When an SEC Inquiry Becomes a Criminal Securities Case.

The SEC’s enforcement staff does not have the power to prosecute criminal charges. When referred, the DOJ can open its own investigation, or it can proceed based on the SEC’s investigative findings. To do this, the DOJ can access the SEC’s investigative files via an access request. As a result, the DOJ can pursue criminal charges based on:

• Evidence the SEC has already gathered
• Evidence the SEC’s investigative files disclose
• Testimony the individual gave during the SEC’s investigation

All testimony given to the SEC is taken under oath and transcribed verbatim. Consequently, that testimony is admissible against the testifying individual in criminal court. However, criminal convictions require proof beyond a reasonable doubt on the same facts that may support civil charges. Even when the DOJ is able to obtain evidence from the SEC, it may not have enough evidence to prove a criminal case.

With the passage of the Sarbanes-Oxley Act in 2002, Congress created 18 U.S.C. § 1348. Unlike most other securities fraud provisions, Section 1348 does not require proof that the security was bought or sold on an exchange, although it does require that the security be one of an issuer with a class of securities registered under Section 12 of the Exchange Act or that is required to file reports under Section 15(d). This allows the DOJ to prosecute securities fraud in a broad range of circumstances.

The five-year statute of limitations that applies in most criminal cases does not apply to criminal securities fraud. Pursuant to 18 U.S.C. § 3301, the statute of limitations for criminal securities fraud is six years.

Rule 10b-5 is the SEC’s most frequently enforced rule. It prohibits the use of any “device, scheme, or artifice to defraud.” Like most criminal charges, Rule 10b-5 requires a finding of “scienter,” meaning the individual intended to deceive or manipulate investors. Negligence alone cannot support liability under Rule 10b-5 at all; civil liability requires scienter, and criminal liability requires in addition that the violation be willful.

How Does an SEC Inquiry Become a Parallel Criminal Case?

The SEC Enforcement staff typically opens a securities fraud enforcement matter as a Matter Under Inquiry (MUI) before (and if) a formal order of investigation is issued. Without a formal order, the SEC does not have the authority to issue subpoenas. This means that, absent a subpoena, the recipient has the option to refuse the SEC’s voluntary request. But (and this is a big “but”) the SEC Enforcement staff is not required to tell you that the request is voluntary. The SEC staff have only the option to seek, and never the obligation to provide, voluntary compliance.

Along with the subpoena, the SEC staff also serve SEC Form 1662. This form discloses that the “matter” is “under investigation” and that “it may be referred to criminal prosecutors for prosecution.” This is the point at which the parallel criminal case is initiated.

While criminal prosecutors at the DOJ typically open a new case based on the SEC’s referral, this does not automatically mean the “wall” between the SEC Enforcement Division and the DOJ comes down. In fact, this “wall” allows the DOJ’s criminal prosecutors to obtain the SEC’s investigative files while simultaneously preventing Grand Jury material from flowing back to the SEC without a court order.

Federal Rule of Criminal Procedure 6(e) creates this one-way information asymmetry. Pursuant to Rule 6(e), the criminal prosecutors at the DOJ may have access to the SEC’s investigative files, but the Enforcement Division of the SEC may not have access to Grand Jury material. As a result, the civil and criminal case tracks remain separate, albeit with the criminal track having access to information obtained during the civil track’s investigative activities.

In United States v. Kordel, 397 U.S. 1 (1970), 397 U.S. 1 (1970), the district court upheld the government’s use of parallel civil and criminal proceedings. The court noted that the SEC’s investigation was not intended to “do the work” for the grand jury. Instead, it was an efficient use of governmental resources to pursue both sets of charges. With the court’s approval, the criminal prosecutors and civil attorneys worked in tandem.

The court also approved of the government’s use of a subpoena to obtain the defendant’s testimony for the SEC civil enforcement proceedings. According to the court, “the fact that the government has already obtained Grand Jury subpoenas for the same information and the same individuals does not render it immunised against other subpoenas that it may have legal authority to issue.”

