Understanding SEC Investigations: Process, Defense, and Legal Tips

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Mark J. Astarita, Esq., a nationally recognized and Martindale AV-rated securities attorney, explains the SEC investigation process and provides insight into successful defenses.

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Introduction

SEC Investigations, and ultimately SEC enforcement proceedings, can be disruptive and devastating events for individuals and corporations. Hiring an experienced securities defense attorney is crucial. Understanding what to expect during the SEC investigation will also help you achieve your desired result.

We are former SEC Staff Attorneys, and Broker-Dealer Attorneys. My partners and I can represent you in connection with an SEC investigation. Two of my partners, James Sallah and Jeffrey Cox, are former SEC prosecutors. I have defended brokerage firms and financial professionals in SEC proceedings for decades. We are all AV-rated at Martindale-Hubbell. Our goal during an investigation is to demonstrate that an enforcement proceeding is unnecessary, to determine exactly what the SEC thinks has happened and to correct that theory and/or to convince the SEC to agree to a resolution before an enforcement case is filed.

It is important to note that an SEC investigation does not necessarily imply wrongdoing on the part of the individuals or entities being investigated. The SEC conducts investigations to gather information and evidence. For example, after unusual price movement in a security, the SEC will send out information requests to every brokerage firm whose customers bought or sold the security. They are looking to identify the purchasers and sellers, not examing the brokerage firm.

Its findings may result in enforcement actions, litigation, or settlements if violations are discovered. However, that is not always the case.

Understanding the Role of the SEC

The United States Securities and Exchange Commission (“SEC”) is a federal agency established to enact securities laws and regulate the securities industry in the United States. The SEC has the authority to bring administrative proceedings and civil litigation anywhere in the US and refers cases for criminal charges to federal prosecutors.

We have covered the role of the SEC Staff in SEC Investigations in other articles at SECLaw.com, including Introductions to the SEC, SEC Investigations, Responding to a Wells Notice, and Can the SEC Bring Criminal Charges? A complete list of posts and articles is available by searching “investigations.”

Our goal in most investigations is to avoid an enforcement proceeding, which we have accomplished in many cases. If there is an enforcement proceeding, we will use our decades of experience to assist you. We aim to defend against the SEC’s allegations. Our goal is to reach an acceptable resolution or to successfully defend you at trial.

Initiating the Investigation

The SEC’s enforcement division investigates potential violations of securities laws and regulations. Several triggers can lead to an SEC investigation:

Tips and Complaints: The SEC often receives tips and complaints from whistleblowers, investors, industry insiders, or the public. If these tips suggest potential securities law violations, the SEC may investigate.

Market Surveillance: The SEC monitors the financial markets for unusual trading activity or patterns that could indicate market manipulation or insider trading. Unusual trading volume, rapid price fluctuations, or other anomalies may trigger an investigation.

Corporate Disclosures: Inaccurate or misleading information in a company’s financial statements, annual reports, or other filings with the SEC can prompt an investigation. This can include fraudulent accounting practices, revenue recognition issues, or other forms of financial fraud.

Insider Trading: Suspicious trading by corporate insiders, such as officers, directors, or employees, ahead of significant company news or events can lead to an SEC investigation. If it is based on non-public information, trading is illegal.

Market Manipulation: Activities designed to manipulate the price of securities or create artificial trading activity, such as “pump and dump” schemes, can trigger SEC investigations.

Regulatory Violations: Violations of securities regulations or failure to comply with SEC rules can result in investigations. These can include violations related to registration requirements, disclosure obligations, or brokerage firms’ handling of customer funds.

Initial Public Offerings (IPOs): The SEC reviews the registration statements and offering documents for companies proposing, or conducting an IPO to ensure compliance with securities laws. If there are concerns about the accuracy or completeness of these documents, an SEC investigation may be initiated.

Whistleblower Reports: The SEC has a whistleblower program that encourages individuals knowledgeable about securities violations to come forward. Whistleblower tips often lead to SEC Investigations. Whistleblowers who provide credible information can be eligible for rewards, and their reports can lead to investigations.

Enforcement Priorities: SEC investigations often begin based on its enforcement priorities, which can shift over time based on market conditions, emerging risks, and policy objectives.

Market Events: Major market events, such as financial crises or significant corporate scandals, can lead to broader investigations into systemic issues or specific companies and individuals involved.

Examination and Data Collection

An SEC investigation can take two forms: formal or informal, and an informal investigation can quickly become a formal investigation.

