Legal Developments in Securities Law

SEC Investigations: What Happens at each Step of an Investigation?

In the news recently, many different stages of an SEC investigation have been reported on – the city of Miami and Miami-Dade county received subpoenas which asked for communications with executives and representatives of the Marlins, a Major League Baseball team, and Harbinger Capital and Phillip Falcone received Wells Notices from the SEC. Individuals have asked if the subpoena means that the Marlins were involved in some sort of securities fraud or if a Wells Notice means the SEC believes you committed securities fraud.  To clarify any misunderstandings, here is an overview of the SEC’s investigatory process.

Step One:  The Tip

The SEC first has to have a reason to suspect that violations of the securities laws have taken place.  The SEC states that, “The Division obtains evidence of possible violations of the securities laws from many sources, including market surveillance activities, investor tips and complaints, other Divisions and Offices of the SEC, the self-regulatory organizations and other securities industry sources, and media reports.” See here.  For example, the SEC staff regularly reviews disclosure documents filed by companies.  As we’ve previously blogged, the SEC also encourages whistleblowers to come forward with information concerning potential violations by offering the chance for a large bounty.  Whistleblowers can include employees of companies or even investors in certain securities who have a sense that securities law violations may have taken place.  This preliminary “tip” will cause the SEC to try to determine the potential violations that took place and to decide whether or not to open up an investigation into the matter – this is a question that is decided privately within the SEC.  Not all “tips” result in an investigation.

Step Two: The Investigation

When the SEC decides to conduct an investigation, the SEC uses many means to determine whether the investigation should result in a case in federal court or an administrative action.  The SEC uses informal inquiries, interviews with witnesses, examinations of brokerage records and trading data, and other methods to develop the facts during an investigation.  SEC investigations are private, and may be formal or informal.  During the informal stage, SEC staff may ask individuals to voluntarily provide the SEC with information.  To obtain a Formal Order of Investigation, the staff requests authorization from the commissioners in order to conduct a formal investigation.  At this stage, individuals and entities may receive subpoenas for documents and testimony, as permitted by the Formal Order of Investigation, which is not a matter of public record.  Subpoenas for documents are often very broad and may require the production of a large number of documents.  This is merely an investigatory stage in the process – the receipt of an SEC subpoena does not necessarily indicate that the SEC suspects that the individual or entity was involved in securities fraud.  The SEC is merely gathering information to analyze in making a determination as to whether to pursue further action.

Step Three: Wells Notice

At the conclusion of the investigation, the SEC staff will decide whether or not to recommend to the commissioners that the SEC institute an enforcement action or federal case. If the staff decides to recommend enforcement, the potential respondent/defendant receives a “Wells Notice,” which apprises the individual or entity of the alleged violations of securities laws it intends to pursue.  The potential respondent/defendant then has the opportunity to submit a “Wells Submission” – which serves to try to persuade the staff that an enforcement action is not warranted.  After considering the Wells Submission, the staff can choose to conclude the investigation or to submit its recommendation for an enforcement action, along with the Wells Submission, to the commissioners. The Commission can authorize the staff to file a case in federal court or bring an administrative action.  Often, cases will settle outside of such proceedings, but in some cases, the SEC proceeds with an enforcement action.

Step Four: Enforcement Action

The SEC may proceed in federal court or with an administrative action.  The Federal Rules of Civil Procedure do not apply in administrative actions and appeals go to the commissioners, but the SEC can seek a civil penalty based on a defendant’s pecuniary gain by filing a civil action only in federal court. At this stage, the SEC will pursue sanctions in the form of monetary penalties, disgorgement of ill-begotten gains, cease-and-desist orders or injunctions, officer-director bars or penny stock bars, among others.

If you’re unsure of where you might fit within the SEC’s process, be sure to contact an experienced attorney. Proper representation and cooperation with the SEC could help you avoid unnecessarily proceeding through an administrative proceeding or civil case in federal court.



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