Introduction: The Role of the SEC

The U.S. Securities and Exchange Commission (SEC) is a federal agency whose mission is to “protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.”  Its daily functions include facilitating market transactions in a way that enhances public confidence, protecting investors from unscrupulous conduct that could cause them financial injury, and protecting capital markets. 

The SEC takes violations of the federal securities laws very seriously. Most violations come to the attention of the SEC via tips, whistleblower complaints, or irregularities in public filings. SEC investigations and litigations can lead to a variety of sanctions including disgorgement of illegally-obtained profits, pre-judgment interest, permanent injunctions, civil penalties, loss of license, reputational harm, and —if the Department of Justice is also involved— criminal penalties and jail time. 

The severity of the possible penalties underscores the imperative of not only securing an SEC defense attorney experienced in the federal securities laws, but also the importance of understanding what to do when the SEC is investigating you.

What Does the SEC Investigate?

The SEC has broad power to investigate behavior indicative of potential violations under the federal securities laws— namely, conduct that has the ability to harm U.S. investors or U.S. capital markets or undermine the integrity of the free market system.  

SEC investigations are initially private and consist of informal questioning, reviewing data, and interviewing witnesses.  The investigation is conducted by its Enforcement Division who recommends to the Commission when to bring civil or administrative actions and when criminal proceedings should be initiated. Most cases are settled without trial.

The SEC investigates the following, as notable examples:

• Falsified financial statements (inflated earnings or decreased expenses);

• Embezzlement;

• Insider trading;

• Check kiting;

• Whistleblower protection issues;

• Kickbacks and payoffs;

• Misappropriation;

• Microcap fraud;

• Problems with digital assets, cryptocurrencies, and initial coin offerings (“ICOs”);

• Hedge fund abuses;

• Broker or investment adviser misconduct;

• Stock fraud;

• Accounting fraud such as the failure to comply with the Generally Accepted Accounting Principles (GAAP) or the Generally Accepted Auditing Standards (GAAS);

• Bribery and corruption— such as violations under the Foreign Corrupt Practices Act (FCPA);

• Ponzi and pyramid schemes;

• Affinity fraud;

• Internet frauds;

• Pump and dump schemes;

• Short selling abuses;

• Issues implementing Dodd-Frank;

• Stock price manipulation;

• Fraud or misrepresentation in SEC filings;

• Fraud in the prospectus;

• Mutual fund fraud;

• Cybersecurity issues; and

• Omissions and misrepresentations.

The above list is only representative of the conduct for which the SEC is empowered to investigate. If the matter also involves criminal conduct, the SEC often coordinates its investigative efforts with the Department of Justice (DOJ) or the Federal Bureau of Investigation (FBI).

What are the Warning Signs of Possible SEC Violations?

The SEC makes it a high priority to remain vigilant for red flags, or warning signs, of SEC violations. These warning signs include certain behaviors or conduct that suggest that the individual or company is violating the federal securities laws. For instance, the SEC and staff are constantly on the lookout for the following warning signs:

• The company is reporting large assets but small revenues.

• There are odd or inconsistent items in the company’s financial statements or their footnotes.

• Audit reports reveal unusual issues in accounting practices.

• Insiders within microcap companies are owners of large amounts of stock.

• Certain requested documents are missing.

• The company’s cash flows are static while the company’s revenues are increasing.

• There are high investment returns of the company with little to no risk.

• The company is using unlicensed sellers or is involved with unregistered investments or offerings.

• Upper management, executives, or directors of the company have received unexplained bonuses or loans.

• The company has had its trading suspended.

• Comparative financial statements contain discrepancies.

• Receipts or confirmations of transactions do not match what has been agreed upon with the broker or investment adviser.

• After certain transactions are completed and advice is rendered, the broker or investment adviser disappears, can no longer be contacted, or cannot be verified.

What are the Penalties for SEC Violations?

As mentioned, the SEC takes violations of the federal securities laws very seriously. The SEC defense attorneys at Oberheiden, P.C. emphasize that individuals and/or companies charged for injuring U.S. investors or capital markets or harming the integrity of free trading can face violations under the following statutes:

• The Securities Act of 1933;

• The Exchange Act of 1934;

• The Investment Advisers Act of 1940;

• The Investment Company Act of 1940;

• Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act);

• The Racketeered Influenced and Corrupt Organizations Act (RICO); and

• The Foreign Corrupt Practices Act (FCPA).

