Securities Fraud: When Can the SEC Impose Officer and Director Bars?

Securities Fraud: When Can the SEC Impose Officer and Director Bars?

Securities fraud is a big deal, and can lead to serious consequences like fines, jail time, and bars from serving as an officer or director of a public company. But not every securities law violation leads to a bar. Here’s an overview of when the SEC can impose officer and director bars for securities fraud.

What is Securities Fraud?

Securities fraud refers to deceptive practices in connection with the buying and selling of securities (stocks, bonds, etc.). Some examples include:

• Insider trading – using non-public information to trade securities
• Accounting fraud – falsifying financial statements and records
• Pump-and-dump schemes – artificially inflating a stock’s price through false or misleading statements, then selling shares while the price is high
• Misrepresentations in prospectuses, shareholder reports, and other filings with the SEC

Securities fraud violates Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. It can be pursued civilly by the SEC as well as criminally by the Department of Justice.

What is an Officer and Director Bar?

An officer and director (O&D) bar is an order from the SEC that prohibits someone from serving as an officer or director of a public company. It directs the person to cease acting in those capacities for a certain period of time. O&D bars are considered an extreme remedy, but may be imposed in cases of egregious, intentional, or recurring misconduct.

When Can the SEC Impose O&D Bars for Securities Fraud?

The SEC can seek O&D bars against any person who violates securities laws while serving as an officer or director. But bars are typically reserved for misconduct that demonstrates unfitness to serve in those roles again. The SEC considers factors like:

• The egregiousness of the violation
• The defendant’s role or position when they engaged in the misconduct
• The degree of scienter (i.e., intent) behind the violation
• The isolated or recurring nature of the violation
• The defendant’s appreciation of their breach of fiduciary duty
• The likelihood that misconduct will recur

Based on those factors, the SEC often seeks O&D bars in these situations:

1. Fraud and Misconduct by Senior Executives

The SEC frequently pursues O&D bars against CEOs, CFOs, and other high-level executives who commit securities fraud. Their misconduct undermines investor trust in the company. Barring them from leadership roles helps prevent recurrences. For example, in SEC v. Diebold Inc., the former CEO and CFO agreed to 10-year O&D bars after causing the company to file false financial statements.

2. Fraud Involving Lies to Auditors or Obstruction of Investigations

The SEC takes a hard line when officers or directors lie to auditors examining the company’s financials or obstruct an SEC investigation. These actions compromise the SEC’s ability to detect wrongdoing. In SEC v. Mark Jensen, the former CFO of Basin Water Inc. got a 5-year O&D bar for repeatedly lying to auditors and falsifying accounting records.

3. Violations that Enrich the Defendant

O&D bars are likely when securities fraud results in personal financial gain for the officer or director. Insider trading is a prime example – the defendant improperly profits from confidential information. But other violations like embezzlement, expense account abuse, or unauthorized compensation can also trigger bars if the officer or director obtains ill-gotten money. For instance, in SEC v. Paul Margis, the CEO of a public company agreed to a 5-year bar after diverting $3 million of corporate funds for personal use.

4. Involvement in Prior Securities Violations

The SEC often seeks bars against recidivist violators of securities laws, especially those with a history of fraud. The rationale is that past misconduct suggests a propensity for future violations. For example, in SEC v. Richard P. Sandru, the agency barred a repeat offender from serving as an officer or director for 20 years due to his serial violations.

What About Negligent Conduct?

The SEC usually doesn’t pursue O&D bars for merely negligent securities violations. There must be some degree of intent, recklessness, or improper motive. As the SEC put it, bars are imposed based on “deliberate or reckless violations” rather than “inadvertent mistakes” . But if negligence is accompanied by lying, covering up, or impeding an investigation, bars become more likely.

Can O&D Bars Be Contested?

Yes, O&D bars may be contested during settlement negotiations or at trial. Arguments against bars include:

• The violation was unintentional or negligent rather than intentional
• The misconduct was an isolated occurrence unlikely to recur
• The defendant accepted responsibility and cooperated with investigators
• The defendant had a clean disciplinary record before this violation
• The defendant improved compliance policies and training after detection
• A bar would trigger severe collateral consequences for shareholders and employees

Sometimes these arguments persuade the SEC to impose less drastic alternatives like suspensions, heightened supervision, or compliance consultants. But for egregious or recurring fraud, the SEC remains aggressive about barring culpable executives.

Takeaways

The SEC can get officer and director bars against individuals who commit securities fraud, but doesn’t pursue bars in every case. Bars are more likely for senior executives, intentional or deceptive misconduct, violations enriching the defendant, and repeat offenders. Negligent violations rarely result in bars unless accompanied by cover-ups or lying. While bars may be contested, the SEC continues to seek them for egregious fraud demonstrating unfitness for future corporate leadership.

References

SEC v. Patel, 61 F.3d 137 (2d Cir. 1995).
Litigation Release No. 23602 (May 20, 2020), https://www.sec.gov/litigation/litreleases/2020/lr23602.htm
Litigation Release No. 24325 (Nov. 10, 2019), https://www.sec.gov/litigation/litreleases/2019/lr24325.htm
Litigation Release No. 23152 (Sept. 27, 2018), https://www.sec.gov/litigation/litreleases/2018/lr23152.htm
Richard P. Sandru, Exchange Act Release No. 64867 (July 12, 2011).
Statement of the Securities and Exchange Commission Concerning Financial Penalties (Jan. 4, 2006), https://www.sec.gov/news/press/2006-4.htm
See, e.g., Gregory M. Dearlove, Exchange Act Release No. 57244 (Feb. 4, 2008); William F. Lex, Exchange Act Release No. 57655 (Apr. 8, 2008).