Investigations start with an informal investigation, where the SEC Staff, comprised of attorneys, accountants, and investigators, begin the examination process without the issuance of subpoenas. They examine brokerage records, trading data, and any other documentation they can acquire without issuing an SEC subpoena.

Again, many witnesses will voluntarily comply with the SEC’s requests, and, in many cases, the SEC can obtain much of the information it needs from public sources. EDGAR filings, press releases, and even social media posts can all assist with the SEC’s informal investigative efforts—and in some instances, they will be enough on their own to trigger a formal investigation.

If an informal SEC investigation leads the Staff to believe that violations have occurred, they will seek to obtain a Formal Order of Investigation. That order authorizes specific Staff members to issue subpoenas to take testimony from potential defendants and witnesses and start a formal investigation.

Once an investigation is authorized, the SEC’s staff, comprised of attorneys, accountants, and investigators, begin the examination process. They collect data, financial records, emails, and other relevant evidence to build a solid case against the alleged wrongdoers. This stage is critical, as the strength of the evidence can significantly impact the outcome of the investigation.

Formal Order of Investigation

The formal order of investigation is important and a copy should be immediately requested once an SEC subpoena is received. The formal order generally describes the nature of the investigation. It designates specific staff members to act as officers for the investigation. It empowers them to administer oaths and affirmations. They can subpoena witnesses and compel their attendance. They can take evidence and require the production of documents and other materials. Formal investigative proceedings are nonpublic unless otherwise ordered by the Commission.

Subpoena Power

The SEC subpoena power is granted under Section 19(c) of the Securities Act, Section 21(b) of the Securities Exchange Act, Section 209(b) of the Advisers Act, and Section 42(b) of the Investment Company Act. The SEC has nationwide subpoena power and can obtain testimony and documents from almost anyone.

I have an extensive article detailing the procedure and rationale for dealing with an SEC Subpoena at https://seclaw.com/sec-subpoena-finra-otr/

Confidentiality and Non-Publicity

SEC investigations are inherently sensitive, and maintaining confidentiality is important. The agency attempts to ensure that information related to ongoing investigations remains non-public, safeguarding the reputations of the investigation subject and the involved companies. However, upon concluding the investigation and filing an enforcement proceeding, the SEC will issue press releases announcing the filing, naming the respondents, and detailing the allegations.

Cooperation and Settlements

Throughout the investigation process, the SEC encourages cooperation from all parties involved. Individuals or entities under investigation can cooperate fully and provide valuable information that aids in resolving the case efficiently. Sometimes, cooperation may lead to settlements, where the accused party agrees to certain sanctions or penalties without admitting guilt. Typically, at this stage, the proposed respondent rejects the SEC’s settlement offer, as they are typically outrageous. In one recent case where I represented the respondents, the SEC’s settlement demand was millions of dollars. After years of investigations, depositions, and a federal court complaint, we settled for less than $400,000. https://www.sallahlaw.com/mark-j-astarita-esq.html

Representing Advisors and Investors, Nationwide.

Enforcement Actions and Litigation

In cases where settlements are not feasible or appropriate, the SEC may opt for enforcement actions and litigation. Enforcement actions can take various forms, including civil suits, administrative proceedings, or cease-and-desist orders. The SEC can seek injunctions, monetary penalties, disgorgement of ill-gotten gains, and even bans from engaging in the securities industry.

Before starting an enforcement proceeding, the SEC typically issues a Wells Notice. This notice informs the potential defendant that charges are going to be recommended. It also allows him to respond.

Possible enforcement proceedings:

• Civil action: The Commission initiates legal action by filing a complaint with a U.S. District Court, seeking a sanction or remedy. This often involves requesting a court order, known as an injunction, which prohibits any further acts or practices that violate the law or Commission rules. Injunctions can also entail the need for audits, accounting for fraud, or special supervisory arrangements. Additionally, the SEC has the authority to pursue civil monetary penalties or the return of illegal profits, referred to as disgorgement. Furthermore, the court may bar or suspend an individual from serving as a corporate officer or director. It is crucial to note that violating the court’s order can result in being found in contempt, potentially leading to additional fines or imprisonment.

