The U.S. Securities and Exchange Commission (SEC) investigates publicly-traded and privately-held companies for a broad range of statutory and regulatory violations. SEC investigations can target issues ranging from inadequate public filings to conducting unregistered initial coin offerings (ICOs); and, in many cases, simply discerning why your company is under investigation can prove challenging.
But, this is just one challenge of many. For companies, may it be a private or public company, facing SEC scrutiny, the risks can be extremely high and executing a sound and strategic defense requires a comprehensive understanding of the facts and law at hand. When company executives and in-house lawyers are not careful, not only can they miss opportunities, but they can potentially increase the risk of civil or criminal prosecution.
“Defending against an SEC investigation is not a simple or straightforward matter. Without an informed and strategic approach, companies (and individuals) can make costly mistakes and expose themselves to unnecessary risk.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.
With this in mind, when facing SEC investigations, there is a lot that CEOs and in-house counsel need to know. Here are 10 key facts about facing an SEC investigation in 2022:
1. Most SEC Investigations Begin as “Informal” Inquiries
Most SEC investigations begin as “informal” inquiries. As the SEC explains, “[f]acts are developed to the fullest extent possible through informal inquiry, interviewing witnesses, examining brokerage records, reviewing trading data, and other methods.”
But, it is important for CEOs and in-house lawyers not to let this characterization of the SEC’s early-stage investigative efforts lull them into a false sense of security. Companies must approach informal requests for records and interviews very carefully, and their executives and in-house lawyers must make informed decisions that give due consideration to the risks at hand. While cooperating with the SEC can prove advantageous given the right set of circumstances, voluntarily sharing too much information can put companies in a precarious position without the opportunity to backtrack.
2. Informal SEC Investigations Can (and Frequently Do) Lead to Formal Investigations
Another important factor to keep in mind is that informal SEC investigations can (and frequently do) lead to formal investigations. If the investigating agents uncover sufficient evidence to warrant devoting additional agency resources, the SEC will issue a formal order of investigation. This is much more than simply a matter of semantics. When the SEC initiates a formal investigation, this triggers additional agency powers, and it also signifies that the agency is prepared to move forward with pursuing civil or criminal charges if warranted (while SEC investigations are civil in nature, the agency will refer matters to the U.S. Department of Justice (DOJ) for criminal prosecution in appropriate cases).
3. SEC Investigations Can Target Numerous Statutory and Regulatory Violations
Speaking of charges, SEC investigations can target numerous statutory and regulatory violations. As we mentioned in the introduction, this makes it paramount for targeted companies to discern precisely why the SEC is investigating. Even if a company’s CEO or in-house lawyers have suspicions as to why their company may be under scrutiny, they cannot afford to make any assumptions at this stage. Instead, they must work with their outside SEC defense counsel, who should engage with the SEC to determine the scope and nature of the inquiry.
To illustrate the breadth of charges that could stem from an SEC investigation, some examples of possible allegations include:
- Material misrepresentations and omissions in public filings
- Social media solicitations and other fraudulent sales and marketing practices
- Public comments that violate SEC rules and regulations
- Issuance of unregistered securities without a valid exemption
- Conducting unregistered initial public offerings (IPOs) and initial coin offerings (ICOs)
- Insider trading and other forms of investment fraud
- Embezzlement and financial fraud
It is also important to keep in mind that while the SEC investigates all misconduct or statutory and regulatory violations that fall within its enforcement jurisdiction, the SEC’s Enforcement Division currently has several top priorities. These include (but are not limited to) protecting Main Street investors from fraud, ensuring compliance concerning blockchain technology and cryptocurrencies, combatting cannabis and CBD investment fraud schemes, and targeting fraud schemes that seek to take advantage of the COVID-19 pandemic.
4. These Offenses Can Carry Significant Civil or Criminal Penalties
All of the offenses listed above carry significant penalties—including criminal penalties in many cases. Whether the SEC and/or DOJ pursue civil or criminal charges depends on the evidence uncovered during its informal and formal investigation procedures. While many criminal charges require evidence of intent, this is not a universal requirement, and this is critical for companies to keep in mind when evaluating their risks and potential defense strategies.
