What Causes An SEC Investigation? Securities Lawyer 101

SEC Enforcement AttorneySecurities and Exchange Commission (the “SEC”) investigations can result from a variety of factors.  SEC investigations can be triggered in ways, including during the SEC’s routine review of SEC reports and schedules, routine inspections by FINRA of clearing houses and/or brokerage firms, reports and tips from investors or whistleblowers, referrals from other government agencies, news reports and the media, and information received in the course of other SEC investigations.

Recent changes to SEC rules and regulations, or new laws such as the enactment of the Dodd-Frank Act, coupled with a down economy increase the risk of SEC investigations because investors are more likely to submit tips and/or complaints about their investments.

The SEC’s Division of Enforcement conducts investigations pursuant to formal Orders of Investigation that authorize the Enforcement Division staff to demand the production of relevant information, either in the form of documents or witness testimony.  The SEC does not have prosecutorial powers, but it may refer cases to the U.S. Attorney’s Office for criminal investigation or coordinate an investigation with the U.S.  Anyone receiving an SEC subpoena should not assume the matter is limited to a civil investigation.

SEC Investigation Triggers

Most SEC investigations are prompted by one or more of the following:

♦ unregistered securities offerings;

♦ accounting deficiencies;

♦ insider trading;

♦ broker-dealer sales practices;

♦ failure to supervise; and

♦ misleading or fraudulent disclosures.

Types of SEC Investigations

There are two types of SEC investigations. The first is the informal investigation, also called a Matter Under Inquiry (“MUI”).  The second is the formal investigation.  Sometimes “informal” is a first stage on the way to a “formal” inquiry.  In both cases, information exchanged between the SEC and the company is confidential, and the investigation itself is not made public.

SEC Informal Investigations

Typically, the first stage of an SEC investigation is the informal investigation.  During this stage, the SEC staff has no formal subpoena power and relies on the cooperation of the relevant individuals and entities to gather information.  Upon conclusion of an informal investigation, the SEC staff may simply close the matter, recommend that the SEC bring an enforcement action or seek a formal order of investigation from the SEC.  In most cases, the informal investigation, if not dropped, becomes officially “formal”, but in some circumstances the agency may proceed directly to enforcement.

SEC Formal Investigations

The SEC approves requests for formal orders when it finds that it is likely that a securities law violation has been committed.  The formal order grants SEC staff the ability to issue subpoenas and to administer oaths.  The SEC’s subpoena powers are surprisingly broad.  When the SEC staff receives a formal order; it commences a formal investigation.  These formal orders may be issued only by senior members of the Enforcement Division.  The orders themselves generally describe the nature of the investigation, and explain what securities laws may have been violated.

The company or individual has the right to see the formal order, though access to staff comments and recommendations will not be granted.

Like informal investigations, formal investigations may be terminated without further action, but staff is usually less willing to do so, as more time and effort has been invested in the case at hand.

The Wells Notice

When the SEC staff concludes its investigation, it may recommend to the SEC that enforcement proceedings be commenced, or it may determine to take no further action.  If the staff has recommended that the Commission commence an enforcement proceeding, it typically provides prospective defendants with a Wells Notice – named after John A. Wells, chairman of the committee that originally implemented the process – informing them of its intention to bring an enforcement action.

The SEC targets will first be notified by telephone, and then by letter.

The recipient of a Wells Notice has generally one month to provide the staff with its response to the Wells Notice, known as a Wells Submission.  The Wells Submission is essentially a brief arguing why an enforcement proceeding is not warranted.  Upon reviewing the Wells Submission the SEC staff may elect to modify or reverse its recommendation to the SEC.

A wells submission is not mandatory.  Some attorneys recommend that their clients make no response, as statements made in a submission may be seen by the SEC as admissions.

SEC Subpoenas

The SEC often issues document subpoenas before seeking to interview or subpoena witnesses.  SEC document subpoenas can be directed at entities or individuals that the SEC believes may have information that is relevant to the investigation.  After reviewing the documents the SEC may subpoena additional materials or witnesses for testimony.