• Administrative action: The Commission can seek various sanctions during administrative proceedings. Unlike civil court actions, administrative proceedings are overseen by an independent administrative law judge (ALJ). The ALJ presides over a hearing and evaluates the evidence presented by the Division staff and any evidence provided by the subject of the proceeding. After the hearing, the ALJ issues an initial decision that includes factual findings and legal conclusions. This initial decision also includes a recommended sanction. Both the Division staff and the defendant have the option to appeal all or part of the initial decision to the Commission. The Commission can either uphold, reverse, or send the decision back for further hearings. Administrative sanctions may include cease and desist orders, suspensions or revocations of broker-dealer and investment advisor registrations, censures, bars from the securities industry, civil monetary penalties, and disgorgement.
  • Administrative proceedings at the SEC have decreased significantly over the last decade as the fairness of the procedure has been widely questioned.

• Numerous objections have been raised to administrative proceedings, given the inherent unfairness of the ALJ, who is paid by the SEC, applying rules written by the SEC to a complaint written by the SEC and prosecuted by the SEC. Making matters worse, those rules favor the SEC, and the first appeal is to the SEC itself.

Resolution of Enforcement Proceedings

My partners and I have been defending SEC Investigations and Enforcement Proceedings for decades. While it is difficult to convince the SEC not to file charges, we have been able to do in a number of cases, including 1) cases an insider trading investigation, we were able to convince the SEC that our client had a legitimate reason to purchase the security, and had been doing so for years; 2) in an insider trading investigation where the client purchased the security the day before a favorable earnings announcement, because the issuer posted the results on its website the day before they were announced (the “URL Guessing Case”) and hundreds of investigations which resulted in favorable settlements for their clients.

Mark was part of the defense team in the landmark case of SEC vs. Materia, which was the first civil use of the misappropriation theory for an insider trading case. Our partners have also:

• successfully negotiated the dismissal of an SEC complaint on behalf of a relief defendant following the filing of enforcement action – SEC v. ECareer Holdings, Inc., et al., Case No. 15-80446-Civ-Cohn/Seltzer (S.D. Fla.)
• obtained dismissal, with prejudice, of Section 17(b) claim on behalf of defendant in SEC enforcement case – SEC v. Recycle Tech, Inc., et al., Case No. 12-21656-Civ-Lenard/O’Sullivan (S.D. Fla.);
• represented Miami doctor in an insider trading case brought by the SEC in federal court. After a two-week jury trial, the doctor was found not liable – SEC v. De La Maza, et al., Case No. 09-21977 (S.D. Fla.);
• Successfully argued dismissal of shareholder suit in federal court alleging insider trading Kamin, et al. v. Acord, et al., Case No. 09-22829-Civ-Jordan (S.D. Fla.) and SEC loses Insider Trading Case
• Defended firm supervisor in an SEC Administrative Proceeding involving allegations of failure to supervise a group of brokers.
• Prosecuted an appeal of the adverse decision to the SEC, including oral argument before the Commission and after remand to the Office of Administrative Law Judges, negotiated a favorable settlement for the client.
• Defense of a large regional brokerage firm in SEC investigation of firm’s institutional trading desk, market-making activities, and syndicate department (declination letter by SEC)
• Defense of CFO of publicly-traded company in SEC investigation of his conduct following company’s restatement of earnings (declination letter by SEC)

Strategies for Navigating an SEC Investigation

Proactive Compliance

Maintaining a robust compliance program is essential in preventing and mitigating the impact of SEC investigations. Companies should regularly review and update their policies to ensure adherence to regulatory requirements.

Prompt and Transparent Communication

Cooperating with the SEC and providing prompt, transparent communication can significantly influence the outcome of an investigation. Demonstrating a commitment to resolving issues and maintaining compliance can be beneficial.

Engaging Experienced Legal Counsel

Engaging experienced legal counsel with expertise in SEC investigations is critical. Skilled attorneys can provide valuable guidance, negotiate with the SEC, and help protect the rights and interests of the respondents.

Conclusion

Understanding how investigations work in SEC enforcement is crucial for anyone navigating the financial markets. One additional and crucial point. Responding to an SEC subpoena, appearing for an investigative deposition, and defending an enforcement proceeding is not for the inexperienced. The guidance of an experienced securities attorney provides the best chance for an acceptable outcome. The attorneys at Sallah Astarita & Cox, LLC represent defendants and witnesses in SEC investigations on a regular basis and have done so for decades. To discuss possible representation call the firm at 212-509-6544.

The attorneys at Sallah Astarita & Cox, LLC are former SEC Staff Attorneys and brokerage firm counsel, with over 100 years of collective experience. If you have received a subpoena from the SEC, a document request from FINRA, or have a dispute with a brokerage firm, call 212-509-6544 for a free consultation. The firm represents investors and financial professionals nationwide.

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