5. Company Insiders Could Also Be At Risk in the SEC’s Investigation
Another factor that is important to keep in mind is that company insiders and members could also be at risk in the SEC’s investigation. If this is the case, the company’s leaders and in-house lawyers will need to be very careful about how they manage their defense—and the company’s in-house lawyers will need to be particularly careful to avoid advising any personnel who are at risk in their capacities. In some cases, corporate defense strategies will involve blaming violations on rogue employees, and dealing with situations in which the company’s interest and individual employees’ interests are at odds presents unique challenges.
6. The SEC has Administrative Subpoena Power
One of the most significant impacts of the SEC issuing a formal investigation order is that it triggers the agency’s administrative subpoena power. While SEC subpoenas do not require judicial approval, they are subject to judicial enforcement, and the federal courts have made clear that they will defer to the agency’s investigative needs and expertise in most cases.
As a result, responding to an SEC subpoena requires a systematic approach. Due to the volume of records SEC subpoenas typically request, companies should begin their response efforts promptly. Preliminarily, this will involve working with their outside counsel to identify all relevant data sources and develop appropriate document collection and review procedures. In tandem with overseeing these efforts, outside counsel should assess all possible grounds for challenging the subpoena and determining whether it is in the company’s interests to either (i) seek to negotiate the subpoena’s scope or deadline (or both) with the SEC, or (ii) file a motion to quash the subpoena in federal district court.
7. The Issuance of a Wells Notice Presents Both Risks and Opportunities
Before taking enforcement action, the SEC may elect to issue a Wells Notice to a targeted company or individual. In the words of the SEC’s Enforcement Division, “it may elect to provide individuals or entities who would be charged in [an] action with a Wells notice explaining the proposed charges against them and informing them that they can make a voluntary submission setting forth their interests and position.”
Responding to a Wells Notice is not mandatory, and it is not in companies’ best interests to submit responses in all cases. Instead, company executives and in-house lawyers must work with their outside counsel to make strategic decisions about (i) whether to respond and (ii) if so, how. Since the SEC can use information disclosed in a Wells Notice response for enforcement purposes, responding presents both risks and opportunities.
8. Companies Targeted in SEC Investigations Need a Comprehensive Picture of the Relevant Facts
To evaluate potential defenses and make informed decisions about matters such as challenging SEC subpoenas and responding to Wells Notices, companies targeted in SEC investigations need a comprehensive picture of the relevant facts. To achieve this, they should work with their outside counsel to conduct a comprehensive internal investigation promptly upon learning of the SEC’s inquiry. While the ultimate goal is to fend off any civil or criminal allegations, companies’ internal investigations should not focus solely on uncovering helpful information. Instead, they should be used to uncover all relevant information so that the company’s leaders and lawyers can make informed decisions.
9. In Most Cases it is Possible (and Preferable) to Secure a Pre-Charge Resolution
Even when the facts are unfavorable, it will usually be able to secure a favorable pre-charge resolution with the right approach to an SEC investigation. This requires not only a thorough understanding of the relevant facts and law but also of the SEC’s investigative procedures and enforcement priorities. As a result, when facing SEC investigations, companies must engage outside defense counsel with relevant experience— ideally including prior experience investigating and prosecuting securities law violations on behalf of the federal government.
10. The SEC Might Not Be the Only Federal Agency Investigating Your Company
The final key fact CEOs and in-house lawyers should keep in mind is that the SEC might not be the only federal agency investigating their company. In many cases, the SEC’s Enforcement Division works alongside its counterparts at the DOJ, Federal Bureau of Investigation (FBI), Internal Revenue Service (IRS), and other agencies. If multiple federal agencies are investigating, this can change the dynamics of the situation, and it can significantly increase both the risks at hand and the challenges of executing a strategic and comprehensive defense.
