14a-6(b) requires companies to file “the definitive forms of all written soliciting materials” “no later than the date on which any such soliciting material is first sent to or furnished to security holders,” provided that the soliciting materials have not previously been filed as preliminary materials. If the proxy materials have not previously been filed as preliminary materials under Rule 14a-6(a), and their filing is required under the Exchange Act and Regulation 14A, then they must generally be filed ten calendar days before they can be sent to shareholders.

Finally, Section 14(a) of the Exchange Act also permits an implied private action by a shareholder or other person to seek the correction of an inadequate proxy statement. In J.I. Case Co. v. Borak (1964), the U.S. Supreme Court recognized this implied private action, reasoning that Section 27 of the Exchange Act gives federal district courts jurisdiction over suits to enforce duties created by the Act, so courts may grant all necessary remedial relief, including damages and rescission, for defective proxy solicitations.

What Proxy Disclosures Most Often Draw SEC Scrutiny?

While any material misrepresentation or omission in a proxy solicitation can trigger SEC scrutiny, certain types of disclosures are more likely than others to trigger an SEC investigation. Some of the most common issues that companies and individuals involved in proxy solicitations face include:

• Related-Party Transactions and Revenue Recognition: Many of the issues that lead to SEC enforcement (including fraud and accounting related to revenue recognition) also have disclosure implications that attract scrutiny during proxy-related investigations.
• Shareholder-Meeting Conduct: When activist investors call special shareholder meetings, the conduct of the shareholders’ meeting itself can lead to scrutiny of the underlying proxy materials.
• Executive-Compensation Disclosures: Executive compensation disclosures are subject to specific requirements under the Exchange Act and Regulation S-K.
• Incomplete Voting Disclosures: Companies have voting obligations and voting disclosure obligations under federal securities law.
• Undisclosed Director Conflicts: Disclosure requirements for related-party transactions can trigger scrutiny when public companies fail to adequately disclose, or improperly disclose, conflicting relationships between company directors and the company.
• Disclosures in Press Releases and Analyst Communications: During a proxy solicitation, public companies often disseminate the proxy statements with a variety of other disclosures. The SEC generally has the authority to investigate the content of any disclosure made to investors during the solicitation period, including information in press releases, analyst communications, and other public information.

How Common Are SEC Disclosure Investigations?

• Accounting, Internal Controls, and Executive Compensation: Most SEC disclosure investigations focus on accounting, internal controls, executive compensation, and governance matters.
• Materiality and Fraud: The SEC rarely launches an investigation unless it has evidence of a material misstatement or omission. While most disclosure investigations focus on non-fraudulent conduct, alleging a “reckless” or “willful” misstatement or omission during an SEC enforcement action (a “fraud” violation) is a possibility.
• Misconduct in Public Announcements and Private communications: Misconduct in public announcements may also have potential enforcement implications, particularly if the misstatements or omissions were made in an effort to conceal other illegal or fraudulent activities.
• Disclosure Controls and Procedures: In public-company disclosure investigations, the SEC frequently includes allegations of ineffective disclosure controls and procedures. For example, the SEC has initiated enforcement actions against companies for allegedly failing to “adopt a comprehensive written disclosure controls and procedures policy.”

How Does an SEC Proxy Investigation Actually Proceed?

Like all other SEC matters, SEC proxy investigations and other proceedings under the SEC’s Rule 14a-9 authority can take two very different forms.

• Inquiries from the Corporation Finance Division (and other SEC divisions) serve as a first-line mechanism for the SEC to police the disclosure practices of public companies. The Division of Corporation Finance issues “comment letters” when it has concerns about a public company’s compliance with federal disclosure laws and rules, with the primary goal of obtaining a “response” in which the company agrees to make corrective disclosures in future filings.
• Investigations by the Division of Enforcement serve as the SEC’s second-line mechanism for monitoring compliance. Enforcement-level investigations are conducted with the goal of gathering evidence that will support a complaint, and ultimately an enforcement action. SEC enforcement staff can initiate an investigation voluntarily, but an investigation that is “formal” will be authorized by a Commission-authorized formal order designating specific SEC staff members to serve as “investigators.”

When Does the SEC Issue Subpoenas in Proxy Investigations?

While the SEC can seek a company’s or individual’s cooperation voluntarily during an inquiry or investigation, the Division of Enforcement can use subpoenas in a formal investigation to compel production of documents and to compel sworn testimony. SEC subpoenas can request a wide variety of documents and communications, and SEC staff can also use “interrogatories” (written questions to which there are written responses) to gather information during a proxy solicitation investigation.