Confidentiality of SEC Investigations

It is important to remember that the SEC is not required to, and typically does not, disclose the investigative status of the subpoena recipient.  There is also no obligation for the subpoena to describe the nature of the investigation.  Absent of an agreement with the government or a court order to the contrary, compliance with the SEC subpoena is mandatory and cannot be ignored.  The recipient of an SEC subpoena must take reasonable steps to preserve potentially relevant hard copy documents, as well as emails and other electronically stored information which may include modifying or suspending document retention policies and the automated deletion of emails.  Not to do so could, in the worst case, result in obstruction of justice charges.

Interestingly, SEC investigations are not subject to the Federal Rules of Civil Procedure, and so recipients of subpoenas have no conventional means of objecting to the scope of the agency’s demands.  The only way to challenge an investigative subpoena is to refuse to comply with it.  In that case, the SEC may, and probably will, apply in Federal court to compel compliance.  That happened two years ago, when San Diego law firm Carrillo Huettel and its founders objected to a subpoena demanding they turn over their attorney-client trust accounts.  The judge ruled against Carrillo Huettel, and the firm is now the subject of an SEC enforcement action.

Witnesses who attempt to quash SEC subpoenas in Federal court file documents in the public domain; the formerly non-public investigation will no longer be confidential.

Response to SEC Subpoenas

Generally, communications with the SEC should be handled by a securities attorney.  Once the SEC becomes aware that a party is represented by counsel it cannot contact that party directly, but must go through counsel.  Apart from cooperating with a securities attorney, an issuer’s employees should be discouraged from engaging in informal or unnecessary discussion of the SEC subpoena or investigation among themselves.  Water cooler chatter about the subpoena may be subject to scrutiny during the investigative process.  If employees later testify, they could be required to disclose with whom they spoke and what was said concerning the SEC investigations.

SEC Enforcement Actions

Upon the SEC staff’s recommendation to bring an enforcement action, it may pursue a civil action in federal court, an administrative proceeding before an administrative law judge, or decide not to bring an enforcement proceeding at all.  Whether the SEC authorizes a civil action in federal court or an administrative proceeding depends on several factors, including the severity of the allegations, the nature of the conduct alleged, tactical considerations, and the type of sanctions sought.

If the Commission decides on an enforcement action, the matter will no longer be non-public.  An announcement of the action will be posted on the Litigation or Administrative Proceedings pages of the SEC website; if it’s a particularly important one, these routine announcements may be accompanied by a press release.  For Federal lawsuits, a link to the complaint will be provided; thereafter, interested observers can follow the court action on PACER.

Should the SEC decide against an enforcement action, it is agency policy- though not an absolute requirement- for staff to send a “termination letter” to anyone who might reasonably believe he was a target of the investigation.  The letter specifies that the investigation has been completed and that staff does not intend to recommend action to the Commission at that time.

Consequences of SEC Enforcement Actions

The consequences of SEC investigations, among other things, can range from a slap on the wrist to asset freezes, large fines and criminal referrals of matters to the United States Attorney’s Office.

Generally, civil suits brought by the SEC seek injunctive relief from further violations of the federal securities laws, an asset freeze, an order for disgorgement of ill-gotten gains, and large civil fines and penalties.  The SEC can also seek to bar a person permanently from acting as an officer or director of a public company or registered entity, such as a broker-dealer, investment company and investment adviser.

Needless to say, any microcap issuer or other person who receives a surprise phone call from the SEC enforcement attorney would be wise to plead an urgent business meeting and get on the phone to a qualified securities lawyer.  Do not try to make friends.  Do not babble everything you think the SEC guy might want to know.  Above all, do not lie.  Let your lawyer handle decisions, give advice, and deal with the SEC.  Failure to do so can be disastrous for companies and individuals alike.

For more information about the SEC investigations, see:


Securities lawyer, Brenda Hamilton provides legal advice to market participants about  securities matters including SEC investigations and testimony.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com.  This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. For more information about going public and the rules and regulations affecting the use of Rule 144, Form 8K, crowdfunding, FINRA Rule 6490, Rule 506 private placement offerings and memorandums, Regulation A, Rule 504 offerings, SEC reporting requirements, SEC registration statements on Form S-1 , IPO’s, OTC Pink Sheet listings, Form 10 OTCBB and OTC Markets disclosure requirements, DTC Chills, Global Locks, reverse mergers, public shells, direct public offerings and direct public offerings please contact Hamilton and Associates at (561) 416-8956 or [email protected].  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
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Boca Raton, Florida 33432
Telephone: (561) 416-8956
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