While the DOJ and the SEC are authorized to pursue parallel civil and criminal proceedings, prosecutors will routinely move to stay the SEC enforcement case while a criminal case is pending. This is to ensure that the civil proceeding doesn’t interfere with the criminal proceedings and does not present any risks of premature disclosure of information which can harm the government’s criminal investigation and prosecution efforts.

Should I Testify or Invoke the Fifth Amendment?

If you are being subpoenaed to testify in an SEC enforcement matter, you should be concerned about both perjury and obstruction charges. Prosecutors seek to prove that individuals made false statements during the investigation, and they routinely present this as a separate charge that is not dependent on the underlying securities fraud. In the case of testimony obtained via SEC subpoena, the government will pursue perjury charges. But, it will pursue 18 U.S.C. § 1001 charges for lying to the SEC Enforcement staff when the false statements are made without oath. Under Section 1001, any false statement made to a federal agent can result in up to five years of imprisonment. As a result, for securities fraud targets and subjects, testifying is a high-stakes affair.

Individuals who are subpoenaed to testify in SEC proceedings have the right to invoke the Fifth Amendment to protect themselves against self-incrimination. However, unlike in criminal cases, “The Fifth Amendment is not a shield” in civil matters. Under Baxter v. Palmigiano, 425 U.S. 308 (1976), a court in a civil proceeding can draw an adverse inference from a witness’s silence under the Fifth Amendment. As a result, individuals who refuse to testify to avoid inculpating themselves in criminal cases will have their silence used against them in an SEC enforcement case.

That said, invoking the Fifth Amendment is still the right move in the following circumstances:

• The government is pursuing a parallel criminal case and has not yet asked the court to stay the SEC’s enforcement proceeding,
• A prosecutors has intervened on the government’s behalf and the SEC has agreed not to pursue a civil case,
• There has been an agreement to grant individual immunity during testimony, or
• You have no other viable option.

In the third scenario, after granting immunity to an individual, the U.S. Supreme Court in Kastigar v. United States imposed the burden on the prosecutors to prove that their evidence came from sources independent of the immunized testimony. That burden is a heavy one that the prosecution carries throughout the taint hearing, and it never shifts to the individual who was granted immunity.

If the DOJ prosecutes your SEC testimony in an SEC enforcement case without the case being stayed or a criminal case being disclosed, then the government has engaged in a deceptive practice and denied you due process. As explained by the Second Circuit Court of Appeals, “The prosecutors’ strategy was to seek information that would lead to criminal charges, all without the target’s knowledge.” In the case of United States v. Scrushy, 366 F. Supp. 2d 1134 (N.D. Ala. 2005), 366 F. Supp. 2d 1134 (N.D. Ala. 2005), the court suppressed the SEC testimony that the DOJ obtained.

In cases where individual executives are employed with registered companies, company policy may require them to answer questions and provide documents to the SEC, even if they are targets or subjects of investigation. These executives could be fired for refusing to answer questions that they have no right to answer if they do so without exercising their right to remain silent under the Fifth Amendment, because the right to remain silent is a constitutional right and must be exercised as such.

What Does a Wells Notice Mean for Criminal Exposure?

A Wells notice is a notice from the SEC Enforcement staff informing the recipient that the staff have preliminarily decided to recommend filing charges against the recipient. Along with the notice, the staff also include a deadline for the recipient’s Wells submission, usually within roughly 30 days of receipt. While the SEC staff are not required to issue a Wells notice before filing a case, the staff may (and often do) issue a Wells notice even in Matters Under Inquiry.

When the DOJ opens a criminal case following the SEC’s referral, prosecutors will review the evidence gathered by the SEC Enforcement staff, including evidence in the target’s Wells submission. Prosecutors use this evidence to establish intent, motives, and other necessary elements of liability. As a result, individuals and firms who receive a Wells notice must make an informed decision about whether (and if) to submit a Wells response.

After the SEC staff concludes its investigation and submits a Wells recommendation, the Commission must vote on whether to authorize civil charges. The Commission votes on a Wells recommendation separately from the authorization of charges. Consequently, while the Commission may not authorize charges based on the staff’s recommendation, it will not authorize charges based on a Wells submission either.

