SEC Investigations 101: How It All Begins

November 1, 2018

SEC HQ front.jpg

By Daniel Portnov

This post kicks off a series for non-lawyers, or non-securities lawyers, who might suddenly find themselves on the wrong end of an SEC document request, subpoena or call from SEC Enforcement division staff.

Receiving a call from SEC Enforcement Division staff can be a sobering experience, especially if you or your company turn out to be the focus of the SEC’s investigation. You will likely have a million questions. One of the first will probably be: “How did this all start?”

This post will explain generally how SEC Enforcement staff initiate their investigations, or a Matter Under Inquiry (“MUI” – pronounced “MOO-ey”). In many cases, the MUI is a precursor to a formal investigation.

MUIs and Investigations can originate in a variety of ways:

  1. SEC Office of Compliance Inspections and Examinations (OCIE) referral: OCIE staff will visit registered securities market participants periodically for on-site exams. If OCIE staff notice irregularities or potential securities laws violations, they will refer the matter to their colleagues in Enforcement.
  2. Referral from a federal or state regulator: Investigations conducted by other regulators occasionally come with a securities component and necessitate tapping the Enforcement division’s expertise. Examples of these referral sources include the Department of Justice, Public Company Accounting Oversight Board (PCAOB), and state securities regulators. In certain instances, such as where market manipulation or insider trading is suspected, the SEC is better equipped to lead the investigation.
  3. Referral from Self-Regulatory Organizations (SRO): SROs directly involved in securities markets and financial services include The Financial Industry Regulatory Authority (FINRA), stock exchanges (e.g., New York Stock Exchange), and clearing firms such as the Depository Trust Company (DTC). These SROs have jurisdiction over their members and will typically first conduct their own investigation.
  4. Whistleblowers or anonymous tips: The SEC has a robust whistleblower program in which tipsters may receive monetary awards – between 10 and 30 percent of the amount collected – if information provided results in a successful enforcement action or settlement with over $1 million in [ missing a word here, I think]. The identity of whistleblowers is protected and, should they be company insiders, are protected from retaliation by their employers.
  5. Referrals from Congress: Sometimes complaints and tips are routed through a Congress member’s office to the SEC’s Office of Legislative Affairs. In rare(r) cases, a Congressional committee or subcommittee’s investigation may uncover violations of securities laws. And, on occasion, Senator Elizabeth Warren will write enough letters and make enough stump speeches that the Staff will consider opening an investigation.
  6. Offshoots of ongoing investigations: Throughout the course of an ongoing investigation, other related entities, such as “gatekeepers” (accountants, lawyers, etc.), may be suspected of knowing participation, negligence, or failures in compliance and controls. A prime example of this are the various entities who helped further Bernie Madoff’s Ponzi scheme or failed to take simple and reasonable steps to uncover it.
  7. Enforcement staff initiative: Intrepid Enforcement staff have been known to find their own potential MUIs simply by reading newspapers, financial trade publications or legal updates. Something as simple as a lawsuit against a financial advisor or broker for unexplained trading losses filed in state court may signal to Enforcement staff that securities laws violations are in play. Similarly, when public companies make statements that contradict their disclosure documents, suddenly and drastically update their disclosure documents after major news breaks, or take to Twitter to hint at major corporate shakeups, someone in the Enforcement division is always ready to run to their supervisor’s office with MUI proposal. Finally, specialized task forces, such as the recently-formed Retail Strategy Task Force, have created initiatives to proactively root out fraud and other abuses in retail investing.
  8. Market surveillance: The SEC’s Division of Trading and Markets tracks trading data closely and flags abnormal or irregular activity, such as when investors who have never traded in a stock suddenly take large positions prior to an earnings announcement. Another dead giveaway for insider trading is buying deep out-of-the-money options just prior to a tender offer or other significant market event.

No matter how a MUI or investigation commences, finding yourself under scrutiny by Enforcement staff can be disorienting and unnerving. In our next installment, we will cover what to do once the SEC makes contact.

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