Violations of the antifraud provisions of the first two statutes are the most common. Broadly, Section 10(b) of the Exchange Act of 1934 and Rule 10b-5 thereunder make it unlawful to employ manipulative and deceptive devices to defraud any person. Additionally, Section 17(a) of the Securities Act of 1933 prohibits fraud and misrepresentations in the offer or sale of securities by defrauding or engaging in deceit upon the purchaser. 

The SEC may also seek liability for: aiding and abetting the fraudulent activity, failure to comply with registration provisions under the Securities Act or the reporting requirements of the Exchange Act, or conspiracy charges.

In addition to the civil enforcement authority of the SEC and criminal enforcement authority of the FBI and DOJ for securities law violations, other regulatory agencies that may be involved in the investigative and enforcement stages include the Financial Industry Regulatory Authority (FINRA), the Commodity Futures Trading Commission (CFTC), and the Internal Revenue Service (IRS). Individuals and companies can also be liable for securities law violations under state law.

“The SEC is a formidable investigative body with the power to impose severe penalties and reputational harm on you and your company— not to mention the significant civil fines, disgorgement orders, and injunctions that are possible. Another reality is the ability of the SEC to coordinate its investigation with other federal agencies such as the FBI or DOJ where criminal activity is present. Securing a federal defense attorney as soon as possible is a critical safeguard, as your attorney can immediately begin negotiating with the SEC on your behalf and preparing your personalized defense strategy.” – Dr. Nick Oberheiden, Founding Attorney of Oberheiden P.C.

How to Respond to an SEC Investigation

If you are under investigation by the SEC or believe an investigation is in the near future, it is important to take immediate action in your SEC defense. The following list provides a critical checklist to utilize when the SEC comes knocking:

• Start researching SEC defense attorneys. Retaining an attorney experienced in SEC investigations and federal SEC defense tactics is a crucial response to an SEC investigation.  Many law firms offer free initial consultations. Use this opportunity to ask questions about SEC investigations, what they will entail, and how the attorney will prepare your SEC defense.

• Heed all demands in the SEC subpoena. The SEC typically begins its investigations by sending subpoenas to recipients who are either under investigation or who may have knowledge of the matter under investigation. In both cases, full compliance with the terms of the subpoena will be critical. The subpoena may demand document production or testimony. Failure to follow the subpoena —including all listed deadlines— could lead to contempt charges.

• Think about what the SEC is asking for and what evidence you need in your SEC defense. It can sometimes be difficult to determine from the contents of the SEC subpoena whether you are the target of the investigation or a mere witness. For this reason, a good proactive step would be to start accumulating the document requests in the subpoena and any other information —including the names of witnesses— that could help in your SEC defense. Your attorney will know how to utilize this information for your SEC defense and can sometimes determine your status in the investigation from the contents of SEC documents and requests.

• Maintain an attitude of cooperation and negotiation. It may be hard to cooperate with the federal agency investigating you and seeking to bring charges against you; however, cooperation is critical. The SEC is known for rewarding cooperation —such as by reducing fines— where individuals and companies assist in their investigation.

• Keep your case confidential. This includes not discussing the progress of your case with friends or posting information about the investigation on social media. Always remember that there is nothing wrong with telling investigative agents —such as SEC staff— that you prefer for your attorney to be present. 

Conclusion

As one of the most important federal agencies in the United States, the SEC’s mission is to protect U.S. investors and capital markets from harm by fostering healthy and secure market transactions. Conduct below this standard could initiate a protracted government investigation.  An investigation by the SEC can wreak havoc on your business and reputation and lead to significant fines, disgorgement orders, injunctions, loss of your license, etc. These penalties could increase substantially if criminal activity is suspected, as other federal agencies will often be involved such as the FBI or DOJ.

Oftentimes, the hardest part is not being able to ascertain your role in the SEC’s investigation— whether it considers you the target of their investigative efforts or simply a witness who may have knowledge of the alleged violation. It is therefore critical for your defense to retain a qualified SEC defense attorney who will immediately begin fighting vigorously to protect you and your company.