The 5 + 5 + 5 of SEC Defense

Oberheiden P.C.

The U.S. Securities and Exchange Commission (SEC) investigates companies (and individuals) for a broad range of federal offenses. This includes offenses that are both civil and criminal in nature, and that can carry penalties ranging from five-figure fines to hundreds of millions of dollars in total liability plus decades of prison time. In short, there is a lot of variability in the SEC’s enforcement efforts, and the scope of an investigation won’t necessarily be readily-apparent from the outset.

Even setting aside the potential consequences, defending against an SEC investigation presents a host of challenges. What are the specific allegations at issue? Where did the SEC get its information, and what additional information is out there for the SEC to find? Can your company fully defend against the allegations, or would it be more prudent to target a settlement? None of these are easy questions to answer, but they are all extremely important when it comes to mounting a defense during an SEC inquiry.

“When facing an SEC investigation, there is no room for error. Company executives need to make informed decisions based on reliable information, and they need to target effective defense strategies focused on resolving the SEC’s inquiry before charges get filed.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

There are many other questions that companies need to answer when facing SEC investigations as well. There are also many steps that need to be taken (and decisions that need to be made) promptly. With this in mind, this article provides an introduction to some of the key considerations involved in defending against an SEC investigation.

5 Preliminary Questions When Facing an SEC Investigation

In addition to the questions referenced above, there are many more questions that companies need to answer when facing SEC inquiries. Here are five preliminary questions that should be the focus of a company’s initial response efforts in most cases:

1. Why Is the SEC Investigating?

In order to mount any sort of defense, you first need to know why the SEC is investigating. This means that you must determine both (i) what triggered the investigation, and (ii) what allegations are being targeted. If the SEC has issued a subpoena, this may provide some clues. However, generally speaking, it will be necessary to interface with the SEC and conduct an internal audit in order to gain a clear picture of the circumstances at hand (more on this below).

2. Do the Allegations Underlying the Investigation Have Merit?

Defending against substantiated allegations and defending against unsubstantiated allegations are two very different propositions. As a result, before you can focus on building a defense strategy, you first need to focus on determining what your company needs to defend against. Is the SEC’s investigation misguided because the agency doesn’t yet have the whole story? Or, do you need to be thinking about what you might be willing to consider in settlement negotiations with the SEC?

3. What are the Potential Consequences of the Investigation?

In addition to identifying the substantive allegations at issue and assessing their veracity, it is also important to consider the potential consequences of the investigation. This includes not only any possible civil or criminal penalties, but also consequences in terms of reputational harm and shareholder losses. Knowing what is at stake will be crucial for developing an informed defense strategy as well.

4. What is the Current Status of the Investigation?

Another key factor is the current status of the SEC’s investigation. How long has the investigation been ongoing, and how close is the SEC to pursuing civil or criminal enforcement action? All SEC investigations warrant a sense of urgency; but, if prosecutors are waiting in the wings, this is a factor that needs to be brought into play.

5. Does Your Company Need to Take Corrective Action?

In many cases, violations of the Securities Act of 1933, Securities Exchange Act of 1934, and other federal securities laws require corrective action. If your company needs to take corrective action in order to mitigate any potential consequences, you will need to think strategically about how to implement this corrective action without unnecessarily raising red flags for the SEC.

5 Defense Strategies for SEC Investigations

Successfully defending against an SEC investigation requires a strategic and targeted approach. With this in mind, here are five potential defense strategies that may or may not be viable depending upon the specific circumstances presented:

1. Demonstrating Compliance

If your company is in compliance with all pertinent securities laws and SEC regulations, then demonstrating compliance could be the best option. However, it is extremely important not to make any assumptions—no matter how confident you are in your company’s compliance program. Additionally, convincing investigators, agents, and prosecutors that their efforts to date have been wasted isn’t necessarily the easiest thing to do, so companies must have comprehensive documentation of compliance that leaves no room for doubt.

2. Challenging the Source of the Inquiry

In some cases, it can be an effective defense strategy to challenge the source of the inquiry. This is particularly true in whistleblower investigations. If it is possible to demonstrate bias, ill-will, or other cause for questioning the merits of the whistleblower’s allegations, this could be enough to convince the SEC that devoting additional agency resources is unwarranted.

3. Fighting the SEC’s Subpoena

While the grounds for challenging an SEC subpoena are limited, when facing an investigation, all options should be put on the table. If the subpoena is overly broad, unduly burdensome, or requests information that is already in the agency’s possession, then a challenge could be warranted. Even if the challenge does not result in the subpoena being quashed in its entirety, fighting the subpoena could still serve to provide some breathing room and help position the company for a favorable resolution.

4. Negotiating a Pre-Charge Resolution

If it is not possible to entirely avoid penalties based upon the circumstances at hand, then an advisable defense strategy will often be to pursue a negotiated pre-charge resolution. Not only does this provide certainty and limit the company’s potential liability exposure, but it can also help to mitigate against the consequences of public disclosure.

5. Preparing for Court

Of course, in some cases, the best option will be to defend your company (and perhaps yourself) in court. If the SEC will not drop the investigation, and if settling is inadvisable, then at some point defense efforts will need to shift toward preparing to litigate at trial.

5 Steps to Take When Facing an SEC Investigation

So, your company is facing an SEC investigation—what do you need to do? Here are five steps that should be taken as soon as possible upon learning about an SEC inquiry:

1. Intervene in the Investigation

Upon learning of an SEC investigation, it is important to intervene in the investigation promptly. This step, which should be undertaken by the company’s legal counsel, serves two separate and equally-important purposes. First, it serves to slow down the investigative process and allow the company’s legal counsel to start putting checks in place. Second, it allows the company’s legal counsel to gather critical information about the source and scope of the inquiry.

2. Assemble the Defense Team

During an SEC investigation, a company’s defense team should include the company’s outside defense counsel, general counsel, executive leaders, and senior IT personnel. However, with regard to internal defense team members, it is important to ensure that no one involved in the company’s response could potentially be implicated in the SEC’s investigation. The team needs to be organized, and there should be clearly-established roles, reporting structures, and lines of communication.

3. Conduct an Internal Audit

In order to assess the company’s potential exposure (if any), it is necessary to conduct a thorough internal audit. This audit needs to be managed by the company’s counsel in order to preserve the attorney-client privilege, and to ensure that it is sufficiently broad in scope. The purpose of this audit is not to try to confirm compliance or target any particular defense strategy, but rather to gain a clear, comprehensive, and unbiased understanding of any issues that may come to light.

4. Develop a Defense Strategy

After identifying the allegations at issue and determining whether (and to what extent) any exposure may exist, then it is time to develop a defense strategy. This defense strategy should factor in all pertinent considerations, and it should be malleable so that any unexpected developments during the investigation can be taken into account.

5. Execute Your Company’s Defense

With a defense strategy in place, it is time to execute. Effective execution is vital, and this is one area in particular where it pays to have outside defense counsel with specific experience handling SEC investigations. Should your company adopt an aggressive posture? Or, is a more conciliatory approach warranted? Is there an opportunity to pursue a pre-charge resolution, or is it time to focus on avoiding an indictment or preparing for trial? Here too, there are a lot of questions that require strategic consideration, and decisions need to be made based on the specific legal and factual issues at hand.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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