12 Keys to SEC Defense with Securities Litigation Attorney Nick Oberheiden

April 13
4:45 PM 2020

Publicly-traded companies, brokerage firms, individual brokers, and various other entities and individuals are all subject to the oversight of the U.S. Securities and Exchange Commission (SEC). Through its Enforcement Division, the SEC aggressively targets companies and individuals suspected of statutory and regulatory violations, and it has the authority to impose substantial penalties for many different types of illegal conduct. Working with the U.S. Department of Justice (DOJ), the SEC can pursue criminal charges for certain offenses as well; and, as a result, when facing an SEC investigation, it is essential to determine both why and how the agency is seeking to move forward. 

Due to the risks involved with facing an SEC investigation, companies and individuals that are being targeted need to make informed decisions about defending themselves effectively. Here, securities litigation attorney Nick Oberheiden, PhD discusses 12 keys to executing an effective SEC defense strategy:

1. Understanding the Scope of the SEC's Enforcement Authority

First, it is necessary to understand the scope of the SEC's enforcement authority. While most people know that the SEC is responsible for overseeing the U.S. securities markets, most people do not know that its enforcement authority extends to various other areas of the law as well. 

For example, in addition to overseeing the U.S. securities markets, the SEC also has oversight of cybercurrency transactions and trading in the United States. This covers everything from initial coin offerings (ICOs) (which the SEC classifies as securities) to transactions conducted with Bitcoin and other cryptocurrencies. 

As another example, the SEC jointly enforces the Foreign Corrupt Practices Act (FCPA) with the DOJ. This includes enforcement of the FCPA's anti-bribery provisions as well as its accounting requirements for public companies whose stock trades on the U.S. exchanges or in the over-the-counter market. When facing an SEC investigation, there are a number of risks that need to be considered, and defense efforts must be tailored to the specific risk(s) at hand. 

2. Determining Whether the SEC's Inquiry is Administrative, Civil, or Criminal in Nature

The SEC has the authority to enforce companies' and individuals' compliance obligations through administrative proceedings, in federal civil litigation, or both. Additionally, as noted above, the SEC can (and often does) work with the DOJ to pursue criminal charges for serious statutory violations. Defending against administrative, civil, and criminal allegations are all very different matters; so, in order to execute an effective defense strategy, it is first necessary to determine whether the SEC's inquiry is administrative, civil, or criminal in nature. 

In some cases, this will be far easier than others. For example, if you learn of the SEC's investigation when you are served with a federal grand jury subpoena, you will know right away that you are facing criminal prosecution. However, in the majority of cases, targeted companies and individuals learn of the SEC's investigation informally, and in this scenario it becomes necessary to assess the circumstances of the investigation to determine its nature. In this vein, it is also important to know that investigations can become civil or criminal in nature after beginning as administrative or civil inquiries, and targeted entities must be careful to avoid miscues that could enhance their potential exposure.

3. Determining the Specific Issues that Are Being Targeted 

With a clear understanding of the scope of the SEC's enforcement authority and whether the SEC's investigation is administrative, civil, or criminal in nature, you can then begin to narrow down the scope of the investigation itself. What issues are being targeted; and, just as important, why are they being targeted? Unless and until you can answer these questions with precision, you cannot execute a defense strategy that is sufficiently tailored to the SEC's inquiry. 

As indicated earlier, the SEC's enforcement authority is broad, and this means that there is a laundry list of potential issues to consider when facing an SEC investigation. Potential issues include, but are by no means limited to:

  • Accounting violations or financial fraud

  • Advertising and solicitation violations 

  • Broker-dealer fraud

  • Cryptocurrency fraud

  • FCPA violations

  • Fraudulent investments or investment recommendations 

  • Insider trading 

  • Market manipulation 

  • Misrepresentation or omission of material information 

  • Securities registration violations

  • Theft of customer funds or securities

  • Unlawful sale of unregistered securities

4. Assembling Your Company's Compliance Documentation

While there are many potential defenses to alleged statutory and regulatory violations in SEC investigations (more on this below), in many cases one of the most-effective defense strategies will be to present the SEC with evidence of your company's or brokerage firm's compliance. Oftentimes, the SEC will pinpoint specific issues which may appear to be representative of violations out of context, but which may ultimately prove to be fully compliant (or, minimally, not worthy of prosecution) when viewed through the lends of the company's or firm's compliance program. 

Of course, this assumes that your company or brokerage firm has an effective SEC compliance program. It also assumes that the program is fully documented, as are the company's or firm's ongoing efforts to maintain compliance. But, if the documentation exists, then presenting it to the SEC at the right time and in the right manner will often serve to avoid further inquiry. 

5. Conducting an Attorney-Client Privileged Internal Assessment

In order to determine whether your company's or firm's compliance program is an asset and not a liability, it will be necessary to promptly conduct an internal assessment focused on uncovering any potential issues before the SEC brings them to light. This internal assessment should be conducted in close coordination with the company's or firm's SEC compliance counsel, as this will ensure that any information uncovered during the assessment is protected by the attorney-client privilege. 