The SEC’s Rule 202.5(e) provides for “neither-admit-nor-deny” language in settlements between the SEC and defendants. Rule 202.5(e) also prohibits the defendant from denying the allegations in a “public forum.” This no-deny rule prevents defendants from making statements that could support allegations of fraud. However, the rule also contains a provision that requires the defendant not admit fault. This protects the defendant during the settlement negotiations. If a defendant admits guilt in the SEC settlement, this admission is admissible in a criminal trial. Rule 202.5(e) does not bar the SEC from insisting on an admission of fault, and the Commission has required admissions as a condition of settlement in certain cases.

In January 2024, the SEC rejected a petition to repeal the no-deny provision in Rule 202.5(e), affirming its support for the practice of accepting settlements in which the terms of the settlement provide for neither admission nor denial of guilt.

This is the point at which most people call a lawyer. Spodek Law Group takes federal criminal defense cases nationwide from its New York and Los Angeles offices.

Can My Company’s Internal Investigation Build the Criminal Case?

Upjohn v. United States (1981) is the controlling Supreme Court case when it comes to interviews with employees conducted during an internal investigation. In Upjohn, the Court held that in the context of an internal investigation, the attorney-client privilege belongs to the company, and not to the employee. As a result, the company can unilaterally waive privilege to disclosures made by employees during the investigation, and it can unilaterally disclose interview memos and emails to prosecutors.

When interviewed during internal investigations, employees are usually required to acknowledge receipt of Upjohn warnings. These warnings provide basic, high-level information regarding employees’ rights to refuse to speak with company counsel during the internal investigation. Upjohn itself arose from an IRS summons seeking employee questionnaires and interview notes, not from grand jury testimony, and employees have no right to the advice of personal counsel during a company's internal investigation. If you are being interviewed as a result of the DOJ initiating a criminal case or the SEC Enforcement Division initiating an enforcement proceeding, you should ask for a copy of the interviewer’s Upjohn warnings.

The DOJ’s Monaco memo encourages registered firms to proactively disclose evidence to prosecutors in order to receive cooperation credit. Prosecutors can impose conditions for firms to receive cooperation credit, and under the Monaco memo, “the DOJ expects companies to disclose, in an appropriate and timely manner, all individuals and entities involved in the alleged misconduct, regardless of their relative culpability.” This means that the company’s internal investigation can turn into the DOJ’s criminal case building.

Another potential risk is if the criminal prosecutors outsource their investigation to the company’s counsel. In United States v. Connolly, Deutsche Bank paid its own outside counsel to conduct an internal investigation and turn the results over to the government, rather than the DOJ and the CFTC conducting the investigation on their own. If you think you may be the target or subject of a federal criminal case, you may need to hire an attorney to represent you in the internal investigation.

If a criminal case is pending, you may still be compelled to produce documents from your company’s records, even if you are the corporate custodian. In Braswell v. United States, the Court held that a corporate custodian could not invoke the Fifth Amendment to shield documents that were produced under the custodian’s authority. If records of your business communications were preserved pursuant to Exchange Act Rule 17a-4, then the records exist independently of you, and they can be obtained without violating your constitutional protections.

Can I Go to Jail for Securities Fraud?

The U.S. Attorney’s Offices and U.S. District Courts can impose up to a 25-year maximum prison sentence for criminal securities fraud.

Under 18 U.S.C. § 1348, securities and commodities fraud can lead to a federal prison sentence of up to 25 years.

Under Exchange Act Section 32(a), “willfully” violating or attempting to violate the Exchange Act or SEC rules is capped at a prison sentence of 20 years. Section 32(a) expressly bars imprisonment if “the defendant proves that he acted without knowledge that the conduct was prohibited.” In effect, this means that an individual’s knowledge and intention are the elements that separate a regulatory violation from a federal felony.

Other federal crimes that can accompany criminal securities fraud allegations carry similar or even longer potential sentences.

How Do the Federal Sentencing Guidelines Work?