Do Public Companies Need to Preserve Evidence During an SEC Investigation?

The duty to preserve potentially relevant evidence arises once a company or individual “reasonably anticipates” litigation. This includes, but is not limited to, receiving an SEC subpoena in connection with a formal investigation. Once triggered, the duty to preserve evidence may require producing a formal litigation hold notice to employees and third parties, preserving relevant computer files, data, communications, and other electronic evidence, and documenting the company’s efforts to comply with its evidence preservation obligations.

What Should I Expect During SEC Testimony in an SEC Proxy Investigation?

Testimony in an SEC investigation is substantially similar to testimony in a deposition. The testimony is generally given under oath and transcribed. The testimony of public company executives, board members, employees, and other witnesses can take hours, days, or even multiple sessions. To make informed decisions about the content and scope of their testimony, company executives, board members, employees, and other witnesses must be fully apprised of their obligations and liability.

How Long Does an SEC Proxy Investigation Typically Take?

There is no universal deadline or timeline for the completion of an SEC investigation. While most investigations begin when the SEC is presented with a potential proxy statement concern, the scope and duration of an investigation can vary depending on the type of securities law violation (or other violation) the SEC is concerned about.

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.

Must a Company Disclose a Confidential SEC Investigation?

An SEC inquiry or investigation regarding a company’s proxy solicitations can expose issuers, individual directors, officers, and other employees to a variety of collateral liability concerns, including:

• Shareholder-Derivative and Securities Fraud Litigation: Even when an investigation remains confidential, plaintiffs’ attorneys and activist shareholders may use their knowledge of a potential (or ongoing) investigation to support claims under federal and state securities laws.
• Government Proceedings: A confidential SEC investigation can trigger more scrutiny (and potentially more questions) from other federal and state authorities.

Do Federal Securities Laws Require Disclosure of All SEC Investigations?

The federal securities laws generally do not impose a blanket duty to disclose all SEC investigations. Whether an SEC investigation should be disclosed generally depends on whether an affected party has a specific line-item disclosure obligation and whether disclosing the SEC investigation is material.

What Line-Item Disclosure Obligations Do Public Companies Have?

Public companies must disclose “the pendency, effective date, or termination of any pending or recently terminated, judicial or administrative proceedings to which the registrant is or was a party,” under Item 103 of Regulation S-K. The SEC is a party to all administrative proceedings involving enforcement under the Securities Act, Securities Exchange Act, and Investment Company Act. If a public company’s proxy solicitation is at issue, then the company’s failure to respond adequately to the SEC’s concerns could trigger an affirmative obligation to disclose the initiation of a formal administrative proceeding under Item 103.

Does Rule 14a-9 Require Supplemental Disclosure of a Prior Proxy Statement?

While Rule 14a-9 does not impose a duty of continuous disclosure of proxy-related information, the SEC advises that “misleading or incomplete proxy statements must be promptly corrected.” Supplemental disclosures are necessary when “a material misstatement or omission in any solicitation material previously filed with the SEC renders a current solicitation material previously filed with the SEC materially misleading.”

How Should Companies and Individuals Protect Themselves During SEC Investigations?

What Role Do Internal Investigations Play in SEC Investigations?

Corporate boards typically appoint audit committees, special committees, or other internal task forces to conduct an internal investigation in order to address the various concerns addressed by the SEC’s inquiry or investigation. The purpose of these internal investigations is to help company directors and executives make informed decisions about how to handle the SEC’s inquiries and requests for information. Key issues in an internal investigation can include:

• Determining whether to invoke the attorney-client or work product privilege,
• Assessing potential accounting, internal controls, governance, and disclosure violations,
• Assessing potential securities fraud and other types of fraudulent violations, and,
• Evaluating the risks and benefits of self-reporting to the SEC (if any).

What Are the Risks of Voluntarily Providing Privileged Material to the SEC?

If the SEC initiates an inquiry or investigation based on non-public information, providing privileged material in response may be a risk. If a company or individual provides privileged material on a “voluntary basis,” this waiver will often apply not only during the SEC’s investigation but also during any later enforcement or private shareholder litigation.

What Are Common-Interest Agreements, and Do They Protect Statements Made to Third Parties?

