For public and private companies in all industries, the risk of being targeted in a U.S. Securities and Exchange Commission (SEC) investigation is a very real concern. As new and innovative securities offerings continue to be developed, and as more companies wade into these uncharted waters, the SEC is using its investigative authority to scrutinize the offerings of companies ranging from technology startups to blue chip stock issuers that have been listed on U.S. and international securities exchanges for decades.
Whether the SEC is investing alleged disclosure violations or an unregistered initial coin offering (ICO), at a base level, the risks facing the targets of SEC investigations are the same: Investigations can lead to charges, and charges can lead to costly litigation. With this in mind, when faced with an SEC inquiry, companies (and their owners and executives) must promptly engage experienced defense counsel and execute a defense strategy focused on resolving the inquiry as quickly, favorably, and discretely as possible.
Contemporary Issues in SEC Securities Litigation
Currently, there are several issues that top the SEC’s list of enforcement priorities. These issues present risks for companies of all sizes in the public and private sectors, and they present risks for individuals at all levels of the corporate organizational structure. Some examples of contemporary issues that are presently triggering a high volume of SEC investigations and securities fraud charges include:
Initial Coin Offerings (ICOs) and Initial Exchange Offerings (IEOs)
Initial coin offerings (ICOs) and initial exchange offerings (IEOs) have become increasingly prevalent in recent years, and this has forced the SEC to prioritize the investigation of fraud allegations involving these offerings as well. ICOs and IEOs are similar to initial public offerings (IPOs) in that they involve the introduction of a new class of securities onto the market, but they vary in many distinct and important ways as well.
As the SEC explained in one of its early warnings about the risks of ICOs for individual investors in 2017, “Purchasers may use fiat currency (e.g., U.S. dollars) or virtual currencies to buy these virtual coins or tokens. Promoters may tell purchasers that the capital raised from the sales will be used to fund development of a digital platform, software . . . . Some promoters and initial sellers may lead buyers of the virtual coins or tokens to expect a return on their investment . . . . After they are issued, the virtual coins or tokens may be resold to others in a secondary market on virtual currency exchanges or other platforms.” While there is nothing inherently impermissible about an ICO from a securities law perspective, as securities, ICOs must be registered, and companies frequently run into trouble as the result of conducting unregistered ICOs.
The same applies to IEOs. Initial exchange offerings are an even more-recent development, and the SEC issued one of its first public warnings to individual investors in January 2020. As the SEC explained, “IEOs are being touted as an innovation on ICOs because they are offered directly by online trading platforms on behalf of companies—usually for a fee—to provide immediate trading opportunities for the digital assets.” Similar to ICOs, the risks to investors, relatively limited access to information, and frequency of unregistered offerings being made have all combined to lead to a wave of SEC litigation involving IEOs.
Social Media and Celebrity/Influencer Endorsements
Concurrently with the rise of ICOs and IEOs, the SEC has also been forced to confront a significant increase in the use of social media platforms to promote investment opportunities. In particular, celebrity and influencer endorsements have taken center stage, as in many cases companies, celebrities, and influencers are all engaging in unlawful promotional practices—not knowing that their activities are subject to regulation and oversight at the federal level.
Recently, there have been several high-profile cases of athletes, musicians, and others facing SEC litigation due to engaging in unlawful promotional practices. This litigation has the potential to be either civil or criminal in nature; and, as discussed in greater detail below, proving an unknowing violation of the law may be an effective defense strategy for avoiding criminal prosecution, but it is generally not a defense in civil securities fraud litigation.
COVID-19 Investment Fraud Scams
Since the start of the pandemic, the SEC has also been forced to deal with investment fraud schemes related to the COVID-19 crisis. Many of these schemes involve efforts to promote fraudulent investment opportunities to vulnerable investors—for example, by claiming that a company is poised to rake in significant profits as the result of producing masks or other necessary supplies. While much of the litigation in this area is targeting truly fraudulent operations, the SEC is examining legitimate companies’ claims and disclosures regarding COVID-19-related revenue opportunities as well.
Complex Structured Investment Products
In addition to ICOs and IEOs, corporate entities, hedge funds, investment firms, and others have been increasingly introducing other new investment products to the U.S. market as well. As the SEC works to keep pace, it is actively targeting companies that offer and promote complex structured investment products. When an investment product clearly violates federal securities laws, or when sufficient questions exist regarding the legality of an innovative structured offering (or the sales practices used to promote it), companies can expect to face scrutiny. If they fail to satisfy the SEC as to their investments’ legality during the investigative process, they can expect to face securities fraud litigation as well.
Disclosure Violations and Financial Fraud
Finally, while there are many new types of securities litigation that present risks for companies and their personnel, allegations of more-traditional forms of securities fraud continue to present litigation risks as well. The SEC’s efforts to scrutinize public companies’ filings have not slowed, and it is continuing to actively pursue employee and investor complaints about private placements as well. For companies, owners, executives, and others who are accused of withholding information or misrepresenting material information to investors, the risks of facing an SEC investigation and ensuing securities fraud litigation can be substantial.
Defense Strategies for SEC Investigations and Litigation
Regardless of the substantive allegations involved, defending against an SEC investigation and seeking to avoid liability in federal securities fraud litigation presents a number of unique and complex challenges. Even with an SEC inquiry is civil in nature, executing a successful defense is unlike defending against allegations of securities fraud in private litigation; and, as a result, a tailored and strategic approach is required.
“For many company owners and executives, facing an SEC investigation is their first introduction to the unique burdens and challenges of federal enforcement litigation. However, they must be prepared to react quickly, and they must rely on the advice of experienced defense counsel in order to avoid potentially-costly mistakes.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.
Defending against allegations of federal securities fraud requires not only a comprehensive understanding of the substantive issues involved, but also intimate familiarity with the SEC’s investigative procedures and the federal enforcement litigation process. With this in mind, some key considerations for defending against allegations of securities fraud in investigations and litigation involving the SEC include:
- Knowing What You Need to Defend Against – With the extraordinary breadth of the United States’ securities laws, one of the first challenges involved with facing allegations from the SEC is to determine what exactly those allegations entail. Is your company being accused of conducting an unregistered offering? Or, is it your company’s disclosure record that is under scrutiny? These are very different scenarios that require very different defense strategies.
- Tailoring Your Defense to the Nature of the Allegations at Hand – In addition to identifying the substance of the allegations at issue, it is also necessary to determine whether the allegations are civil or criminal in nature. Defending against civil securities fraud litigation and defending against the possibility of facing criminal securities fraud charges present different challenges entirely.
- Using the Available Facts and Law to Your Advantage – In many cases, companies and individuals can successfully defend against securities fraud litigation by affirmatively presenting evidence of compliance. Various safe harbors and statutory exceptions provide opportunities to defend against securities fraud allegations as well. When facing securities litigation, it is important to conduct a comprehensive assessment and utilize both the available facts and the available law to your advantage.
- Seeking to Prevent Protracted (and Public) Enforcement Litigation – Once made public, securities litigation presents an entirely new set of risks for companies, their owners and executives, and others. As a result, taking a proactive approach and seeking to prevent litigation by confronting the SEC’s allegations during the investigative process will often be the best strategy for achieving a positive outcome.
- Being Prepared for Whatever Lies Ahead – Regardless of the issues involved, when facing federal securities litigation, companies and individuals need to be prepared for whatever lies ahead. This means gaining a clear understanding of the risks involved, identifying all possible defenses, and executing a litigation defense strategy focused on avoiding (or minimizing) liability by all means available.