Individual and entity sentencing is driven by the Federal Sentencing Guidelines. In the context of a federal criminal case, the sentencing judge applies a range determined by: (i) the “Offense Level” and (ii) the “Criminal History Category.”

The “Offense Level” is determined by the primary nature of the crime plus “enhancements” based on specific facts and figures. Under Sentencing Guideline 2B1.1, the “Offense Level” for criminal securities fraud is driven primarily by the estimated amount of investor loss.

At the lower end of the spectrum, losses up to $6,500 lead to the most-moderate sentencing ranges. However, loss amounts above $25 million can lead to “life” (or at least 25-year maximum sentences). As a result, when the criminal prosecutors target individuals and firms for securities fraud, the estimated loss amount will likely be at the top of the list of factors to be considered during sentencing.

How Does a Criminal Case Differ from Private Securities Litigation?

Many of the rules and elements that allow defendants to get civil cases dismissed do not apply in federal criminal cases. Criminal prosecutors have a lower bar to clear than private plaintiffs in securities litigation, and they can seek criminal penalties even when private litigants are unable to seek damages.

In federal criminal cases, prosecutors are never required to prove investor reliance, while this element is required in private securities fraud cases.

Similarly, prosecutors are never required to prove actual economic loss and loss causation. While these elements are required in private cases, they do not have to be proven to obtain a criminal conviction in a federal criminal case.

Can a Criminal Conviction Lead to Fines and Restitution?

Criminal fines in securities fraud cases are calculated similarly to those in other criminal cases. But, securities fraud cases can involve huge gross gains or huge gross losses. In these cases, 18 U.S.C. § 3571(d) provides for fines of twice the gross gain or gross loss. These fines can quickly run into the hundreds of millions of dollars.

Federal judges can also impose restitution orders requiring defendants to repay investors their losses.

What Can the SEC Impose Without a Criminal Conviction?

If the DOJ chooses not to pursue criminal charges based on its access to the SEC’s investigation files, then the SEC may still pursue a civil enforcement case. In Kokesh v. SEC (2017), the U.S. Supreme Court classified disgorgement, the SEC’s most-common civil remedy, as a penalty subject to the civil penalties statute of limitations, which the SEC enforcement staff at the time characterized as a five-year limit. In Liu v. SEC (2020), the Supreme Court also limited disgorgement to the net profits from the conduct at issue, after the subtraction of costs of legitimate business operations.

The National Defense Authorization Act of 2021 (NDAA) amended the securities laws to grant the SEC Enforcement staff ten years to seek disgorgement when the allegations in the enforcement case are based upon scienter. Disgorgement claims that are not based upon scienter are still subject to a five-year reach-back limitation period.

In June 2024, the Supreme Court decided SEC v. Jarkesy, which significantly altered the SEC’s Enforcement division’s ability to pursue civil penalties for fraud. With its decision, the Supreme Court abolished the SEC’s in-house SEC fraud penalty proceedings, ruling that the practice violates the Seventh Amendment by denying defendants the right to a federal jury. For the cases that previously would have gone through the SEC’s internal process, the lauding opinion of SEC v. Jarkesy means that defendants are now entitled to a federal jury and the full-scope civil discovery and procedure in federal district court.

While criminal securities fraud cases present an immense risk of imprisonment and enormous financial penalties, an SEC civil enforcement case does not carry the potential for imprisonment and its remedies are more limited. Specifically, the SEC can seek disgorgement of net profits and tiered civil penalties (but not treble damages), and it can seek to ban individuals from acting as executives or directors of registered companies.

Can Your Securities Fraud Allegations Lead to Civil Damages?

Yes, if your company is publicly traded, the allegations could expose the company (and potentially you as well) to private securities fraud litigation. Securities class action lawsuit defense counsel at Spodek Law Group often work alongside our white-collar defense attorneys to protect our clients against facing civil liability as a result of the government’s criminal and civil enforcement efforts. For example, the information and testimony that the government obtained during its investigation will be available in the public record and can be used by private litigants to sustain their class action lawsuits.

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.