When conducting an internal assessment, the goal is simple: to find the truth. As much as you may want to confirm compliance, and as tempting as it may be to try to interpret the results of the assessment in your company's or firm's favor, this is not the point. Rather, the point is to gain unbiased insight into your company's or firm's current level of risk so that you can tailor your defense strategy accordingly.

6. Assessing All Potential Defenses

Once you know what the SEC is looking for and what it is going to find, then you can begin building your company's or firm's defense strategy in earnest. In virtually all cases, there will be multiple defense opportunities available, although identifying the available defenses is a task that requires a thorough understanding of the relevant facts and the relevant law. 

As most pertinent defenses are either highly fact-specific or unique to the specific statute(s) at issue, identifying viable defenses requires a clear understanding of the allegations being targeted. This is why it is essential to undertake the steps listed above prior to attempting to build an SEC defense. 

For example, let's assume that the SEC is investigating allegations of insider trading. Some of the defenses that may be available (and that would not be relevant to other types of SEC investigations) include:

  • The "insider" information was disclosed prior to the trades being executed

  • The insider was unaware that the information was non-public at the time of its use

  • The insider did not actually have access to the non-public information

  • The insider relied on multiple pieces of public or non-material information rater than a single piece of material non-public information (known as the "mosaic defense")

  • The allegedly unlawful trades were made pursuant to a Rule 10b5-1 scheduled trading plan

7. Building a Sound and Cohesive Defense Strategy

As mentioned above, oftentimes, companies, firms, and individuals will have multiple potential defenses to allegations raised during an SEC investigation. When this is the case, it is generally best not to assert all of these defenses at once-throwing everything at the wall and seeing what sticks. Instead, the better option is usually to build a cohesive defense strategy centered around a few key themes that can really be driven home when interfacing with the SEC. 

There is another consideration here as well: In some cases, defenses can be inconsistent, if not mutually-exclusive. For example, attempting to assert a mosaic defense in an insider trading case while also arguing for the applicability of Rule 10b5-1 could potentially create confusion and raise questions about the veracity of both defenses. Asserting certain defenses may mean disclosing certain information to the SEC as well, and this may or may not be advisable-particularly if other options are available.

8. Focusing On a Pre-Charge Resolution

When facing an SEC investigation, there will be opportunities to resolve the investigation short of administrative or civil charges being filed (or the SEC referring the case to the DOJ for criminal prosecution). In order to take advantage of these opportunities, targeted entities and individuals must know how and when to do so, and they must be prepared to take a proactive stance in the SEC's investigation. Left unchecked, there is a high probability that an SEC investigation will lead to some form of enforcement action. However, with the right approach, companies, firms, and individuals can often achieve favorable results without taking their defense strategies to formal administrative, civil, or criminal proceedings. 

9. Responding to the Wells Notice

If the SEC completes its investigation prior to a resolution being achieved, it may issue a Wells notice. A Wells notice is a letter that states the SEC investigators' intention to move forward with enforcement efforts, either in an administrative proceeding before one of the SEC's administrative law judges (ALJs) or in federal district court. 

While the delivery of a Wells notice is not required, it is fairly common practice today. Critically, the Wells notice is not a charging document-it is a statement of the SEC investigators' intent to move forward with seeking approval to commence proceedings. Upon receiving a Wells notice, the recipient has the opportunity to respond, and the SEC will consider the response in tandem with the Wells notice itself in order to decide whether enforcement action is warranted. 

10. Proactively Addressing Any Identified Compliance Deficiencies or Violations 

In any event, whether the investigation is resolved without further action or it leads to a Wells notice (or a referral to the DOJ), any compliance deficiencies or violations identified during the inquiry will need to be remedied. This is true for both issues identified during the internal assessment and issues identified by the SEC. 

Ideally, necessary remedial action can be taken before the SEC initiates enforcement proceedings, and this can in turn mitigate or eliminate any potential consequences. At the same time, however, when correcting compliance issues or addressing past violations, it is imperative that companies and firms are careful to avoid raising red flags that could have the opposite consequence of tipping off the SEC. 

11. Handling Pre-Litigation Matters and Preparing for Your Company's Hearing or Trial

If the SEC decides to more forward with administrative or civil enforcement action, or if the DOJ decides to seek an indictment, then the process of defending your company, your firm, or yourself transitions to an entirely different stage. However, there are still opportunities to achieve a favorable pretrial result. Here, too, a proactive and strategic approach is key, and defense efforts need to remain laser-focused on addressing the particular factual and legal circumstances at hand. 

Eventually, there may come a point at which you determine that the best option is to present your case to an ALJ or a federal district court judge. If and when this point comes, you will need to rely on highly-experienced SEC defense counsel to argue for a favorable result at the administrative hearing or at trial. 

12. Determining Whether the SEC's Investigation Presents Other Law Enforcement Risks

Finally, when responding to an SEC investigation, it is important not to focus on the investigation in isolation. Depending on the circumstances involved, it is possible that other federal agencies could be considering enforcement action as well. From the Internal Revenue Service (IRS) to the U.S. Department of Homeland Security (DHS), various other agencies target public and private entities for offenses related to those investigated by the SEC, and targets of SEC investigations must keep this in mind when choosing what defenses to assert and what information to disclose. 

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