Securities Fraud: SEC Investigations and Criminal Exposure

The SEC investigation and the criminal investigation are not the same proceeding. They are frequently the same facts, viewed through different statutory frameworks by different agencies that share information freely.

Securities fraud occupies a distinctive position in the white-collar criminal landscape because it is among the offenses most likely to involve parallel civil and criminal proceedings. The Securities and Exchange Commission has civil enforcement authority over violations of the securities laws. The Department of Justice has criminal enforcement authority over the same conduct. The two agencies coordinate their investigations, share evidence, and time their respective proceedings to maximize the government’s overall enforcement leverage. A defendant who settles an SEC civil matter without understanding the criminal dimensions of the same conduct may find that the civil settlement has provided the government with admissions that it will use in the criminal prosecution.

The Elements of Criminal Securities Fraud

Criminal securities fraud under 18 U.S.C. 1348 requires proof that the defendant, in connection with any security of an issuer with a class of securities registered under the Securities Exchange Act or that is required to file reports under the Act, knowingly executed or attempted to execute a scheme to defraud any person in connection with any security of such issuer, or obtained any money or property by means of false or fraudulent pretenses, representations, or promises.

The parallel criminal provisions of the Securities Exchange Act at 15 U.S.C. 78j(b) and Rule 10b-5 promulgated thereunder require proof of a material misrepresentation or omission, scienter, connection to the purchase or sale of a security, reliance, economic loss, and loss causation. Insider trading cases are prosecuted under the Rule 10b-5 framework, with the government required to prove that the defendant traded on material nonpublic information obtained in breach of a duty of trust or confidence.

The SEC Investigation Phase

The SEC’s investigation of potential securities violations proceeds in two phases: the informal inquiry and the formal order of investigation. In the informal phase, the SEC staff gathers information voluntarily through requests for documents and voluntary interviews. In the formal phase, following a formal order issued by the Commission, the staff possesses subpoena authority to compel testimony and document production.

A subject of an SEC investigation who receives a voluntary request for documents or a Wells notice, the SEC’s notification that staff intends to recommend enforcement action, is at a stage where civil and criminal exposure must be assessed together. The voluntary production of documents in response to an SEC request may constitute a waiver of Fifth Amendment rights in connection with those specific documents. The testimony provided in an SEC formal investigation proceeding may be used in a subsequent criminal prosecution. The interaction between the civil and criminal proceedings requires counsel who practices in both domains.

The SEC’s wells process, the opportunity to submit a written response to the staff’s anticipated recommendation before any enforcement action is filed, is one of the few pre-charge opportunities to present the defense’s view of the facts to the authority considering charges. It is an opportunity that requires preparation equivalent to a sentencing memorandum in a criminal case, and it is an opportunity that most subjects treat as significantly less important than it is.

Insider Trading: The Most Commonly Investigated Theory

Insider trading prosecutions require the government to prove that the defendant traded while in possession of material nonpublic information, that the information was obtained in breach of a duty, and that the defendant knew or should have known the information was obtained in breach of that duty. The duty element has been the most contested component of insider trading law, with different circuits applying different standards until the Supreme Court’s decision in Salman v. United States in 2016 clarified the personal benefit test applicable to tippee liability.

Insider trading investigations typically begin with the SEC’s surveillance of unusual trading activity preceding significant corporate announcements. Statistical anomalies in options trading, equity purchases concentrated in the days before merger announcements, and trading patterns inconsistent with the defendant’s usual investment behavior are the triggers that initiate investigations. By the time an insider trading defendant receives any formal notice of the investigation, the government typically has months of trading records, communication logs, and witness interviews already assembled.

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Defense Strategies in Securities Fraud Cases

Defenses in criminal securities fraud cases address each element that the government must prove. The materiality defense challenges the significance of the information allegedly traded upon, arguing that a reasonable investor would not have considered it significant in their investment decision. The scienter defense challenges the defendant’s knowledge of the misrepresentation’s falsity or the nonpublic nature of the information. The duty defense, most relevant in insider trading cases, challenges whether the relationship through which the information was obtained imposed the kind of duty of trust and confidence that the law requires.

The parallel civil proceeding provides defense counsel with an unusual window into the government’s theory before the criminal case is fully developed. The SEC’s formal charging documents, the civil complaint or administrative proceeding, describe the government’s factual and legal theory in detail that the criminal indictment alone does not provide. Analyzing that theory, identifying its weaknesses, and developing a defense strategy that addresses both the civil and criminal dimensions simultaneously is the work that distinguishes comprehensive securities fraud defense from case management.