A common-interest agreement is a contract under which two or more parties disclose privileged material to each other during the course of an investigation. If the communication did not have an independent privilege, then the common-interest agreement will not protect it from discovery.

Are Individual Corporate Personnel Entitled to Advancement of Defense Costs or Indemnification?

Advancement and indemnification rights generally depend on applicable state law (e.g., California, Delaware), the provisions of company bylaws, and the language of other corporate governance documents.

Will Individual Corporate Personnel Need to Hire Separate Defense Counsel?

Securities law violation allegations may present conflicting interests for companies and their directors, officers, and other employees. When necessary, it will be necessary for companies and their directors, officers, and other personnel to hire separate defense counsel. This becomes critically important when the SEC’s investigations or enforcement actions focus on a specific individual’s actions or statements during the solicitation process.

Does Issuer Liability Establish Liability for Corporate Directors, Officers, and Other Personnel?

Corporate liability does not establish liability for every director, officer, or other personnel involved in soliciting shareholder votes. While a public company can trigger a violation of Rule 14a-9 through a misstatement or omission, it will generally be unnecessary to prove individual liability for an enforcement action or private lawsuit, unless a violation is based on a particular individual’s statements during a proxy solicitation.

Can Individual Personnel Face Liability for Their Own Misleading Proxy Solicitations?

While the government generally does not establish liability for company personnel in cases involving public company liability, an individual director, officer, or other employee can be held liable for their own materially misleading statements and/or omissions during a proxy solicitation.

What Happens When SEC Staff Members Find Proxy Violations?

When an SEC proxy investigation leads to a recommendation for enforcement action, the subject(s) of the investigation are usually given an opportunity to argue against recommending enforcement action during the “Wells process.” The Wells process is one of the few opportunities available to the subject(s) of an SEC investigation to present their arguments directly to the staff members who initiated and investigated the matter.

Can SEC Staff Members Close the Investigation Without Recommending Enforcement Action?

SEC staff members may close investigations without recommending action to the Commission. With that said, this is the exception rather than the rule. If the SEC staff member(s) involved find evidence of a securities law violation, they will usually recommend enforcement action. The other common scenario is a “Wells notice” from the SEC.

What Is a Wells Notice?

A Wells notice is a letter from the SEC that is essentially a “heads up” to the recipient(s) of the notice. It serves the dual role of letting the recipient(s) know that the SEC staff recommends recommending enforcement action (against the recipient(s) or someone else) and informing the recipient(s) of the SEC staff’s preliminary views about a relevant securities law violation. A Wells notice is not a “Commission finding,” and its issuance does not mean that the SEC will ultimately pursue an enforcement action.

With that said, a Wells notice is a significant step. The next steps are either negotiating an enforcement settlement with the SEC, taking the case to an administrative or federal court, or fighting to have the SEC’s Commission dismiss the Enforcement Division’s recommendation.

What Are the Consequences of a Proxy Enforcement Action Settlement?

The consequences of a proxy enforcement action settlement can include:

• Disgorgement: “Equitable relief in the form of disgorgement is a remedy focused on the relief of ill-gotten gains.”
• Civil Monetary Penalties: SEC enforcement cases often involve civil penalties.
• Injunctions: This is an order that prohibits the SEC staff from enforcing certain conduct in the future.
• Officer-and-Director Bars: An officer-and-director bar can prohibit an individual from serving as an officer or director of a public company for a fixed period of time (e.g., three, five, or ten years) or for life.
• “Bad Actor” Disqualification: Certain injunctions and orders by the Commission can disqualify issuers and individual personnel under “Regulation D’s bad-actor disqualification,” which prohibits them from relying on several of the “safe harbor” exemptions in the Securities Act.

What Are Some Examples of Public Companies Facing SEC Enforcement in the Proxy Solicitations Context?

In 2023, the SEC charged McDonald’s under Section 14(a) of the Exchange Act and Rules 14a-3 and 14a-9 of Regulation 14A in connection with a proxy solicitation in 2018. The SEC alleged that McDonald’s issued a materially false and misleading proxy solicitation bystating that its former CEO had departed after agreeing not to contest separation. The SEC alleged that he had a conflict of interest because he was having an improper relationship with an employee. In McDonald’s settlement, it agreed to remedial measures, and the SEC did not impose a civil penalty. However, the former CEO, who had not cooperated with the SEC, was ordered to pay $400,000, and he agreed to a five-year officer-and-director bar.

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.